3/15/2010 EBAY : eBay, Inc.

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eBay, Inc. EBAY

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EBay's turnaround is in full swing.

by Thesis 03/01/10
Larry Witt,
CFA
EBay has grown from a small U.S. online auction
marketplace into a global e-commerce powerhouse in
the past decade. Although the core auction business is
Authors can be reached at Analyst
being pressured by cyclical and secular head winds,
Feedback
we believe eBay's fixed-price business and PayPal will
Morningstar's Editorial Policies
help maintain the firm's robust cash flow and wide
economic moat.
Analyst Note
First Impression of eBay's 4Q
EBay's auction business (about one fourth of firmwide
Results
by Larry Witt, CFA, 01-20-10 sales) exemplified a classic network effect for many
years. Buyers went to eBay because that is where the Earn 15-25% An

Discuss sellers were, and sellers went to eBay because that is

See what other investors are where the buyers were. Additionally, many consumers
saying about EBAY found the auction format a unique and fun way to shop Morningstar's Take
for bargains. However, its auction business has been
Price 03-01-2010 Fair
hit with a double whammy: a severe cutback in
23.88 USD 28.0
discretionary consumer spending in the economic recession as well as auction
fatigue, as consumers increasingly prefer the convenience of the fixed-price format. Consider Buy Cons
Although we think there will always be demand for online auctions, we now expect 19.60 USD 39.2
auction revenue to decline during the next several years.
Stewardship Grade

Also, technological innovations have eroded eBay's network effect. First, software
applications now allow sellers to seamlessly manage their listings across multiple
platforms. For example, a merchant may cross-list its products on eBay, Amazon, Bulls Say
and its own website. Second, Internet search has supplanted retail sites (including • EBay is a global e-comm
eBay) as the starting point for many online product searches. In addition, paid than 30 countries.
search allows merchants to set up their own online store and "buy" traffic, which • The company is solidly
can eliminate the need for a third-party platform altogether. Competing sites such margin remaining north

as Amazon and hyperlocal free sites like Craigslist have also weakened the appeal • PayPal, which boasts m
almost as many as Ame
of listing on eBay.
several large merchants

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3/15/2010 EBAY : eBay, Inc. Analyst Report | Anal…
gross merchandise volume in the United States and 65% globally. We think PayPal's
Name
opportunity off the eBay platform is even greater. In fact, PayPal's total payment
eBay Inc.
volume off eBay is 30% greater than on it. In addition, PayPal is already accepted
Google Inc.
by about half of the top 100 online retailers in the United States, has more account
Amazon.com Inc.
holders than Discover Card (and almost as many as American Express), and
processes more than 25% of online retail transactions in the U.S. We expect PayPal Yahoo Inc.

to capture more market share of online transactions in the future. Overstock.com Inc.
Compare These Stocks

Valuation
Our fair value estimate is $28 per share, which implies forward fiscal-year Video Reports EBAY
price/earnings of 14 times, an enterprise value/EBITDA of 7.3 times, and a free
cash flow yield of 8.3%. We project overall revenue growth to average 9% during
the next five years. Bolstered by the acquisition of GMarket, fixed-price transaction
volume should increase an average of 11% during the next five years. We project
auction transaction volume to decline an average of 1% during the next five years.
We also expect eBay's take rate (commissions earned on trading volume) to
decrease slightly during our forecast period because of competition. Overall, we
forecast revenue from eBay's core marketplace segment (includes auctions, fixed-
price, advertising, and classified sites) to increase an average of 5% over the next
five years. Although PayPal's growth will be somewhat weighed down by weakness
in eBay's auction business, we still expect healthy growth at PayPal and project
average annual revenue growth of 15% during the next five years. We expect the
overall operating margin to improve slightly from 22% in 2009 to 24% by 2014
driven by our expectations for margin expansion at PayPal, the company's fastest-
growing business unit.

Risk
In an effort to reinvigorate growth in its core e-commerce platform, the company
has introduced several changes, including fee changes, new search functionality,
and a loyalty program. This could backfire, as most of these initiatives are geared
toward fueling growth in fixed-price transactions and could alienate eBay's loyal
auction community. PayPal faces increased competition from Checkout by Amazon.
PayPal could come under regulatory scrutiny from banking authorities as it expands
its service offerings.

Management & Stewardship

After leading the marketplace division for three years, John Donahoe took over as
CEO in 2008. Before joining eBay, Donahoe was CEO of Bain & Company and at
one point had worked for eBay's former CEO Meg Whitman while at Bain. Overall,
we hold eBay's corporate governance in high regard. We like that executive officers
and directors are required to hold a multiple of their annual base salary or retainer
in eBay stock (5 times in the case of the CEO). Management and the board
beneficially own 14% of the stock, including a 13% stake for chairman and founder
Pierre Omidyar and 2% for Whitman. These executives and directors have a decent
record of doing right by shareholders, including providing excellent disclosure. The
company has also adopted majority voting, which gives shareholders greater
control over the composition of the board of directors. We do, however, take a dim
view of the staggered board elections and executives' personal use of the company
aircraft. Additionally, the company's record of capital allocation is mixed, as good
acquisitions like PayPal are offset by poor ones like Skype.

Overview

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3/15/2010 EBAY : eBay, Inc. Analyst Report | Anal…
computers, clothing, and books. EBay has 90 million active users. The company's
online payment service, PayPal, has 80 million active accounts around the world.

Strategy: Management is focused on reigniting growth on the core e-commerce

platform by emphasizing fixed-price listings. PayPal remains a key priority as the
business aims to increase its use on the eBay platform and other e-commerce sites.
The company has also diversified into other online business lines including
classifieds, comparison shopping, and communications.

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