Friday, October 24, 2008

The Skype's the Limit

eBay’s acquisition of Skype in 2005 has been one of the many controversial moves eBay been recently making. The purchase was originally marketed as the missing piece to create the holy trinity in eBay’s hallowed e-commerce halls (along with eBay’s auction sites and PayPal.) The thinking was that Skype would accelerate transactions among strangers as they communicated to each other more efficiently. eBay later found out that people are more interested in buying/selling quickly then chatting it up about those transactions. Consequently, Skype did not live up to all the hype, and eBay has been paying for the acquisition ever since. So the question remains, eBay goofed – but how bad? How bad really is Skype? I think if you look at their performance; you’ll find surprisingly that Skype is not bad at all…

What did eBay pay for Skype?

First things first, how much did eBay exactly pay for Skype? I’ve noticed a lot of numbers floating around the web anywhere between 2.6 to 4.1 Billion. The variance stems from the tiered payment structure that was negotiated to be based on Skype’s future performance. EBay had agreed to initially acquire Skype for $1.3 billion in cash and $1.3 billion in stock and would pay up to $1.5 billion more if Skype met financial targets by 2008 and 2009. eBay ended up paying 530 million out of the 1.5 billion performance portion to settle the transaction. So the grand total paid was 3.13 Billion dollars. If that wasn’t complicated enough, eBay at the same time took a 900 Million dollar charge basically valuing Skype at 2.23 B (out of the 3.13 B they paid)

How is Skype doing anyway?

So investors agree eBay overpaid and eBay agrees with them. So, just how bad is Skype? Well, let me breakdown revenue numbers and current growth rates and you be judge.

Revenue in the past 4 quarters came in at 521 million vs. 332 million for the previous 4 quarters giving us a growth rate of 56.9 % Y/Y, a growth rate that currently eclipses Amazon, Yahoo and yes…even Google.
But what good is growth if that growth is drastically slowing down? - Amazingly, growth is not slowing down – in fact it’s accelerating! Just this week Skype logged its fastest growth rate of user activity in its history – Skype logged an additional one million more concurrent users (a good measure of usage) in just 35 days.

So here we are; we have a company growing 50+ percent year over year, is currently accelerating growth and most importantly profitable. It sounds to me like we got the bases loaded for investors.

What’s Skype worth?

Skype had Q3 2008 revenue of $143 million and is on track to reach 2008 revenue of $570 million. Let’s be conservative and assume the current economic crisis hits revenue growth and causes it decelerate almost half to 30% next year, we can still expect somewhere around $741 million in 2009 revenue.
Skype's operating margin (excluding options) is expected to come closer to 16% in 2009. This would yield 2009 pro-forma operating income of $119 million and tax-adjusted pro-forma earnings of approximately $107 million. Again, just being very conservative and a forward P/E multiple of 30x (again restricting PEG to 1.0x) we get a current valuation of roughly $3.2 billion. 3.2 Billion Is more than the 3.13 Billion dollars that eBay paid and definitely more then what eBay has valued Skype at 2.23 B

Sometimes it’s okay to be a third wheel.

I understand Skype does not have any of the promised synergies with eBay. As a standalone company however – it would definitely be valued much more then the unloved step child it is now. Skype should be a net positive toward eBay, and at worse have a neutral effect on investor sentiment. Being a third wheel can be okay as long as that wheel is carrying its own weight…say like on a tricycle.

Friday, October 17, 2008

Getting something for nothing

In my first post I had made the point that investors have un-fairly punished the whole of eBay for their struggling core site. I pointed out that eBay is now made up of a lot more then just auctions and their healthy high growing properties are now suffering “guilt by association.”

Paypal is Sleeping with the Enemy

I received many challenges on how I breakdown my original revenue lines, and I want to thank those critics. My goal is always first give all the facts, and then give my opinion.

Here are two good points that eBay shorts made.

1) Much of Paypal’s revenue comes from eBay’s auctions sites
2) Much of eBays Marketing services also come from eBay’s auctions sites

I want to tip my hat to people that pointed this out and take these points into account.

Let's take a closer look

So how much of PayPal’s revenue comes from the (now perceived as cancerous) eBay auction sites?

49% and falling – here is the percentage of Paypal’s revenue from eBay auction sites for the last 4 quarters

56% Q4 2007
54% Q1 2008
51% Q2 2008
49% Q3 2008

As you can see the trend is that more and more of Paypal’s revenue is coming not from eBay auctions sites but from Merchant Services, like the non-widely known recent agreement for WalMart.com to accept Paypal.

In an effort to sever revenue associated with eBay; let me be conservative and assume half of the revenue generated from Paypal’s eBay relationship will go away – that still gives us a ttm (trailing twelve month) revenue total of 1.73 Billion (out of 2.34 B) in revenue and growing 27% Y/Y. During a recent investor conference John Danohoe disclosed that PayPal’s operating margins (excluding options) is expected to come around 20% in 2009 – So that gives us a net income of approximately 346 Million for the Paypal unit for the last 12 months.

Following the same exercise for Marketing Services (assuming one half of the advertising on eBay will be toast and a 40% operating margin) we get a (ttm) 263 million in net income and growing at 50+% Y/Y

We call can agree Skype has no synergies with eBay and we can safely claim their full net income does not rely on eBay auctions sites. So Skype’s (ttm) contribution is approximately 89 million in net income growing at 40+% Y/Y (again using John Donohoe’s disclosed operating margin of Skype of approximately 16% & 40% for marketing revenue)

In total we get:

346 million from Paypal (excluding ½ of eBay transactions)
263 million from Marketing Services (taking out ¼ for ‘foreseen’ eBay losses in traffic)
89 million from Skype
----
(ttm) Net Income (excluding taxes) of 698 Million

That gives us an EPS of non-Auction entities of .54 cents a share based on a diluted share count of 1.29 B

.54 cents per share gives us a P/E (based on $15 as of early 10/17/2008) of 27*

Okay, okay so what does this all mean?

How does a P/E of 27* compare to other large Dot Coms?

As of early 10/17/2008

We get

Google@ 282 P/E is 25
Yahoo@13 P/E is 25
Amazon@53 P/E is 38
Bidu@240 is 71

So essentially your getting healthy high growing companies like Paypal, Skype, Kijiji, Shopping.com, 25% of Craigslist, Shopping.com, and Rent.com (among others) for a reasonable P/E of 27*. This is in-line with other dot coms, and more importantly completely taking eBay.com (and all its international counterparts) out of the equation.

Don’t throw the Baby out with the bath water

I hope I’ve proven my point that the market has completely written of eBay auction sites as the next AOL. This may be true, but as I've clearly laid out above - investing in eBay today at $15 has this assumption already priced in; you’re in effect getting eBay.com (and all it's international auction sites) for free. I personally don't think eBay is going away any time soon, and I acknowledge the monumental challenges ahead. The fact remains that there is still no better place to sell or buy your vintage 1977 Led Zeppelin shirt...and as the Oracle says, if you can something for nothing, you’re already ahead.




*Will be higher depending on tax rate

Thursday, October 16, 2008

The 3rd Quarter is here and eBay is in the basement.

Make no mistake about it, the current market sentiment has largely written off eBay as a failing business. Lower GMVs (Gross Market Value), stalled user growth (at 3% Y/Y), economic downtrends, new radical changes to the core site, and extreme competition from other sites like Amazon are all putting unprecedented pressure on eBay.

With so much negative forces, it’s no surprise that eBay is being thrown in the dumpster.

A more holistic view
There are legitimate concerns about deceleration to the eBay.com property (especially in the US market). I believe though that the investment community at large is missing key pieces of the EBay Empire. The only way current valuation makes any rational sense would be to assume that the other eBay properties (including their fast growing Paypal.com/Skype components) will undergo a contraction in revenue; something that even naysayers have trouble foreseeing.

Just a few facts
eBay generated 2.11 billion dollars in revenue in the 3rd Quarter, of this 952 million (or 45%) came from sources outside eBay.com! Let me break it down

597 million from Paypal (27% Y/Y growth)
212 million from Non-eBay sites, Shopping.com, Rent.com, Kijiji (29% Y/Y growth)
143 million from Skype (46% Y/Y growth)
----
952 million

As you can see those are very healthy growth numbers (especially in this economic climate) True these divisions do have lower margins then the traditional eBay sites, but fortunately their high growth rates offset this shortcoming for now. Do people realize that almost half of eBay is not eBay.com (as people know it?)

Getting something for nothing
I’ll let people absorb this and in my next post, I’ll show how I believe investing in eBay today is like getting “something for nothing”

Good Luck everybody