eBay: My Kind of Turnaround — Eagle Point Capital

eBay is emerging from a multi-year restructuring that has resulted in a simpler and more focused business. After agitation from activist investors and a change in leadership, eBay looks ready to leverage its valuable core marketplace to return to sustainable growth. Though much of the heavy lifting is in the rearview mirror, eBay’s stock has yet to fully reflect the business’s potential.

Background

eBay is one of the world’s largest ecommerce platforms, originally launching as an auction-based website in the late ‘90s and transitioning to a global marketplace for online shoppers. Over 180 million buyers across the globe are active on eBay’s platform and nearly $100 billion of merchandise changed hands on eBay’s marketplace over the last year. Outside of China, eBay is the world’s second largest online retailer behind Amazon and occupies a #1 or #2 position in most major markets where it operates.

Until 2019 outside of its core marketplace eBay also owned StubHub, an online ticket exchange and resale platform, as well as a global portfolio of leading classifieds websites.

Despite owning a prized ecommerce asset in the golden age of internet retailing, eBay’s leadership team became distracted and failed to deliver adequate shareholder returns over the mid-2010’s. A modest rise in eBay’s share price from 2015 to 2019 woefully underperformed peers by 100%+ and drew the ire of activist investors. In January 2019 Elliot Management and Starboard Value disclosed large investments in eBay and released a letter to management urging the company to shed noncore assets and reinvest in its core business.

Corporate Restructuring

After engaging with Elliot and Starboard, eBay’s board began to reshape the business. The activist investors proposed that eBay:

1. Sell noncore assets of StubHub and Classifieds;

2. Reinvest in the core marketplace to invigorate organic growth;

3. Return excess capital to shareholders through repurchases and dividends.

Elliot and Starboard recognized that eBay had a valuable ecommerce asset with vast potential that was being obscured by unrelated business lines. Worse, at a time when the broader ecommerce market was growing like a weed, results were stagnating on eBay’s marketplace platform. From late 2017 to early 2019, gross merchandise value (GMV), which is the amount transacted between buyers and sellers on eBay’s platform and an online marketplace’s most important metric, was going nowhere.

Deciding to take action after years of missteps, eBay’s board conducted a strategic review. Coming out of the review eBay:

- Parted ways with existing CEO Devin Wenig in September of 2019;

- Sold StubHub to Viagogo for $4.05B in February of 2020;

- Hired Walmart ecommerce COO and former eBay executive Jamie Iannone as CEO in April 2020;

- Announced the sale of the classifieds segment to Adevinta for $9.2B in July 2020, and;

- Released the strategic priorities for the new, slimmed-down business during the Q2 earnings call.

In short, it’s been a busy 18 months for eBay. What has occurred is similar to the “cancer patient” strategy we wrote about a few weeks ago and has given the market a lot to digest.

The “New” eBay

What is left at eBay is essentially what the company started with two decades ago, an online marketplace that connects buyers and sellers.

Marketplace Dynamics

An online marketplace makes money by taking a cut (a take-rate) of the goods or services transacted on the platform. This can take the form of charging the seller a fee, the buyer a fee, or both. Who pays the fee matters because it drives where the company needs to place primary focus. For example, on Airbnb it is free to list properties and no service fees are charged to hosts, so the renter pays the entire fee. Uber extracts fees from both drivers and riders. Conversely, eBay only charges sellers fees, and as such is largely beholden to a vibrant seller community.

In a marketplace like eBay, which thrives on a two-sided network effect, the right supply needs to come first. This feeds demand, which in turn brings on more supply, leading to greater demand and so on. Without a solid seller base and resulting supply of the right products, eBay’s network begins to erode. This is exactly what started to happen over the past several years. eBay fell behind competitors by not making things easy for sellers. The site was hard to navigate, managing different payment types was cumbersome and costly for sellers, seller registration was far from seamless, and there was a general lack of support and innovation for sellers as the leadership team focused on the wrong areas. CEO Jamie Iannone commented that the company has recently focused on acquiring buyers at all costs, which sacrificed what really mattered – supporting the seller base.

Strategic Priorities

The management team reviewed their key priorities for the next several years with investors over the summer and, unsurprisingly, the focus lies on improving the seller experience. The management team’s go-forward plan has three pillars:

- Defend the core;

- Become the platform of choice for sellers, and;

- Cultivate lifelong trusted relationship with buyers.

Each priority is wrapped around getting back to focusing on where the company has been able to win and improving the buying and selling process.

The company has historically dominated the non-new and vintage in-season categories. Additionally, the marketplace has a very strong position with enthusiasts looking to shop categories such as luxury items, parts and accessories and motors, fashion, electronics, collectibles and more. These areas are at the core of why people love eBay and are squarely where management is now focusing. They believe the addressable market for these core competencies is north of $500B.

In addition to focusing on these “nichey” areas where they can dominate, the company is working to remove friction from the buying and selling process to enable sellers to be more successful. The company is not just giving this initiative lip service, as there are tangible examples of early progress.

First, the business is in the process of completing a rollout of a “managed payments” program across the global seller network. This new payments platform allows sellers to seamlessly accept various forms of payments such as Apple Pay, credit cards, PayPal, and Google Pay without going through different processes. This was a major pain point for sellers before and the improvement has been well received. The company expects managed payments to result in at least $2B in incremental revenue and $500M of incremental operating income by 2022.

Also, the company has introduced authentication programs in certain product categories. So far, eBay has partnered with 3rd party firms to authenticate luxury watches and sneakers and intends to broaden the program to other categories. Authentication significantly improves volume and average selling price and again has been very popular with both buyers and sellers. The sneaker program has been a hit with younger Gen Z and Millennial buyers, introducing new potential long-term and repeat users.

Finally, eBay has made a slew of operational improvements. To name a few the team has; improved the shipping process and cost for sellers, rolled out new marketing tools for small businesses to drive traffic back to their eBay stores, simplified the seller registration process, launched a storefronts mobile app, pushed promoted listings, and utilized behavioral data and machine-learning to improve buyer search results which has resulted in a material increase in buyer conversions.

I won’t try to quantify each of these initiatives, but it’s critical that the company has completely refocused its efforts on driving growth in the marketplace. While these efforts are in the early stages, the company has shown green shoots of improvement in active buyers, GMV, and topline revenue growth over the past few quarters.

The business has undoubtedly received a boost in usage from stay at home orders due to the pandemic, particularly in Q2. But even major markets, such as South Korea, that are largely un-impacted by shutdowns have shown 5%+ growth. Most importantly, any growth on the marketplace platform should prove highly valuable given the capital-light nature of the business model.

Fundamentals and Valuation

Because running a marketplace requires little physical infrastructure, eBay earns high returns on capital and generates significant free cash flow. The core business will produce roughly $2.3B of free cash flow in 2020 on ~$9.6B of gross capital and less than $5B in tangible capital. With even modest revenue growth going forward, investors should enjoy excellent incremental returns.

The business is well capitalized with less than 1.5x net debt and ample flexibility to return capital to shareholders, which they intend to continue doing.

eBay has a healthy appetite for its own stock, repurchasing $700M of shares last quarter with $2.5B left on the current repurchase authorization. The outstanding repurchase authorization alone represents over 7% of the current market cap. At present prices continued repurchases should prove to be a great use of capital.

Valuation

eBay has roughly a $35B market cap and trades for a headline 15x earnings. However, because of the recent classifieds transaction this doesn’t tell the whole story. When eBay sold the classifieds segment they received a mix of cash and stock valued originally at $9.2B. The transaction has been well received by the market as a good strategic fit for Adevinta and their shares have risen since the deal was announced, making the new value of the deal north of $11.2B.

The transaction should close in Q1 of next year, and eBay will receive roughly $2.5B in cash and hold ~$8.7B worth of stock in Adevinta. Even though eBay’s equity stake in Adevinta has risen by $2B since announcing the deal, the shares could be volatile so to be conservative I’ll assume the original deal price of $9.2B is fair value. I doubt Elliot and Starboard would have agreed to sell Classifieds at a discount, so I’d lean towards the run-up in share price maybe being overly optimistic, but who knows. It’s not certain what eBay will do long-term with this equity stake, but given their penchant for returning capital to shareholders it would not surprise me if they sold most or all of the position to release more capital.

Strip out the $9.2B value for the Adevinta deal and eBay’s core business is trading for roughly 11x 2020’s free cash flow. Using a 10% discount rate an 11x multiple implies around 1% terminal growth for eBay’s marketplace; an extremely low bar to clear. The valuation becomes even more surprising considering the high-quality nature of eBay’s earnings as they require little capital, are highly scalable, and global in nature. If any or all of the initiatives discussed above take hold and result in just modest growth, eBay’s stock should be a winner.

With a renewed singular focus on its prized marketplace asset, I would consider it an abject failure if the business doesn’t at least grow at a GDP-like clip over long periods of time, which would be worth at least 15x earnings. In reality, I expect much higher growth to materialize in the coming years given the potential of an established two-sided online network and rejuvenated strategy.

Consider a scenario where eBay grows revenue and free cash flow at 5% annually (i.e. no margin expansion), returns 90% of capital to shareholders, and the core business is valued at 15x free cash flow five years from now. This does not require any heroic assumptions and would result in 15-20% annual returns to equity holders.

Summary

Activist investors often target an underperforming and undervalued company, get some quick wins and a share price bump and move on. It’s usually then that the long-term investors move in and can reap the real rewards. I see this happening now at eBay with Elliot and Starboard moving out and investors like Pat Dorsey and Seth Klarman buying or holding large positions. The heavy lifting of shedding noncore assets, bringing in a new management team, and creating a laser focus on one objective has been done. Now is the time for patient shareholders to wait for these efforts to show sustained impact in the financials.

Buffett has said: “I try to invest in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will.” I’d say eBay qualifies here as it was severely mismanaged over the past almost decade, yet still earns excellent returns on capital and maintains a massive network. How exactly the new management team leverages this network into results may be a bit fuzzy at this juncture. Analysts will try to pinpoint precise GMV numbers and take rates for the next several quarters when it appears an investment in eBay simply requires taking a step back and asking if the marketplace is likely to grow at all in the coming years.

I see eBay as a similar situation to NortonLifelock – a newly simplified, high return on capital business likely to return capital to shareholders and priced at a no-growth valuation. Comparing the two I lean towards preferring Norton because of the relative simplicity of the product and competition and considering Norton received all cash for their asset disposals. I wouldn’t fault anyone for buying into eBay today, and you could argue the upside is higher (if the team does a good job the stock could easily fetch north of 30x earnings). I’d prefer to watch the business closely and if it becomes clear that they plan to monetize the Adevinta position or the core business becomes irresistibly cheap, I would be happy to own the stock.

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