Read the 39th issue of the AMM Dividend Letter
AMM Dividend Letter #39: Proving Yourself Wrong & eBay
Download the 39th issue of the AMM Dividend Letter
AMM Dividend Letter 39 Proving Yourself Wrong & eBay (PDF)
Episode Transcript
Welcome to the second episode of the AMM Dividend growth Podcast. In this podcast I’ll breakdown a current holding in the AMM Dividend Growth Portfolio. Today’s episode is all about eBay. We classify eBay as a new dividend payer and a special situation investment.
If you want to read the full letter and check out all the charts and graphs that go along this episode there is a link in the description. You can also go to amminvest.com/episode2 for the full show notes, the transcript, and a link to the full letter.
Before we get going I need to read you the disclaimer.
[disclaimer]
A common myth about companies that start paying a dividend is they are out of high growth opportunities. So they might as well return their excess capital back to shareholders through dividends.
Cliff Asness and Rob Arnott found the opposite in their 2003 paper “Surprise! Higher Dividends equal Higher earnings growth”
They list several reasons as to why this is but two reasons really stood out.
The first reason is once a company initiates a dividend they DO NOT WANT cut it. Cutting a dividend will hammer their stock price. So when management starts a dividend they are signaling that the dividend is well covered and that the company is going to grow and generate more than enough new capital to reinvest and pay the dividend.
The second reason is capital discipline. Every business has a capital budget for the year. A company that has to return some of its capital back to shareholders is forced to choose the best projects that should generate the highest returns on investment, create the most value, and drive the best growth for the company.
Too much retained capital may lead to empire building by management. The company will get bigger but not necessarily better.
So, what does this have to do with eBay?
They’ve been guilty of poor capital discipline.
Management invested in businesses like Skype and Rent.com that didn’t strengthen their core business. And the investments took management’s focus away from the other opportunities in ecommerce. Opportunities that would’ve really strengthen eBay’s core business and grown the value of the company.
But now eBay is going to return some of its excess capital to shareholders in the form of a dividend. Yes, this new dividend policy was pushed by activist investors but it is a sign that management has found some capital discipline and is refocusing their efforts on improving its core business and they are no longer engaging in empire building.
eBay’s new quarterly dividend will be $0.14 per share which is a 1.47% dividend yield based on today’s price.
A reason why we like having new dividend payers in our portfolio is they tend to produce above-average dividend growth. The first dividend is usually at a low payout ratio – that whole afraid to cut a dividend thing – as management gets comfortable with the dividend they increase the payout ratio. The dividend grows from regular business growth and from an increasing payout ratio
eBay’s current payout ratio is 21.69%. Plenty of room for eBay to increase the payout ratio.
EBay’s cash dividend payout ratio is low at 25.53 percent too.
And eBay’s free cash flow to equity coverage ratio – how much eBay’s free cash flow to equity covers its dividend and share repurchases – is 126.44%
More than enough cash flow to cover its current capital return plans and increase it in the future.
The main catalysts for price appreciation and further dividend growth stems from recent shareholder activism.
Elliott Management took a 4% stake in eBay and Starboard Value also took a big stake in the company. Both hedge funds are pushing for the same thing. Spinning off or selling StubHub and eBay’s Classifieds Business. Both are non-core assets and the true value of both assets are being overshadowed by eBay.
This is the same situation eBay was in before with PayPal. eBay used to own PayPal and PayPal’s true value was being overshadowed by eBay’s. eBay eventually spun off PayPal because of shareholder activism.
Spinning off PayPal was the right thing to do for shareholders then and we think spinning off StubHub and its Classifieds Business is the right thing to do for shareholders now.
Early in their life together StubHub benefited greatly from eBay’s balance sheet and their capital investments to help StubHub grow. StubHub could invest more aggressively in their platform and eBay’s backing helped StubHub close some big deals like its partnership with Major League Baseball. But after these early wins, the benefits trailed off.
eBay was hoping the two platforms would benefit further from cross promotions. StubHub is really good at reselling tickets and that should be its only focus. What products from eBay do you cross promote to someone who just bought a concert ticket on StubHub? You can try to sell them a t-shirt of the band but then you’re that guy at the concert wearing a t-shirt of the band you’re about to see.
Two key metrics for StubHub’s business are Gross Merchandise Volume (GMV), the total dollar amount transacted on their platform, and the Take Rate, the amount per transaction that flows into StubHub’s revenue.
Since 2013 StubHub’s Gross Merchandise Volume has grown from $3.1 billion to $4.75 billion, a compound annual growth rate of 8.4%.
During this time StubHub’s take rate has floated between twenty-two and twenty-three percent. Revenues have grown from $629 million in 2013 to $1.068 billion at the end of 2018, a compound annual growth rate of 11.17%.
When we look at similar competitors we estimate StubHub’s EBITDA margin to be around 30%. Which means StubHub accounted for $320.40 million of eBay’s 2018 EBITDA. Based on management’s expectation of 6% growth in 2019, StubHub should produce about $505.89 million in EBITDA. Using a comparable Enterprise Value to EBITDA ratio of 14x, StubHub in 2019 is worth $4.754 billion and accounts for about $5.50 per share of eBay.
StubHub probably operates at a higher EBITDA margin, eBay doesn’t break them out, and it should probably trade at higher EV/EBITDA ratio given its growth, margin profile, scale advantages, and its attractiveness as an acquisition target for a Private Equity or for a company like Live Nation (LYV).
I think the most intriguing asset that eBay owns is its online Classifieds Business.
Back in the pre-digital era, the most profitable section for newspapers was the classified section. Instead of paying a sales force to go out and find businesses to advertise in your newspaper, advertisers would call you. The newspapers would charge high rates in relation to the ad size because they could. Newspapers had local monopolies. It’s why Warren Buffett used to love buying Newspaper companies.
With the advent of the internet age, you can place your classified ad anywhere. The local monopolies that newspapers had are gone but classified ad monopolies never went away.
An online classified business only works if it can connect the most sellers with the most buyers. This creates a strong direct network effect.
The direct network effect occurs when the usage of a product or service by owner user increases the product or service’s value for other users. The more people that sell their goods or services on a classified site increases the value for buyers on that site.
Once an online classified business has built a network effect it is hard to dethrone them. Just look at Craigslist, it hasn’t changed much since 1999.
An online classified business also requires very little reinvestment to maintain its leading position. This leads to very high returns on invested capital and high returns on incremental invested capital.
eBay’s Classifieds business holds a monopoly like position, which is more than 80% market share, in 10 countries.
Classified businesses come in two forms, horizontal and vertical.
A horizontal classified is just like the old classified section of the newspaper. It covers a wide range of categories: jobs, places to rent, services, used cars for sale, etc. The modern example, again, would be Craigslist. You can find pretty much anything on there.
A vertical classified is focused specifically on one category like RV Trader or Motorcycle Trader. eBay’s classifieds group contains both horizontal and vertical classified businesses.
eBay’s Classifieds Group has been growing its yearly revenue at a compound annual growth rate of 9.8% since 2015.
eBay doesn’t break out its Classifieds Business’s operating margins but we estimate its EBITDA margins should be around 45%.
We have a chart in the full letter highlighting three comparable online classifieds businesses.
Again, if you want to see the charts and graphs there is a link in the show description or you can go to amminvest.com/episode2.
For comparison we used three single country horizontal classified businesses. FINN from Norway, Blocket from Sweden, and Leboncoin from France. I probably didn’t say the last one correctly.
All three are in developed Western countries and all three are the leading online classified company in that country. Very similar to eBay’s collection of classifieds.
Finn’s EBITDA margin is 46%, Blocket’s margin is 52% and Leboncoin has a 55% EBITDA margin.
The issue with this comparison is that all three are owned by Schibsted and it could be a case of managerial and operational excellence that is leading to the high margins. But they do have a persistent margin profile.
We estimate eBay’s Classifieds group will generate $506 million EBITDA in 2019. Using an EV to EBITDA multiple of 16x, we value eBay’s Classified Business at $8.1 billion or around $9 of eBay’s current share price.
We think the Classifieds Business is a prized asset and would probably trade at a higher multiple if it is spun-off and it would attract a premium offer from a company like Schibsted.
Moving onto eBay’s core marketplace business.
The perception – given its current valuation – is eBay’s core marketplace business is an impaired business. But eBay is still a leading global ecommerce business. Depending on the country it is either in the number 2 slot behind Amazon or in a couple countries like South Korea, Italy, and Australia it is ranked ahead of Amazon in the number 1 slot.
Despite its poor market perception eBay’s core marketplace is still growing.
Since 2015 eBay’s Gross Merchandise Volume, GMV, has grown at a compound annual growth rate of 3.56% and its revenue has grown at a compound annual growth rate of 5%.
While the core marketplace business is not impaired, to be fair it has not matched its closest competitors.
Sine 2015 Walmart grew its ecommerce revenues at a compound annual growth rate of 44%, Wayfair at 45%, Etsy 27%, and Amazon grew its online retail revenue, not its total revenue, at 19%.
The rise of ecommerce is a global secular trend and eBay, a leading ecommerce business, should be benefiting a lot more from this trend. eBay’s closest competitors sure are.
Part of the underperformance has been due to poor operational execution. And another part has been management’s lack of focus on improving and expanding its core marketplace business.
As I mentioned earlier, management has been sidetracked with other investments like Skype, Magento, and Rent.com. This lead to them missing out on some niche ecommerce opportunities. The lack of focus also allowed eBay’s cost structure to increase leading to deteriorating operating margins.
Operating margins back in 2013 were 30% and now at the end of 2018 they were 20.7%. Not a good trend.
The good news is that the ecommerce trend is still in its early stages. There are still a lot of opportunities for eBay to expand its core marketplace business, expand into other complimentary niche ecommerce businesses, while reducing excess operational costs and expanding its margins.
When we back out the EBITDA and enterprise value of StubHub and the Classifieds Business from eBay we’re left with $2.84 billion in EBITDA. eBay is expected to grow 5% in 2019 and the remaining Enterprise Value is $25.5 billion.
The market is currently valuing eBay’s remaining core marketplace business at a 9x EV to EBITDA multiple. We think the core marketplace should trade at least at a 12x EV to EBITDA multiple to its expected 2019 EBITDA which gives us an enterprise value of $35.8 billion.
Backing out the $9 per share for the Classifieds Business and the $5.50 per share for StubHub leaves about $23 per share for eBay’s core marketplace. If the core marketplace traded at a 12 x EV to EBITDA multiple it would be around $36 per share. Which would push eBay’s total share price up to $50 per share.
If management can trim costs, expand margins, and grow its revenue higher than 5% then eBay’s core marketplace should command an even higher EV to EBITDA multiple and fetch a higher enterprise value.
A couple of risks to our investment thesis.
The crux of our thesis is that eBay spins off or sells both StubHub and its Classifieds Business. If after its strategic review, eBay decides to keep both businesses then the catalysts for unlocking eBay’s value are gone at least in the near term.
The inherent value in all three businesses can still be revealed but it would take a much longer process. In the short-term eBay’s stock price would probably sell off as event-driven investors close their positions and other disappointed short-term investors sell their stock too.
But given eBay’s track record of listening to activist shareholders and pursuing value enhancing transactions – the PayPal spin off – we think the odds of eBay backtracking on this are low.
Also, Elliot Management and Starboard Value are activist investors known for fighting hard to get their way. Elliot Management seized an Argentinian naval ship in Ghana to get Argentina to pay the money it owed Elliott on a defaulted bond.
The other main aspect to our investment thesis is that eBay’s core marketplace business is worth more than what the market is currently valuing it at.
It will be up to current management to show the market that they are focused on cutting costs, expanding their margins, and growing the company at a higher rate. Given their recent efforts to switch the merchant of record from PayPal to Ayden is a sign they are moving in the right direction.
The merchant of record is the intermediary between the buyer and seller on eBay. When the merchant of record was PayPal the buyers would pay PayPal and then PayPal would pay the seller. PayPal took 3.5% from the buyer and pays a 1% fee to the merchant bank of the acquirer. PayPal’s profit was the spread.
eBay’s new partnership with Ayden allows eBay to become the merchant of record. The spread will tighten but instead of all the value from the spread going to PayPal, eBay will now earn most of it.
The Ayden deal should also lower costs for eBay and for the sellers on its platform. A better lower cost experience for the sellers helps build upon eBay’s direct network effects. The more sellers on its platform should draw more buyers to its platform enhancing eBay’s direct network effects.
We already kind of did this earlier but we value eBay based on a sum of the parts analysis.
We estimate the 2019 EBITDA for all three businesses. Then applying a 12 x EV to EBITDA multiple to eBay’s core marketplace, a 14x multiple to StubHub, and a 16x multiple to the Classifieds business we get an enterprise value of $48.6 billion. Then we back out the debt and add back the cash to get an equity value of $45.9 billion. With around 914 million shares outstanding we get a total value of $50 per share.
This is our base case.
StubHub and the Classifieds business could easily trade at higher multiples. And if the core marketplace grows faster and its margins improve then could easily trade at a higher multiple too.
Thank you for listening. If you enjoyed this episode please subscribe through your favorite podcast player and please leave us a rating and review. And if you want to get our full AMM Dividend letter and everything else we send out to our clients, there is a link in the show notes or you can sign up at amminvest.com/podcast.
