eBay: Elliott’s New Target – Does the Thesis Check Out?

Summary:

  • The well-known activist investment firm, Elliott Management, sent a public letter to eBay’s Board of Directors articulating their rationale for investing in eBay and their plan for improvement.
  • eBay appears to fit the activist investor playbook of underperforming operations, valuable assets hidden within the company, and a lagging stock price
  • Elliott’s “Enhancing eBay” plan appears reasonable as it looks to strengthen the core business over time rather than playing for short-term profits and putting the balance sheet at risk with excessive leverage

Introduction:

eBay was founded by Pierre Omidyar in 1995. He continues to be a top shareholder (owns ~6% of the company) and serves on the board. The business has grown significantly since the first item was purchased (a broken laser pointer) over 20 years ago. Today, they are an e-commerce behemoth that facilitates nearly $95 billion worth of transactions across their various platforms.

Elliott Management isn’t the first activist to be involved in the company. Carl Icahn was a large investor a few years back and ultimately pressured eBay to spin-off PayPal. Over the last few years, eBay has struggled to grow despite participating in the secularly growing e-commerce market.

Elliott made their position public with an open letter to the Board of Directors on January 22nd. Like many activist targets, eBay has some unique assets (StubHub and Classifieds) that Elliott is pushing to separate from the business. But more importantly, Elliott wants the core Marketplace segment to return to higher growth rates as well as improve an operating margin that has significantly deteriorated in recent years.

Company Overview:

In the simplest terms, eBay facilitates commerce.  Through their various platforms of Marketplace, StubHub and Classifieds, they connect millions of buyers and sellers. Their revenue model is based on collecting fees from successful sales on their platform as well as advertising.

  • Marketplace: 80% of revenue; online marketplace at ebay.com
  • StubHub: 10% of revenue; online ticket platform
  • Classifieds: 10% of revenue; a collection of online classifieds brands including mobile.de, Kijiji, Gumtree, Marktplaats, eBay Kleinanzeignen, and others.

Starting a marketplace business is incredibly difficult. Without any sellers posting inventory, no buyers will go to the website. On the other hand, without any buyers coming to the website, no sellers will post inventory. eBay has solved this “chicken or the egg” problem and now has approximately 179 million active buyers and 25 million sellers transacting to generate a gross merchandise volume (“GMV”) of roughly $95 billion.

For buyers they offer:

  • A wide range of inventory from 25 million sellers
  • Multiple delivery options
  • Best price guarantees
  • Seller reviews
  • Authentication for luxury items

For sellers they offer:

  • Access to 180 million buyers
  • Option to list inventory through a fixed price or auction-style format
  • Opportunity to list new, refurbished, used, and collectible items
  • Promoted listings to accelerate sales
  • Seller analytics (optimal listing and pricing strategies)
  • Fee discounts and preferential search standing for top sellers

Overall, eBay is one of the world’s largest online retailers and commands the #2 position in the U.S.

Elliott’s Plan: “Enhancing eBay”

On January 22, 2019, Elliott Management sent a public letter to eBay’s Board of Directors articulating their rationale for investing in eBay and their plan for improvement. The plan is organized around a handful of central pillars:

  • Portfolio Review
  • Revitalize Marketplace
  • Operational Improvements
  • Capital Allocation / Leadership & Oversight

Portfolio Review

As previously mentioned, eBay has many other online properties outside of the core eBay Marketplace. They also own StubHub, the online ticket exchange, and eBay Classifieds, a collection of online classifieds websites. These assets are growing faster than the Marketplace business and command premium valuations. Elliott believes that significant value could be created from selling or spinning off these assets.

Furthermore, if eBay Classifieds and StubHub were valued on their own, then the remaining core eBay Marketplaces business would have an implied valuation of just ~6x EBITDA (at the time of the publication of the letter). This implies a depressed valuation for a profitable, growing business that is an attractive acquisition target.

Revitalizing Marketplace

Despite eBay’s long history and well-known brand in the e-commerce market, they have consistently underperformed industry and peer growth rates for some time. Put another way, eBay has lost substantial share over the years. As you can see in the chart below, eBay has significantly underperformed competitors such as Wayfair, Walmart (US e-commerce), Etsy, Target (digital channel sales), and Amazon.

Ebay Marketplace Performance vs e-commerce Market and Peers

The company has had several issues over the last few years, including Google search algorithm changes, a password hack, and technical issues for sellers. Elliott wants management to refocus attention away from non-core projects towards the core eBay Marketplace business. Given the relative size of the business, revitalizing Marketplace will have the greatest impact on the overall company.

Operational Improvement and Margin Expansion

As eBay’s costs have grown much faster than revenues in recent years, margins have fallen from over 31% to ~23% from 2013 to 2018 (including the expensing of stock-based compensation). They have spent aggressively to grow the business (advertising spend up ~70% and product development spend up ~45% since 2013). Stock-based compensation has also grown rapidly, now representing over 5% of sales. This is much higher than peers. Yet, eBay is growing much slower. Needless to say, these increased investments have not delivered material incremental growth for the company and have resulted in operating profits actually declining since 2013.

To tackle these issues Elliott proposes a handful of measures aimed at improving organizational productivity, sales and marketing efficiency, product development effectiveness, and vendor relationships, among others.

This should result in eBay still having plenty of capital for the right projects to invigorate growth while at the same time ceasing spend on low return projects. Elliott believes this should increase operating margins by ~400bps to a 32% core adjusted operating margin by 2021. This margin target is in-line with eBay’s prior long-term margin range when they spun-off PayPal.

Capital Allocation / Leadership & Oversight

While eBay has a buyback program in place today, Elliott is pushing the company to accelerate this program given the combination of an upcoming earnings acceleration and a valuation that stands near multi-year lows.

Their overall capital allocation plan calls for 80% of free cash flow to be returned to shareholders through buybacks and dividends and the other 20% to be spent on M&A.

Lastly, Elliott wants the Board of Directors to establish a Strategy and Operations Committee. The Committee’s mandate will be to successfully execute Elliott’s Enhancing eBay Plan.

Note: On eBay’s fourth quarter 2018 conference call, they announced an increase in their repurchase authorization and expect to repurchase $5 billion of stock in 2019. Also, they initiated a dividend for the first time in their history (quarterly payment of $0.14/share). Therefore, it appears that eBay has already executed many of the capital allocation initiatives Elliott is pushing for.

Potential Transaction Overview:

Ebay Potential Transaction Overview

Does Elliott’s Plan Make Sense?

Based on eBay’s performance over the last few years, it’s clear they need to refocus on the Marketplace business. They have struggled to grow GMV above mid-single-digits during a time when the economic environment has been healthy. While that might not sound all that bad for a mature company, in the context of an end market that is growing double digits, it implies significant share loss.

As the table below depicts, total worldwide e-commerce sales have grown in the 20% range over the last few years. Importantly, this growth is forecasted to continue into the future. For 2019, Shopify expects worldwide e-commerce to grow ~18%. In contrast, eBay expects GMV to grow just 1% at the mid-point. Clearly, eBay is not keeping pace in the quickly evolving environment.

Total Worldwide Ecommerce Sales

Rationalizing the cost structure while getting the business growing again will have a massive impact on the company.

However, it is important to remember that eBay posted the below market growth rates while also spending heavily on advertising and product development. What would eBay’s growth have been if they didn’t ramp up that spending? This is the key question investors need to ask themselves.

The answer might very well be… at a similar growth rate because the advertising and product development spending was ineffective at driving GMV growth. But if this isn’t the case, then cutting the growth of investment spending will negatively impact the top line and the business could shrink.

Elliott believes this won’t be the case and based on management commentary, it does look like eBay invested a lot in very low return projects.

“On the first part vis-à-vis marketing, we did a high degree of experimentation last year. We tried a lot of different new things. We pushed to the efficient frontier of returns and, frankly, we pushed far beyond.”

Devin Wenig, eBay CEO, on the Q4 2018 conference call

In addition to the advertising and product development spend, eBay has some of the highest G&A costs in the peer group.

In the context of below end market revenue growth and higher than average expenses, Elliott’s Enhancing eBay plan seems to make a lot of sense.

Portfolio Review

The decision to separate Classifieds and StubHub is more nuanced. Whenever separating off an asset a company needs to decide if they are a better owner of the asset than it would be as a stand-alone entity or as a part of another company.

In other words, does the core Marketplace business add value to StubHub and Classifieds or do StubHub and Classifieds add value to the Marketplace business?

eBay’s management believes that there are synergies between the platforms.

For Classifieds, they can increase the visibility of seller inventory by listing it across multiple websites. They are also able to leverage the traffic between the sites. For instance, if someone is searching for a product on a classifieds site and there is a product that matches the search for sale on eBay, then they will show an ad in the middle of the feed. Another big initiative for the company has been the Motors vertical expansion in several of its markets. This drove $200 million of GMV to eBay from Classifieds in 2018 and contributed roughly 1% of revenue growth to Classifieds in Q4 2018. While this sounds great, it is very small and only represents ~0.2% of Marketplace’s 2018 GMV.

For StubHub, management talks about cross-merchandising between the platforms. For example, when you buy a ticket to a baseball game on StubHub, they will advertise a jersey for you to buy from eBay at checkout. Also, when you search for tickets in the eBay marketplace, they will redirect you to StubHub. They have been doing this for a few years now but haven’t quantified the impact of the efforts.

Overall, there does appear to be some synergies from having eBay own all these separate websites. However, the warranted valuations for StubHub and Classifieds as stand-alone entities is probably much greater than any synergies eBay can achieve from owning these other platforms.

Can eBay’s Other Opportunities Offset Competitive Pressures?

eBay’s core Marketplace business faces significant threats by not only Amazon but also fast-growing e-commerce sites such as Wayfair, Etsy, Zalando, Walmart, Target, Shopify, Rakuten, etc. eBay is losing mind share with consumers as the large brick-and-mortar retailers heavily invest in their online presence and other more niche focused sites pop-up.

These are significant risks, but eBay also has some very large opportunities to grow outside of pure GMV growth.

Advertising

Their total Marketplace Advertising portfolio generated roughly $600 million in revenue in 2018, of which ~$180 million was Promoted Listings. They expect to grow this business to $1 billion over the next few years. This revenue growth should come on at a very high incremental margin.

Payments

eBay is taking more control of the payments on their site which will lower costs for sellers, increase payment options for buyers, as well as increase revenue for eBay. The agreement with PayPal allows eBay to intermediate up to 5% of GMV between July 2018 and July 2019 and 10% between July 2019 and July 2020. There is no operating agreement with PayPal beyond that time.

eBay’s management has framed the opportunity at $2 billion in revenue and $500 million of operating profit once they convert all their GMV.

Conclusion:

eBay has struggled to find its place in recent years with GMV growth significantly underperforming the broader global e-commerce market. They have invested significant capital and tested a wide range of initiatives, but the results have been underwhelming.

Elliott’s plan is centered around separating off the Classifieds and StubHub segments as well as refocusing on the core Marketplace business. While there appears to be some benefit to eBay owning StubHub and Classifieds, any benefit is overwhelmed by the discounted valuations placed on these assets because they are part of eBay. Their plan for the Marketplace segment is to refocus on the core business which should help streamline costs while investing in the right initiatives to reinvigorate growth. This appears to strike an appropriate balance between efficiently running the company while not depriving it of capital needed for attractive projects.

Overall, Elliott’s involvement appears to be positive for shareholders. They are not pushing for inappropriate leverage levels or indiscriminate cuts across the board to hit margin targets. While eBay faces many competitive pressures- which appear to be intensifying, they still participate in a secularly growing industry. If they are able to start growing at a high single-digit rate with expanding margins, it could be an interesting company for investors to take a look at.

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2019-02-07T17:42:50-05:00