EBay Inc. (EBAY) has made a habit of converting competitive threats into fresh growth opportunities.
A few years ago, the prevailing view of eBay's core Marketplace e-retailing business was that it represented yesteryear's model at a time when online shoppers were swiveling toward low-fixed-price merchandise from large sellers and traditional retailers.
Under CEO John Donahoe, Marketplace embraced this consumer shift, favoring large sellers, facilitating the creation of virtual stores and emphasizing fixed-price sales. The move alienated some auctioneer traditionalists but has led to double-digit growth rates in recent years. Last quarter, almost 70% of merchandise volume was from fixed-price goods, and both profit margins and active user totals accelerated from already strong levels.
The paypal factor
Now it is eBay's PayPal division that's producing excellent results in an environment where popular perception holds that the battle over electronic and mobile payments will make life tough for the large incumbent players. PayPal, the pioneering secure digital wallet, is feasting on the runaway growth in mobile payments, an area that has attracted Google (GOOG) and credit-card processors, birthed the startup Square (from Twitter founder Jack Dorsey) and interested scores of other upstarts and competitors. PayPal's user growth accelerated unexpectedly last quarter to its strongest pace in eight years, growing by five million to 123 million. Mobile payment volume tripled from a year earlier.
This performance pushed eBay to another strong quarterly performance, as the San Jose, Calif., company posted a 17% gain in adjusted operating profit to 70 cents per share, a penny above forecasts, and closed out a fine year of growth and investor enrichment. The powerful 70% surge in eBay shares last year and the company's consistent ability to overachieve its own strategic goals won eBay honorable mention as the runner-up to Gap Inc. (GPS) in Yahoo! Finance's first Company of the Year selection in 2012.
The company's chances of continuing to win accolades rest mostly on PayPal. It's telling that, in discussing eBay results, Donahoe addresses PayPal first and offers the most forceful commentary on growth opportunities there, even though the division generates just about 40% of company revenue. With revenue growing at better than 20% per year, however, Paypal is likely to account for a majority of eBay profits within a couple of years.
PayPal probably represents a majority of the market value of the entire company even today, given the attractive network economics of payment systems and investors' eagerness to place hefty multiples on them. As PayPal becomes the key growth vehicle, eBay as a company will become that much more agnostic as to where and how customers buy things, assuring itself a central place in global commerce as it evolves.
The company is hurriedly maneuvering to strike partnerships to broaden users' ability to pay via PayPal through mobile phone and retail points of sale, in addition to online. The intensity of this effort, indeed, is why eBay's earnings guidance for the present quarter was slightly short of prevailing estimates. With the urgent opportunities presented by the explosion in mobile transactions, eBay said it would invest a bit more heavily in PayPal growth initiatives.
The eBay strategy
A former business consultant, Donahoe prefers to lay out clear multi-year strategic plans for eBay, and the company is now overachieving its targets two years into a three-year plan. The company has also made shrewd complementary acquisitions of StubHub, Shopping.com, GSI Commerce and Bill Me Later.
In 2012, investors finally caught on to this impressive pattern, embracing the stock and inflating its valuation to a lush premium over the broader market and most other mega-cap tech stocks. The shares are now at 19-times projected 2013 operating profits, some five multiple points higher than the market. This says the Street is giving the company the benefit of the doubt, but it also means eBay's margin for error is slimmer. When eBay unveiled its slightly muted first-quarter guidance after trading hours Wednesday, the stock initially blipped lower in a reflex move before recovering to add about 1%, a sign of growing sensitivity to hints of any slowdown.
This means future stock appreciation will probably be less dazzling than during last year's ferocious run, and will be more in line with the company's achievable annual profit and free-cash-flow growth in the low-double-digit percentage range. In March, management will lay out its next set of long-term strategic goals. This event will likely serve to refresh the enthusiasm of a financial audience that's now more demanding of great results, from a company that has almost made the public forget it was considered a mere '90s novelty act just a few years ago.
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