On a day when the broader indices sunk on global growth concerns, shares of e-retail marketplace eBay (NASDAQ:EBAY) bucked the trend and bounced higher thanks to an open letter to management from activist investor Elliott Management. In the letter, Elliott Management disclosed a $1.4 billion stake in eBay, and suggested certain strategic initiatives that they believe could cause eBay stock to double within the next two years.
EBay stock rose sharply on the news.
But, is that really possible? Can eBay — a stock dogged by slow growth and margin concerns, and often viewed as the eyesore of an otherwise attractive e-commerce industry — actually double within the next two years?
Yes. There’s a pathway for eBay stock to double by the end of fiscal 2020 through core product innovation, differentiated advertising, re-prioritized spend, and share repurchases. That isn’t my base case. But, it certainly is possible.
Moreover, my base case still points to healthy upside in a two-year window and suggests shares are undervalued here.
Overall, eBay stock looks good here. There is an outside chance the stock doubles within two years in an “everything goes right” scenario. But, even if everything doesn’t go right, eBay stock still looks undervalued here considering the company’s long-term staying power in a secular growth e-commerce industry.
What the Letter Says
Elliott Management’s letter describes the fund’s Enhance eBay initiative, which is a five-step process focused on unlocking and maximizing shareholder value over the next two years. Those five steps are as follows:
Step 1: A comprehensive portfolio review. Essentially, Elliott Management believes that eBay should shed its StubHub and Classifieds businesses in order to re-focus on the core Marketplace business. They also believe that, given peer multiples, the standalone value of both StubHub and the Classifieds business is greater than their value as part of eBay. Thus, eBay could sell those businesses for a net gain.
Step 2: Revitalizing Marketplace. Elliott Management points out that eBay has been a slow grower in an otherwise red-hot, 20%-plus growth e-commerce industry. They peg this lack of growth on a lack of focus and innovation in the e-commerce market. By re-focusing on Marketplace and emphasizing e-commerce related innovation, Elliott believes eBay can supercharge growth in the Marketplace business.
Step 3: Operational improvements and margin expansion. Elliott correctly points out that the company has been unsuccessfully spending an arm and a leg to drive growth over the past several quarters, with the net result being still-slow revenue growth, out-sized expense growth, margin compression, and flat profit growth. Elliott believes that, through re-prioritizing wasteful spend, eBay can dramatically expand margins while maintaining healthy revenue growth.
Step 4: Appropriate capital allocation. Although eBay has share buybacks in the pipeline, Elliott believes the company should accelerate share repurchases. They also think the company should implement a dividend with a 1.5% yield, and pursue e-commerce related M&A opportunities.
Step 5: Effective leadership and oversight. Broadly speaking, Elliott believes the changes they are proposing represent a dramatic shift in company culture, and that such shift requires a re-evaluation of the talent and personnel required to lead the new eBay.
Through these five steps, Elliott believes eBay can do about $4.10 in EPS by fiscal 2021, which they believe lends itself to a fiscal 2020 price target of $55 to $63-plus based on a 13 forward multiple. To put that figure in perspective, it’s almost double the average analyst’s 12-month price target on EBAY stock and 21% more generous than the highest analyst target of $52.
How eBay Stock Could Double
While it is often easy to write off activist investor letters and calls for 100%-plus upside as pipeline dreams of disillusioned bulls, that isn’t the case here. Elliot’s proposals make sense.
EBay is a 5% revenue grower with broad exposure to a 20%-plus growth industry … that implies room for revenue growth acceleration through product innovation and iteration. The company also way overspends on advertising and isn’t getting decent return on those ad dollars. This implies room for margin expansion if the company re-prioritizes spend.
What exactly should eBay do to re-charge revenue growth and boost margins? They need to make their platform more relevant and millennial-friendly. It’s no secret that eBay has a millennial problem. Millennial consumers prefer Amazon (NASDAQ:AMZN), Nike (NYSE:NKE), American Eagle (NYSE:AEO), and many other websites over eBay, which experiences a lower mindshare.
It doesn’t help that eBay has a minimal app presence. The company also needs to redesign its UI and improve the app experience to catch the eye of younger consumers. Also, eBay needs to start pushing dollars toward influencer marketing. It needs to leverage social media stars to promote eBay to younger audiences via Instagram, Snapchat and other social platforms.
Through doing all these things, eBay should be able to maintain 5% revenue growth over the next several years. Margins should also slightly expand to ~32.5%. In combination with aggressive buybacks, that could easily drive fiscal 2023 EPS to $4.80. Based on a historically average 15 forward multiple, that equates to a fiscal 2022 price target of $72. Discounted back by 10% per year, that equates to a fiscal 2020 price target of $60, essentially double today’s price.
Bottom Line on EBAY Stock
Elliott Management isn’t full of hot air. EBay stock is undervalued, and there is a pathway for this stock to double over the next two years. Will it happen? Probably not. A more realistic outcome is $3.50 EPS by fiscal 2023. Using a 15x forward multiple and 10% discount rate, that equates to a fiscal 2018 price target of $36. That’s still above eBay’s current price tag. Thus, there’s an outside chance eBay stock doubles over the next two years, and a very good chance shares rally 10% within the next few weeks. That combination makes eBay stock an attractive buy here.
As of this writing, Luke Lango was long EBAY, AMZN and NKE.
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