EBay's Strong User Growth Offers Catalysts for 2013

Coming on the heels of last month's analyst day,  eBay's (EBAY) first-quarter fiscal 2013 update underscored the strength of its core businesses, the tremendous opportunity as the company moves further into mobile and offline commerce, and the undeniable potential of emerging markets. 

Although second-quarter revenue and earnings-per-share forecasts fell modestly short of consensus expectations, we believe this was the result of a cyclical softness in Europe; recently acquired Marketplaces and PayPal users (who tend to be less engaged than established users); and increased search, data, and site operation investments. Instead of viewing these issues as negatives, we believe investors should view the acceleration in active users (which grew 13.5% to 116.2 million users for Marketplaces and 16.3% to 127.7 million users for PayPal) as validation of the strength of the company's network effect (the foundation of our wide-moat rating) as well as its enormous potential monetization opportunity in the years ahead.

We plan to make a few minor adjustments to our valuation assumptions based on the first-quarter results, but there is no change to our current fair value estimate. We remain confident in management's blueprint to achieve 2013 forecast targets, which remain unchanged at $16.0 billion-$16.5 billion in revenue and adjusted EPS of $2.70-$2.75, as well as its ambitious 2015 financial objectives, including $300 billion in enabled commerce volume, revenue between $21.5 billion-$23.5 billion (representing high-teens average annual growth), operating margins hovering around 27%, and adjusted EPS growth of 15%-19% (placing the 2015 EPS near $4.00). The 2013 revenue goal will require a bit of catch-up in the back half of the year--revenue growth of 14% for the first quarter was at the low end of the implied 14%-17% growth target for the year. However, we believe increased user engagement efforts will help the company reach its targets and offer investors a clear catalyst over the back half of the year. Although market sentiment has become increasingly murky in recent days, we believe Wednesday's modest sell-off could be an attractive entry point for investors with longer-term investment horizons and the ability to withstand potential market volatility.

Mobile remains a cornerstone of eBay's long-term investment story. Explicit mobile merchandise or payment volumes were not disclosed, but comments from management's conference call led us to believe that the company remains on track to reach (and possibly exceed) its 2013 goals of $20 billion in both mobile merchandise and payment volumes during 2013 (representing 53% and 43% growth, respectively). Approximately 2.8 million new Marketplaces and PayPal users were added through mobile devices during the quarter, putting the company on a pace that exceeds its volume-growth targets for the year, in our assessment. Additionally, user trial and adoption rates remain strong, with one out of every four PayPal account holders making a purchase through PayPal mobile during the past 12 months. With its cross-merchant functionality and wide array of funding options, we believe consumers will increasingly gravitate to eBay's portfolio of versatile mobile shopping and payment apps in the periods to come.

PayPal got off to solid start in 2013 with revenue increasing 18% (20% on a currency-neutral basis) to $1.5 billion. The growth was primarily a function of a 16% increase in active registered users to 127.7 million (representing the fifth consecutive quarter of sequential acceleration in this metric) and a 21% increase in total payment volumes to $41.0 billion, supporting our view that PayPal is gaining traction as a preferred checkout method. 

PayPal's segment level margins decreased 230 basis points year-over-year to 24.1%, but were not a surprise given management's previous comments about 2013 being a heavy investment year for PayPal. Specifically, the segment-level margin declines were the result of a lower transaction margins (resulting from a higher proportion of large merchants in the customer mix as well as foreign currency hedges) as well as consumer awareness, mobile product, and offline payment processing investments. Although we expect segment margins to remain in the 24% range for much of 2013, we believe the growth opportunities inherent in mobile and offline payments more than offset the costs involved. 

PayPal is now available at approximately 20,000 retail locations in the U.S., which will expand to 2 million-plus by the year end, through PayPal's partnership with
 Discover Financial Services (DFS). We also remain confident that lower take rates offline (compared to its core PayPal business) will be partly offset by lower loss rates, resulting in a relatively benign hit to overall segment profitability as this initiative accelerates. There is no change to our five-year PayPal segment revenue growth and profitability projections (average annual top-line growth nearing 20% with segment-level margins just north of 25%), which are partly driven by increased user growth stemming from mobile adoption. However, we acknowledge that international expansion efforts (including the rollout of PayPal Here to the United Kingdom and other foreign markets) as well integrating PayPal into LG's smart TV platform provides multiple levers to better tap the $10 trillion global addressable commerce market in the years to come. 

EBay's Marketplaces segment also remains fundamentally strong, with active users increasing 13% to 116.2 million (also representing the fifth consecutive quarter of sequential acceleration in this metric), core gross merchandise volumes increasing 13% (16% growth domestically), revenue growing 11% (13% on a currency-neutral basis), and 340 basis points of segment margin level margin improvement to 42.1%. Again, we believe active user growth was the key highlight, as it confirms that the site enhancements the company has made the past several years have made eBay a more relevant shopping destination for domestic and international consumers and that mobile device adoption will be additive to segment growth trends (which gives us increased comfort with our five-year segment revenue growth forecast calling for 10% average annual growth). We're also sticking with our five-year segment-level margin forecast of approximately 40%, but were impressed by 200 basis points of sales and marketing expense leverage during the quarter, which management attributed to more effective marketing allocations as well as the influx of mobile users (which tend to come directly to the Marketplaces platform). While we believe eBay will continue to make marketing investments in the years to come amid an increasingly competitive online and mobile commerce landscape, and agree with management that the marketing expense leverage will not be as great in the second quarter, we will closely monitor the company's marketing efficiency in the years ahead, as it could represent an underappreciated source of margin expansion.

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