EBay: Marketplaces Volume and Margins Raise Concerns

With  eBay (EBAY) recently announcing its intent to spin off PayPal, its third-quarter update provided an opportunity to reassess the moat sources underlying each business. Our view on PayPal is largely unchanged, as active users (up 14% to 157 million), payments per active user (up 7%), and mobile payments (up 72% to $12 billion, or 20% of total payment volume) suggest that its network effect is intact. PayPal's segment margin decline (down 180 basis points to 20.9% due to Braintree's lower take rate and mobile investments) raises questions, but we still believe longer-term margin opportunities exist as current investments wind down. Management didn't provide much color about PayPal's potential as a funding source on Apple Pay or future NFC integration, though we continue to believe PayPal's versatility, security features, and convenience make it a natural partner for mobile payment platforms.

Marketplaces presents more of a mixed picture, as the segment is still feeling the effects of May's data breach and Google search algorithm changes. Active buyers increased 13% to 152 million, but gross merchandise volume growth slowed to 9% (versus a 12% run rate year to date). Management is attempting to counter slowing volume with increased marketing, driving segment margins down 300 basis points to 35.9%. Although we view some of these marketing investments as prudent ahead of the holidays and believe eBay is taking measures to adjust to search engine changes, we have concerns that new user acquisition may become more costly in the periods to come, but will wait to assess holiday traffic before adjusting our margin assumptions.

There is no change to our $63 fair value estimate. Embedded in this are stand-alone valuations of $31 per share for PayPal (midteens revenue growth and margins improving to 25% the next five years), $27 per share for Marketplaces/eBay Enterprise (high-single-digit revenue growth and margins in the high 30s), and more than $5 per share in net cash.

Morningstar Premium Members gain exclusive access to our full  eBay analyst report, including fair value estimates, consider buying/selling prices, bull and bear breakdowns, and risk analyses. Not a Premium Member? Get this and other reports immediately when you try Morningstar Premium free for 14 days.