3 Takeaways From eBay's Quarter

We see three takeaways from narrow-moat eBay's EBAY third-quarter update, the company's first since the departure of CEO Devin Wenig.

First, competitive and regulatory (sales tax collection among small sellers) headwinds are likely to pressure gross merchandise volume growth, partly neutralize efficiency plans, and keep revenue and operating profit growth confined to the low- to mid-single-digit range near term. EBay's updated 2019 outlook for revenue of $10.75 billion-$10.80 billion (2%-3% growth) and adjusted earnings per share of $2.75-$2.78 strikes us as realistic, as does its initial 2020 outlook for low-single-digit revenue and EPS growth. We expect modest acceleration in subsequent years due to advertising and payments, but it's still difficult to identify a tangible path to matching the low-double-digit growth we expect from the global online commerce industry.

Second, there will be few shifts in strategic priorities under interim CEO Scott Schenkel, with an emphasis on enhancing eBay's buyer and seller experience (prioritizing buyer retention) and developing nascent payment intermediation and advertising businesses. We like that the company is moving forward with its operational efficiency plan--focusing on marketing, research and development, corporate, and procurement optimization--which is expected to drive 2 points of additional margin expansion in the next two years, implying 30% margins by 2021.

Third, despite searching for a permanent CEO, eBay appears to be moving ahead with the sale of StubHub, with management planning to share "an update on the StubHub business before the next earnings release" (late January). We also believe eBay will eventually sell its Classifieds business, though this process will probably take longer and may involve multiple transactions and geographies.

Weighing the various moving parts, we plan to maintain our $38 fair value estimate, as the contribution from marketplace improvements will be offset by competitive and regulatory headwinds.

While we see the potential value unlocked by the sale of eBay Classifieds and StubHub, the impact on our fair value estimate will ultimately depend on the sale price (for reference, activist investor Elliott Management previously valued the businesses at $8 billion-$12 billion and $3.5 billion-$4.5 billion, respectively), how the transactions are structured, and use of proceeds. Despite this opportunity to unlock shareholder value, we still see greater upside for investors in Amazon AMZN.

Dissecting eBay's financial outlook further, the company's fourth-quarter guidance--$2.77 billion-$2.82 billion in revenue (representing a decline of 2%-4% on a reported basis and between a 1% decrease and 1% increase on a currency-adjusted basis) and adjusted EPS of $0.73-$0.76--appears realistic even after factoring in continued sales tax collection issues, which accounted for roughly half of the 6% year-over-year decline in U.S. gross merchandise volume and should persist through the first half of 2020. The company's updated full-year guidance--revenue of $10.75 billion-$10.80 billion (down from $10.75 billion-$10.83 billion due to sales tax collection and foreign currency translation and representing 2%-3% growth on a currency-adjusted basis), adjusted operating margins of 28% (reaffirmed), adjusted EPS of $2.75-$2.78 (up from $2.70-$2.75 due to buybacks)--also seems achievable.

Management's preliminary 2020 outlook for low-single-digit revenue and EPS growth also appears appropriately conservative, with competitive and sales tax collection headwinds neutralizing advertising and payment momentum. Management's targets for advertising (which it expects to generate more than $700 million in revenue during 2019 and $800 million in 2020) and payments (which is still expected to contribute $2 billion in revenue and $500 million in operating profit by 2022) should add 3 points of revenue growth in 2020, with much of the benefit coming in the second half of the year. However, much of the benefit will be offset by the aforementioned sales tax collection issues (which could affect eBay's U.S. business longer than management anticipates), foreign currency translation stemming from a stronger U.S. dollar, and the lingering impact of the divestiture of German flash sale site brands4friends. The company's operational efficiency plan should drive some margin benefit in 2020--our preliminary model calls for about a point of expansion to 29%, even after accounting for advertising and payment investments--but the EPS impact will be muted by roughly 7 points due to foreign currency, reduced interest income based on lower cash balances, and a higher tax rate.