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eBay: Buy It Now?

By Robert D. Hof For the head of a company widely considered the Internet's biggest business success, Margaret C. Whitman likes to downplay how far eBay (EBAY) has come. The chief executive of the largest online marketplace told investors at a Goldman, Sachs & Co. conference in February that nine-year-old auction and e-commerce site has scarcely begun to get rolling.

In nearly all the markets in which eBay offers items for sale, from apparel to automobiles, she says, it has less than a 5% share. And its $2.2 billion in sales last year, up 79%, barely scratches the surface of what eBay reckons is a potential $1.9 trillion overall market. Insisted Whitman: "We are actually in the early growth years."

Humility or hubris? Either way, Whitman had better be right. Investors keep bidding up the price of her company's stock like it's an A-Rod rookie baseball card. Since the start of last year, it has doubled, to $69 a share. That values eBay at $44 billion -- more than Sears Roebuck (S), Costco Wholesale (COST), and (AMZN) combined. And with a price-earnings ratio of more than 60 based on 2004 forecasts -- which is considerably above the Standard & Poor's 500 average -- Whitman has little room for error.

GOING GLOBAL. So why do 15 of the 23 analysts following eBay -- a half-dozen more than did just three months ago -- have a buy or strong buy rating on it? Skeptics might suggest it's the Bubble Revisited. But if Whitman is right about eBay's vast, untapped opportunities -- and she likely is -- that could drive the stock yet higher. "To the extent that this growth can be maintained over the next three to four years, investors who buy [even] today should get a good return," says Legg Mason analyst Thomas S. Underwood, who has a target price of $80 in the next 12 months.

Several eBay initiatives could keep it humming. Most important is that the company is rapidly expanding around the world. Now operating in 28 countries, eBay saw international sales shoot up 96%, to $211 million, last quarter. Tops on the list: China, where eBay last year bought a local site called EachNet that was originally modeled on eBay itself.

The number of Internet users in China, already at 80 million, is expected to pass the U.S. by 2006. That growth is translating in spades to EachNet, where the number of members quadrupled last year, to 4.3 million. "We think this is a very large opportunity," says Bill Cobb, eBay's senior vice-president of international (see BW, 3/15/04, "eBay's Patient Bid on China").

FIXED PRICING. PayPal, eBay's online-payment unit, also has surpassed expectations by a wide margin since eBay bought it for $1.5 billion in 2002. The number of PayPal accounts, including both buyers and sellers, jumped 73% in the fourth quarter vs. a year earlier, topping 40 million and producing $131 million in revenues. The reason: eBay has steadily melded PayPal into the buying process, so that in many cases, auction winners and other eBay buyers can pay for items with a few quick clicks immediately after the auction closes.

Now, eBay is going a big step further: A new initiative aims to make PayPal the online payment system of choice for as many as 263,000 small and midsize Web merchants that can't afford a merchant credit-card account.

Finally, eBay has come a long way in making the once-scruffy site a cleaner, well-lighted place that appeals to the consumer masses. It has gotten more active in combating fraud, both with internal software that sniffs out patterns in listings associated with fraudulent behavior and by offering free insurance on goods that don't get delivered or aren't what was promised. To attract buyers not accustomed to auctions, eBay also has encouraged sellers to offer more items at fixed prices with the Buy It Now feature, which allows bidders to end the auction by paying a set amount. Fixed-price sales now account for 28% of gross merchandise sales on eBay.

And eBay has maintained a TV ad campaign at a time when many Web sites have downplayed traditional advertising in favor of buying placements on search engines such as Google.

STEADY PERFORMER. The result: The one-time online flea market now is vying not only with more conventional Web shopping venues such as Amazon and Yahoo! Shopping but with brick-and-mortar stores as well. "We really became a mainstream shopping destination for the holidays," says Whitman.

The potential to join Wal-Mart (WMT) in the hearts and minds of consumers isn't the only thing that's keeping investors interested. While eBay's p-e ratio may look high, it's not so high given its continuing growth rate. Scott Kessler, an analyst with S&P, notes that eBay's so-called p-e-to-earnings-growth ratio (PEG), stands at 1.5 for 2004, about the same as for the S&P 500 overall and 16% less than the S&P 500's info-tech index. Moreover, says Kessler, eBay's stock has been less volatile than the S&P 500 overall, so that big swings aren't as likely.

Despite all that, even the bulls aren't predicting barn-burning gains from here. Analysts' average target price this year is just above $74, a mere 7% higher than now. Indeed, some have already taken profits and worry that others will do the same on any negative news. Pat O'Neil, founder of Loring Investment, sold 80% of the eBay holdings in his Loring Hedge Fund in 2003. It's not that he doubts that eBay is a keeper, which is why he didn't sell it all. But he says the price has gotten out of hand for investors hoping for a short-term gain. "If something comes out to panic them, I think they'll reduce their holdings," he says, which could push the stock back below $60.

SOLID HOLDING. eBay does face a number of challenges, and if it isn't successful countering them, investors could indeed get spooked. For one thing, rivals such as Amazon have seen rapid growth of their own marketplaces, and soon-to-go-public search phenom Google has attracted thousands of merchants seeking similar access to potential buyers.

At the same time, growth in eBay's core U.S. business has gradually slowed, though revenues still rose 38% last year. While eBay's push to attract larger, branded merchants could recharge that growth, the process has been relatively slow to date.

None of those concerns appears likely to slow down eBay itself anytime soon, and the consensus is strong that this is a solid, long-term holding. But anyone hoping to see eBay's stock follow the same trajectory as its underlying growth may well be disappointed. Hof is BusinessWeek's Silicon Valley bureau chief

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