Best known for online auctions, the PayPal parent is building a diversified portfolio of Internet businesses. So why aren't investors happier?
In its television ads, eBay describes itself as the place to get "it," whatever it may be. The company deliberately leaves "it" undefined to emphasize the immense variety of goods available for auction on its site. "It" is anything a consumer can imagine. But as eBay expands into myriad new businesses—from telecommunications to social networking—some investors are puzzling over what it (eBay) is becoming.
Since shelling out $1.5 billion in 2002 to acquire online payment processor PayPal, eBay (EBAY) has aggressively expanded into areas well beyond its core business of charging people fees to auction off goods via the Internet. Over the last five years, a spate of acquisitions—some of which are just now generating significant profits—has made the company into something of an enigma. EBay is a Web auctioneer. It's an online payment processor and bank of sorts (PayPal). It's a ticket seller (StubHub). It's a global Internet telephone service (Skype). It's a classified ad service (Kijiji).
Now eBay is said to be moving into the social search business. Tech industry blogs such as GigaOm and TechCrunch are buzzing that eBay is in talks to acquire StumbleUpon, a popular site that lets users find other Web sites based on their interests and the recommendations of others. Both eBay and StumbleUpon declined comment.
The difficulty of defining eBay and how its businesses fit together partially explains the reaction to the company's first quarter earnings on Apr. 18. EBay reported profits of $377 million, a 52% increase over the prior year. Much of the growth stemmed from eBay's new businesses: "Our diverse portfolio of businesses that we began to build a few years ago is showing sustainable traction. We're extremely pleased with their results this quarter," eBay Chief Executive Meg Whitman told analysts during a conference call.
Such growth would typically impress investors. Particularly when Wall Street was predicting about $500 million less than the $1.77 billion in revenues eBay reported. But investors didn't show much enthusiasm. The stock declined 3.6% on Apr. 19 and regained just under 1% on Apr. 20.
What's troubling investors is a slowdown in the company's "core" auction business, even as other businesses post gains. (It also didn't help that IAC/InterActiveCorp's (IACI) Ticketmaster filed suit the same day over tickets sold through eBay's StubHub business.) EBay's auction business accounts for 69% of its revenue. That business grew 23% on sales of $1.25 billion, but investors have been used to growth rates of 40%. Active auction users grew 10%—a significant drop considering the category grew 25% during the first quarter of 2006 compared to the prior year. "Our concern is the core eBay business has been in a pretty steady downward spiral for several years now and it doesn't seem to be reversing itself," says Derek Brown, an analyst at Cantor Fitzgerald. Brown is recommending investors shed the stock.
The trouble with that view, say some analysts, is that it fails to see what eBay is evolving into. Tim Boyd, an analyst at American Technology Research who correctly anticipated eBay's revenues would beat the Street's expectations, sees eBay as an e-commerce and online advertising company that uses each business to fuel the other. "It doesn't make sense to look at this thing as solely an auction company anymore," says Boyd.
A Pal That Pays
Indeed, eBay sees itself as a portfolio of companies that encompasses all the activities people perform on the Internet: trade, communicate, shop, search, and entertain. The eBay bulls see it as a diversified company with a hand in each one of the Internet's cash pots.
The newer members of eBay's portfolio are gaining momentum. PayPal grew 31% on revenues of $439 million. Its user base expanded 36%, to 143 million accounts. For eBay, an initial attraction of PayPal was its potential to enable sellers and buyers to share one trusted payment service instead of registering and working with multiple merchant bank cards. Facilitating transactions is important for eBay, which makes most of its money from taking a cut of sales.
PayPal's largest growth, however, has come from outside eBay. In the first quarter of 2007, it processed roughly $11.4 billion in transactions—about $4.4 billion was on non-eBay sites. That amount was a 51% increase from the prior year. For PayPal users, the service functions as something of an online bank, delivering interest, processing transactions, and even wiring money to friends through eBay's Internet phone service Skype. "The company [PayPal] has a lot of potential," says Matthew Kelmon, a portfolio manager at Kelmoore Investment, which owns eBay shares.
EBay jumped into the communications business by acquiring Skype in September, 2005, for $2.6 billion plus stock (see BusinessWeek.com, 1/9/07, "eBay Pressured to Move on Skype"). The service posted its first profitable quarter this year, growing 123%, to sales of $79 million, and adding 101 million new users. (Skype now has nearly 200 million customers.) EBay uses Skype to lubricate transactions by making it easier for consumers to talk to sellers, ask questions, and build trust. Skype also is a leader in the market for Web phones.
In the future, eBay could merge Skype with its classified advertising businesses to serve click-to-call ads, tapping into the market for local advertising. EBay is currently exploring such a service with Google (GOOG) and Yahoo (YHOO), separately. Market researcher Borrell Associates estimates that about $8.6 billion will be spent on local Web ads in 2010 (see BusinessWeek.com, 1/29/07, "Small Biz Ads: The Year of the Web").
EBay's advertising business and other small services also posted significant growth, swelling 65% to $60 million. This business is perhaps the most complicated of all because it is not confined to simply one kind of advertising. EBay has been serving classified ads through a network of foreign ad sites, such as Kijiji and Marketplaats, as well as via its 25% stake in Craigslist (see BusinessWeek.com, 3/8/05, "eBay's Stealthy New Classified Ads Site"). It shares advertising revenue with Google, which serves search-related text ads on its non-U.S. auction pages. The company also has a wide-ranging advertising deal with Yahoo. By 2010, Internet advertising is expected to become a $27.8 billion market in the U.S. and a $29.5 billion market outside the U.S., according to a January Oppenheimer & Co. (OPY) report.
Stumbling upon New Opportunities
With such large markets available for eBay's new businesses, it is not difficult to imagine a future in which eBay's auction business no longer dominates the company. EBay sees that long-term potential, though company executives underscore that a chief objective is to "reinvigorate" the core business. An acquisition such as StumbleUpon could help eBay's auction business by leveraging its recommendation technology to suggest other specific items related to goods sellers are bidding on or have bought. Currently, eBay recommends related categories of products.
Of course, eBay also could integrate Skype with StumbleUpon, using the call features to strengthen the networking aspects of both. It could potentially integrate the service with its classified ad business, using it to recommend ads related to products people are looking for.
With the variety of businesses that are now part of the company, what is eBay? More than just auctions—that's for sure.