Why A Big-Spending eBay Is A Bummer

See the latest eBay (EBAY ) ads. Take a deep, cleansing breath. "People are good," the ads say. "They're joining a community where anything is possible if we all put our mind to it, and believe. EBay. The Power Of All Of Us." A nation, a world that we lately have found so harshly divided can be, on eBay, joyfully one.

If this were 1954, someone would call it a commie plot. Instead, Planet Earth's biggest flea market aims to be our common denominator. (Whether it's our lowest, I'll leave to you; to me, it's a mystery how the Age of Aquarius turned into the Age of Auctions.) As a business, anyway, eBay has made much progress. Next year, when it turns all of 10 years old, eBay expects $4.2 billion in revenue and nearly $1 billion in net income. The stock, a split-adjusted $1.50 at its 1998 initial public offering, recently topped $110. Powering that move -- and differentiating eBay sharply from busts of the Internet bubble -- was steady growth in cash flow. Even after capital spending and what little it spent on acquisitions, eBay generated megabucks to spare.

UNTIL NOW. EBAY'S most recent financials reveal a notable development in how the company is seeking future growth. You can see what I mean in the table below. Since 2000, each year has brought smart increases in eBay's cash from operations, minus capital spending and acquisitions. Last year, the surplus came to $292 million. But this year through Sept. 30, eBay had spent $10 million more in cash than it generated. In the comparable 2003 period, it had a surplus of $230 million.

What's going on? Acquisitions. In April, eBay spent $152 million to buy a German classified advertising site, mobile.de. In August, it paid $50 million for Baazee.com, an auction site in India. A month later, it raised its stake in a Korean trading site, Internet Auction, to 97% from 62% at a cost of $485 million.

Lifted by holiday shoppers, the current quarter will surely swell eBay's cash flow. But eBay also is shopping. In October, it bought most of Internet Auction's remaining shares for $37 million. On Nov. 11, it announced a $290 million deal for a Dutch classifieds site, Marktplaats.nl. Whether eBay ends 2004 having generated more cash than it used is questionable. Beyond doubt is that cash flow after capital projects and acquisitions this year will plunge below levels the past two years.

Don't get me wrong. EBay is itself in no financial danger. Its balance sheet shows nearly $2.1 billion in cash and short-term investments against less than $125 million in borrowings. So it plainly can afford this shopping excursion. Just the same, accelerated outlays raise a couple of warning flags for those investors who have vaulted the company's market value above $73 billion, past even American Express (AXP ), never mind such humdrum retailers as Target (TGT ) ($46 billion) or Amazon.com (AMZN ) ($16 billion).

First, the aim of anybody who owns a business is to get cash out of it. EBay easily could pay cash dividends to investors now but believes it can make the capital grow faster internally. "We expect to return excess cash to our shareholders at one point in the future," a spokesman told me via e-mail. "However, considering eBay's stage of growth, we don't believe that point is right now." Second, taking eBay's surplus cash and spending it on mostly foreign Internet sites could pay off as nicely as investing in its original domestic business has proved. But those potential rewards come at higher risks. In Taiwan, for example, eBay's auction site is locked in the kind of market-share war it never faced at home.

So, yes, go ahead. Take a deep, cleansing breath. Join the eBay believers: People are good. Just remember that when people elect to pay 17 times next year's sales and 75 times next year's earnings, they're usually good and stupid.

By Robert Barker

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