eBay: Double-Digit ROE Still Sustainable

Summary

• We expect its promoted listings revenue to cannibalize marketing services revenue, but we believe its superior revenue growth could lead to a net positive impact by 2022.
• We forecasted eBay’s resale GMV as a percentage of total GMV to grow from 9% in 2020 to 16% in 2025, benefiting from the high growth resale market.
• eBay has had an average return on equity of 43.9% over the past 10 years from 2011 to 2020, which we still see sustainable at around 30% per year.
• We expect its share buybacks from its FCFs to decrease in 2022 following the sale of its 2 business segments over the past 4 years.
• With a revised revenue projection for 2021 taking into account its marketing services and other revenues growth, we have obtained an upside of 26.07% based on DCF analysis.

From our previous coverage of eBay Inc (EBAY), stock has dropped by 12% from $74.02 to $65.14. In Q3 2021, eBay's revenue declined by -6.23%. In this analysis, we examined eBay's product listings initiatives, the company's resale GMV growth and its ability to conduct share buybacks. In our previous analysis, we examined its GMV growth which we forecasted to remain steady through 2025 despite its declining buyer base as it focuses on high-value buyers. Moreover, we highlighted its transition to Adyen (OTCPK:ADYEY) for payment processing with lower cost compared to PayPal (PYPL) resulting in the increasing take rate of its GMV. Lastly, we also highlighted its consistent free cash flow as the company has a low capex business model as a 3P e-commerce platform.

eBay has been shifting its advertising segment towards promoting items on its platform instead of redirecting to third-party platforms. While this shift has cannibalized its revenue from third-party ads, we determined that the incremental revenue generated would outweigh the cannibalization effects. Additionally, we analyzed eBay's resale GMV and expect that it could increase as a share of eBay's total GMV to 32% by 2025. Lastly, we analyzed its FCFs and expect buybacks to normalize following the sale of its business segment. Overall, we have a Buy recommendation for eBay using DCF analysis with a projected decrease of shares outstanding as we expect the company to continue with future share buybacks.

Promoted Listings Revenue Contribution Outweighs Impact From Cannibalization

eBay's promoted listing revenue grew by 19.47% in 2021. This is in line with the shift in the advertising strategy eBay has been pursuing since 2019. eBay has been gradually shifting its advertisement strategy from allowing third-party advertisers on the website which is under the marketing services segment, to providing sellers on the platform the ability to advertise their own products contributing to the promoted listing revenue of eBay. However, with decreased advertising space for third parties, its Marketing Services segment has declined by 1.4% over the past 5 years.

In Q2 2021, only 1.4 mln out of 19 mln sellers use the promoted listing feature on eBay. We believe this indicates the potential to grow as more sellers explore the offering on eBay. We projected the revenues from third-party ads based on the three-year average growth rate. For the promoted listings, we annualized 2021 revenues based on the first three quarters. From 2022 onwards, we assumed revenues to increase by $142.33 mln each year based on the 2021 revenue increase.

As of 2020, 1.82% of the revenue has been contributed by the increase in promoted listing revenues offset by the third-party advertising revenue under marketing services and other revenues. Based on our projections, while we expect the cannibalization to continue moving forward, we expect promoted listing revenues to be higher than marketing services revenue from 2022 onwards having a net positive impact on the company. Overall, we believe this could generate a net positive revenue impact for the company even as it cannibalizes its third-party ad revenue. Furthermore, we believe this strategy could allow eBay to generate more GMV related revenue as it would keep more customers on its site instead of driving traffic away to external platforms.

eBay's Refurbished Program Focuses on High Growth Resale Market

In November 2021, eBay permanently launched an offering for the sale of refurbished goods, eBay Refurbished. Further, following the successful test launch in the previous year, eBay extended it to include multiple condition grades for products sold along with a warranty with each purchase refurbished product.

According to the World Resource Institute, one of the indicators of the rise of the resale market is digital platforms using their marketplaces to sell resale products online while initiatives such as Platform for Accelerating the Circular Economy (PACE) are expected to spur the growth of the circular economy. Furthermore, the global supply chain issues are believed to have helped the secondhand market as:

this may be the perfect scenario for resale, which relies on inventory already in the seller's hands. - Roxanne Mayer, MKM Partners.

GlobalData forecasted the e-commerce resale market to reach $121.4 bln by 2025 at a CAGR of 16.81%, higher than the total retail e-commerce market that is forecasted to grow at a CAGR of 12.66%. A reason for this according to a consumer survey by Zogby Analytics is that 74.6% of consumers purchase secondhand goods to save money. According to Choose to Reuse, secondhand goods are estimated to be about 50% cheaper than new goods. On the merchant side, the primary method used for secondhand selling is online at 66.5%.

In 2020, an average of 75% of eBay customers worldwide had purchased secondhand goods. As secondhand goods are 50% cheaper than new goods based on Choose to Reuse, we calculated eBay's GMV per buyer for secondhand goods to be $75.68 in 2020 which is 50% of the average GMV per buyer as per our previous analysis. The average resale GMV per buyer was multiplied by 75% of eBay customers worldwide to obtain eBay's resale GMV in 2020. We then forecasted eBay's resale GMV to grow at the same rate as the e-commerce resale market until 2025. The forecasted market growth rate was assumed to account for eBay's Refurbished program. Overall, we forecast eBay's resale GMV as a percentage of total GMV to grow from 9% in 2020 to 16% in 2025.

Buybacks Expected to Support ROE

eBay has had an average return on equity of 43.9% over the past 10 years from 2011 to 2020. The company has an exceptionally high 10-year average net income growth of 399% from 2011 to 2020 contributed by income from discontinued operations from 2018 to 2020. The average equity value growth of -7.63% in the same period with the company repurchasing an average of $3,245 mln worth of common stock per year from 2011 to 2020.

However, net income includes income from discontinued operations from the Classified Business ($10.4 bln in 2021) which impacts the ROE (10-yr average of 43.9%). Thus, we derived a return on operating income instead to account for the income from discontinued operations. This translates to a 10-yr average of 28.24%, which is still very high. From 2022 onwards, we see the operating income over equity value increasing year on year even without the income from discounted operations, due to the share buybacks

From 2018 to 2020, eBay had the capability to utilize its free cash flow to conduct share buybacks as its free cash flow increased. Further, eBay has been actively buying back shares and as of Q3 2021, the company has increased its estimated 2021 share buyback from $5 bln to $7 bln as eBay acquired extra cash from the sale of its businesses. We believe that eBay could utilize the additional cash to continue buying back shares.

Moving forward, we have projected eBay's free cash flow. We do not expect eBay to maintain its share buybacks in 2022 following the sale of its businesses in previous years. We estimate the share buyback relying solely on our projected free cash flow to be at $2,063 mln.

Risk: Decreasing Cash to Debt Ratio

eBay's cash to debt ratio has declined over the past decade from 0.52 in 2011 to only 0.09 in 2020. Although the company has divested businesses in the past, it did not improve the cash to debt ratio due to the higher focus on share buyback.

Based on our forecasted EBIT, we estimate its debt payment to be 73% of EBIT in 2022. However, beyond 2022, we forecast its debt payments as a % of our projected EBIT to decrease to 30% by 2025. Hence, we believe the company may be able to meet its debt obligations in the future even though the cash to debt ratio has been on a decline.

While eBay had negative net income in 2017 due to $3.3 bln of income tax provision, the company has generally stable 5-year average revenue growth of 4.2%. The company has a high 5-year average gross margin of 76.8% due to its lean business model which does not carry any inventory. Additionally, the company was also having a high net margin of 34.60% on average from 2016 to 2020.

We have continued using DCF analysis to value eBay as we did in the past analysis as we still expect the company to generate stable free cash flows. The company's terminal value is based on industry average EV/EBITDA of 26.09x based on selected e-commerce marketplaces.

We estimated the 2021 Transactional and Marketing services and other revenues in 2021 based on the prorated Q1 to Q3 2021. Our projection for transactional revenue remains the same as our previous analysis which uses forecasted number of buyers growth and GMV per buyer. Whereas for Marketing services and other revenues, we expect it to decrease at a 3-year average from 2018 to 2020 at 13.4% through 2025. Also, we accounted for the divestiture of eBay Korea by subtracting out its estimated revenues as covered in our previous analysis.

Based on the assumption that eBay could repurchase its common stock in 2022 using its entire free cash flow, we have divided the $2,063 mln by its share price of $65.14, thus having a decrease in shares outstanding of 31.67 mln. The new shares outstanding based on our assumption is 594.33 mln shares.

Based on the discount rate of 10.5%, our DCF model shows a 26.07% upside.

Verdict

With the shift from providing advertisements for third-party platforms, eBay provides sellers with the opportunity to promote their products on eBay's platform itself. We estimated the increasing cannibalization from promoted listings towards third-party advertising to provide a positive impact on revenue of $33.63 mln in 2022 and to increase to $71.82 mln by 2025. Besides that, we believe eBay's refurbished goods sale could benefit from the higher growth compared to the total retail e-commerce market with increasing consumer preferences towards secondhand goods and the ability to tackle the issue of global supply chain with inventory available. We estimated eBay's resale GMV could account for 16% of total GMV by 2025. Furthermore, eBay's free cash flow has increased from 2018 to 2020 with the sale of its discontinued operations and used for share buybacks but we expect it to normalize in 2022 onwards. Excluding the income from discontinued operations, our forecast shows eBay increasing its ROE to 23% by 2025. We have revised our revenue projections and by assuming that eBay continues buying back its shares in 2022, we rate this stock as a Buy recommendation with a price target of $75.06.