By Technology Research Group eBay's (EBAY) 10-K filing did little to change our bearish stance.
Revenue growth is slowing (2% vs. 11% in 2008). Margins are getting pinched. Cost-containment measures are readily apparent. Financial reporting remains far from conservative. Profits for 2009 were inflated by a series of income-accelerating items. Without these non-operational gains, net income would come in nearly 70% below reported levels.
Recurring restructuring charges, liberal use of discretionary expense accruals and weak revenue deferrals round out a list of earnings management concerns. Providing guidance in pro forma terms aggravates matters. Key takeaways can be summarized as follows:
- Normalizing expense capitalization, valuation allowances (as a percentage of asset balance), NOL utilization, restructuring reserves, one-time gains and deferred revenue would pull EPS down to 56 cents for the year (vs. $1.83 as reported).
- Return on equity falls to 5.4% (vs. 17.3% as reported) in sustainable operating terms.
- Cash flow is up only 1% for the year and highly uncorrelated with net income.
- Expense accruals jumped to $982 million (27% of current liabilities) from $785 million (17.4%) in 2008; usage conservative in absolute terms; direction of change worth noting; magnifies cash flow deceleration. .
- Consensus estimate for 2010 falls by 23% when measured on a fully expensed basis (GAAP estimate = $1.28 per share, pro forma = $1.67 per share).
- Pro forma estimates overstate profitability and understate valuation multiples.
Valuation and RecommendationShares are up 93% over the past 12 months and valued at 13 times trailing GAAP earnings (note: valuation depressed by one-time gain in the fourth quarter of 2009; normalizing inverted EPS variance would put P/E right around 19). Comparable online marketplace provider Amazon.com (AMZN) trades at roughly 58 times. Whether Amazon.com deserves such a lofty appraisal is open to debate. Earnings management is conservative. Operating trends are in much better shape. A fairly substantial premium would seem warranted. eBay's erratic financials should constrain upside. Downside volatility could be substantial. We reiterate a sell rating and $19 price objective. Target multiple moves to 12 times forward earnings from 14 times to reflect shift to pro forma estimates.
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