eBay a Haven in Hard Times

Economic slowdown has paid off in the past for the online auction giant.
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Fears of an economic slowdown may be taking their toll on the stock market, but a little recession may be just what it takes to jump-start eBay (EBAY) - Get Report.

That's because consumers flock to the auction giant for cheaper goods when times get tough, while sellers become more adamant about moving items that might otherwise lie around.

And the boost in both buyer and seller activity ends up helping eBay's auction business.

"So, if you want a DVD player in this economic environment, you might be happy to have last year's DVD player at 50% off retail," eBay CEO Meg Whitman told

Business Week

back in March 2001, as the U.S. economy was entering its last recessionary period. "And we see people finding things in their garage that can raise thousands of dollars in cash. So we're seeing a pickup in sellers."

Indeed, eBay got a big boost from the last recession, which lasted from March to November 2001, according to the National Bureau of Economic Research. Shares of eBay rallied 80% during that period, even as major indices, including the

Nasdaq

, the

S&P 500

and the

Dow Jones Industrial Average

, dropped.

Now, as signs emerge that the U.S. economy could be headed for another slowdown, eBay again may become increasingly attractive to investors.

This is especially true in light of the recent housekeeping done by the company. After several sluggish quarters,

eBay reported that it had regained momentum in its core auction business, which grew revenue 24% during the fourth quarter, up from 22% growth during the third quarter.

That news eased fears that its decade-old bread-and-butter business was being rendered obsolete by technological change, while vindicating management claims that fluctuations were instead driven by the mix of incentives offered to users -- and sparking a rally in eBay shares.

And far from a relic of bygone days, recent weeks have demonstrated that eBay is finding inventive new ways of tying up its deeply defensible auction business with some of the hottest new technologies on the Web. eBay is working on a deal with teen social-networking site Bebo that could bring it better exposure to a newer and younger demographic,

The Wall Street Journal

reported last week. Along with Bebo, eBay is also reportedly working with social networking sensations Facebook and Myspace.

Still, despite an attractive valuation, shares of eBay can't seem to hold onto gains. The stock trades at about 20 times forward earnings -- the lowest of any Internet giant -- and has a price-to-earnings-to-growth ratio of 1.2.

But despite gaining as much as 13% since announcing its fourth-quarter earnings in January, eBay is now up only 3% in 2007.

Much of that giveback, of course, is due to the same concerns over a slowdown that hit major indices over that period. But if fears actually do materialize, they may wind up helping eBay, as they did six years ago.

Still, eBay faces its share of challenges. The biggest will be to continue to maintain the impressive growth in its PayPal business unit despite mounting competition. Revenue for PayPal grew 37% in the fourth quarter of 2006 from a year earlier -- a rate more than 50% faster than that of eBay's auction business -- and came in at a hefty $417 million. While Skype, eBay's high-profile Internet telephony unit, grew at a blistering 164%, it contributed only $66 million during that time.

While PayPal continues to lead the online payment market, it has plenty of room to grow, PayPal President Rajiv Dutta said in an interview. An impressive two out of five U.S. Internet users already have a PayPal account, but the service accounts for less than 10% of total e-commerce volume. And despite growing at a healthy clip, e-commerce accounts only for less than 4% of the volume in retail.

But PayPal will face intense competition as it sets out to extend its lead during 2007. In January, at the World Economic Forum in Davos,

Microsoft

(MSFT) - Get Report

Chairman Bill Gates announced that the software giant is considering entering the online payment market.

However, the most immediate pressure will come from

Google

(GOOG) - Get Report

, which has been aggressively pushing its Checkout payment service with promotions and prime advertising territory on its home page and in its search results.

Google revealed that it had spent $58.4 million promoting Checkout in 2006, and previously had indicated that approximately $30 million of that was spent in the fourth quarter alone. The company also said that its cost of revenue likely would increase in 2007, meaning that it could be backing Checkout even more aggressively over the next year.

eBay is quick to play down the threat posed by Checkout. During the company's fourth-quarter conference call with investors, Whitman said that the high-profile service actually may have helped PayPal because of the publicity it generated about online payments.

Dutta points out that Checkout falls short of being a payment service and is merely a quicker way for people to use their bank or credit cards with merchants. And Google hardly aims to replicate PayPal's business model with Checkout.

But despite the differences, PayPal and Checkout offer consumers a common, attractive feature: an easy and safe way to make transactions on the Internet. And while Google's biggest hope with Checkout is to drive more ad sales by bringing more merchants into its fold -- and not to make money off payments directly like PayPal -- that is hardly a respite for eBay either.

For Google, it's imperative to bring in new advertisers and continue to grow sales at a breathtaking pace. After all, the company took a hit after showing that quarterly growth wasn't what it used to be, despite

reporting a fourth quarter that outstripped Wall Street expectations.

And with more than $11 billion in liquid assets and twice the quarterly revenue of eBay, Google has the resources to make its presence felt -- even if it isn't intending to pull the rug out from under eBay.

PayPal, for its part, isn't planning to stand still. Along with expanding services in new countries and extending its outreach to merchants, it's also experimenting with innovations, such as letting users send funds to each other through their Skype clients.

PayPal's performance was crucial to buoying eBay as it sorted through its teetering auction business. In the event of an economic downturn and with more heat from Google, though, it may be eBay's auction segment that comes through with an expected kick.