At the Top of the Heap, eBay Still Must Look Down - TheStreet

At the Top of the Heap, eBay Still Must Look Down

Why Yahoo!'s Overture acquisition could give eBay its greatest threat yet.
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With

eBay

(EBAY) - Get Report

preparing to report second-quarter earnings on Thursday, the company's stock price suggests that investors expect smooth sailing. But the water may be about to get a little choppy.

If history is any guide, eBay's earnings will beat Wall Street expectations, and the company will raise its guidance. That's what investors seem to expect, as eBay's stock is now trading at more than 75 times its projected 2003 pro forma earnings.

But investors may be overlooking a growing new threat to the company. Some analysts see

Yahoo!'s

(YHOO)

proposed acquisition of Overture as the first shot in a second round of competition for eBay. While no one expects eBay's ship to be sunk in the coming battle, the competition does have the potential to trim eBay's future revenue and earnings, analysts say.

Yahoo! combined with Overture "has the potential to definitely eat into eBay's world," said Carrie Johnson, an e-commerce analyst for consulting firm Forrester Research. "This is a legitimate threat, and one that eBay, I'm sure, has its eye on pretty closely."

eBay has faced down plenty of previous threats. In what some consider the company's first wave of competition, for instance, it blew out of the water auction competitors such as Yahoo!,

Amazon.com

(AMZN) - Get Report

and Onsale.

eBay emerged from such competition as the dominant player in online auction and as one of the best-positioned companies in e-commerce. Unlike many of its Internet rivals, the company has consistently posted profits -- although without including stock options expenses -- and surging revenue.

In the first quarter, for instance, the company reported earnings of $104.2 million, or 32 cents a share, on $476.5 million in revenue. That was up from the same period a year ago, when eBay earned $47.6 million, or 17 cents a share, on $245.1 million in sales.

Even including the cost of options, eBay would still have seen its earnings jump, going to $76.8 million, or 24 cents a share, in the first quarter, from $1.2 million, or zero cents a share, in the year-ago period.

eBay projected it would earn 30 cents a share -- 33 cents a share pro forma -- in its just-completed second quarter on sales of up to $500 million. That compares with the same period last year, when it earned $54.3 million, or 19 cents a share, on $266.3 million in revenue. Last year's results do not include earnings or revenue from PayPal, which eBay bought last fall.

Meanwhile, analysts are expecting eBay to report 35 cents a share in pro forma second quarter earnings on $505.9 million in sales.

King of the Mountain

eBay's continuously strong financial performance has helped send its stock surging this year. Since the beginning of the year, the company's shares have gained 62.4%, ending the day Friday at $110.11.

So far this year, nothing has seemed to slow down eBay's financial performance -- or its stock gains. The company and its investors have shrugged off a potentially costly loss in a

patent suit , questions about its prolific use of

stock options and competition in its fast-growing

automobile auction area from an erstwhile partner.

But the developing second wave of competition may be more difficult for the company to ignore.

In recent years, much of eBay's growth has come from fixed-price sales, where merchants sell for a set price, instead of putting goods and services up for bid. In the first quarter, for instance, such transactions comprised 26% of the total sales conducted through eBay's site, up from 19% of total sales in the year-ago quarter. About 37% of the year-over-year growth in sales conducted through eBay in that quarter came from an increase in the adoption of fixed-price transactions.

The increasing importance of fixed-price sales has made eBay look less like an auction site and more like a mall or shopping search engine. But eBay's format stresses a uniform appearance, so it can be difficult for sellers to stand out or to showcase listings.

That limitation and others have left an opening for competitors, analysts say.

The Threat

Facilitating actual transactions has proved profitable for eBay, since the company gets a commission of up to 5.25% for each item that's sold on its site and up to 15% for items that are sold through its fixed-price Half.com site.

The reason why Overture, combined with Yahoo!, represents such a threat to eBay is that many of the 88,000 merchants who advertise on eBay also advertise on Overture -- and Overture is an important expense for them, according to analysts.

Some have estimated the amount of sales by merchants through the combination of Yahoo!'s and Overture's offerings total about half to two-thirds that of eBay.

By buying Overture, Yahoo! can market its store-hosting service, its auctions and its shopping area to Overture's clients, opening up the possibility of earning a listing fee and transaction fee from clients.

Google, MSN and AOL are likely to move in similar directions, attempting to tie their sponsored listings to actual transactions, analysts say.

Calling the Big Dogs

The most important new class of clients for eBay and its potential competitors are large enterprise customers, some analysts say. These are the

IBMs

(IBM) - Get Report

and

Dell Computers

(DELL) - Get Report

of the world that are looking for new outlets to sell new products and liquidate old ones.

Right now, eBay can be difficult for big companies to use, as they fear of saturating the market. Also, eBay's background and ethos of favoring of small-scale sellers mean the site has few ways of allowing big sellers' listings to be presented prominently.

That notion is something the company might want to revisit if it hopes to attract more listings from more enterprise customers, said Scot Wingo, CEO of closely held ChannelAdvisor, which helps large-business customers list items on eBay and other marketplaces.

"Right now eBay, by far, is the best option out there," said Wingo. "But if there were other channels, a lot of customers would be open to selling a certain percentage on eBay and a certain percentage (elsewhere)."

But catering to large businesses could well alienate smaller sellers.

Given a viable alternative -- and more intense competition from enterprise customers -- they also might spend some of their marketing dollars elsewhere.

"I think you will see some small sellers move away from

eBay's platform," said Johnson.

To be sure, eBay is hardly dead in the water. eBay has 31.1 million active users and blanket name recognition. And, as Wingo notes, eBay's potential competitors have problems of their own. By combining with Yahoo!, Overture could well lose its distribution on MSN, Lycos and other networks, sacrificing some of its utility to merchants. Further, Yahoo! could alienate merchants if it gives too much preference to those who use its services.

Even if merchants start spending marketing dollars on other sites, they'll likely continue to spend money on eBay, said Johnson. With eBay, merchants essentially pay for performance. And they'll keep on paying, as long as they keep on selling, she said.

Meanwhile, at least for now, eBay and the search engines often reach different audiences, Johnson said. The shoppers who turn to eBay are often the most experienced consumers online, while those that shop through search engines are often new to e-commerce, she said.

"I don't know that it's going be that one replaces the other," Johnson said. "Both will serve a pretty valuable role."