eBay Gets Benefit of the Doubt

The company's guidance falls short of estimates, but investors focus on quarterly revenue growth of 52%.
Author:
Publish date:

Updated from 9:49 a.m. EDT

Shares of

eBay

(EBAY) - Get Report

rose more than 7% as investors took in stride the company's restrained earnings guidance and focused on standout third-quarter results.

That view was reinforced by a couple of analyst reports issued on Thursday morning. Noting the accelerated third-quarter revenue growth of the company's international business, as well as the company's penchant for giving conservative earnings forecasts, Friedman Billings Ramsey analyst Shawn Milne, for instance, upgraded his rating on eBay's stock to outperform from market perform.

"We believe business trends are better than expected despite initial

2005 guidance," Milne said in his report. "Moving into the seasonally stronger

fourth and first quarters, we believe near-term data will be positive for the stock," he added, raising his price target on eBay's stock to $105 a share from $90.

(Friedman Billings Ramsey does not have investment banking business with eBay.)

In his own note, American Technology Research analyst Mark Mahaney echoed Milne's comments. Dubbing eBay "the best Internet stock to buy now," Mahaney reiterated his buy rating on the company's shares and upped his price target on the company's stock to $107 from $105.

"We would put new money to work in eBay right here," Mahaney said. (American Technology Research does not do investment banking.)

With those kinds of endorsements, eBay's stock was up $6.55, or 7.2%, in recent trading, to $97.91.

The online auction giant reported earnings of $182.4 million, or 27 cents a share, in the three months ended Sept. 30, up from earnings of $103.3 million, or 16 cents a share, last year. Sales jumped 52% from a year ago to $805.9 million.

Excluding amortization costs, payroll taxes related to options exercises and other costs, the company earned $195 million, or 28 cents a share, in the 2004 quarter. On that basis, analysts polled by Thomson First Call were expecting eBay to post a profit of 27 cents a share on sales of $779.9 million.

Back in July, the company projected it would earn a pro forma 25 cents a share on sales of $770 million.

For the fourth quarter, the company projected it would earn 30 cents a share -- 32 cents a share excluding charges -- on $915 million in sales, $29 million higher than its previous guidance. Analysts were pegging EPS at 33 cents and revenue at $906.6 million in the quarter.

For 2005, eBay expects to earn $1.42 a share -- $1.50 a share excluding charges -- on sales of up to $4.2 billion. Wall Street had forecast earnings of $1.60 a share on sales of $4.29 billion.

The stock surged despite the mixed long-term picture, recently rising $5.42, or 5.9%, to $96.78.

eBay could earn more in 2005, but the company plans to invest some $200 million next year in "key, strategic investments," company CFO Rajiv Dutta said in a conference call. Among those initiatives are an effort to boost the marketing of its Chinese auction site and continuing its international expansion of both its auction and online payment services, Dutta said.

"Our philosophy has been to take a certain amount off of our incremental leverage and invest it back in the business. That's not a new philosophy. That's what we've been doing for many years," he said. "We think that's the appropriate thing to do."

Still, analysts noted that the company is often conservative in its first forecasts of coming-year earnings. Last October, the company predicted in 2004 it would earn 91 cents a share -- 98 cents a share excluding charges -- on $2.9 billion in sales. Now the company expects its full-year earnings to be $1.14 a share -- $1.20 a share excluding charges -- on $3.25 billion in sales.

Over the last two years, eBay's earnings have been about 30% better than its initial projections, while revenue has come in 17% better than the company's earliest guidance, Milne said in his note.

Still, Milne and other analysts did not take into account stock options costs, which eBay currently chooses to ignore in its income statements. But a prospective accounting rule would require all companies to expense options beginning next year.

eBay has not yet disclosed how much options costs would have depressed its third-quarter results. (It typically releases those figures in its

Securities and Exchange Commission

filings.) And it didn't include options costs in its 2005 guidance.

In the first half of this year, options expenses would have reduced eBay's earnings by about $39.6 million, or 6 cents a share, the company estimated. That charge would have made its earnings about 10% lower than it actually reported.

In addition to a forecast below analysts' expectations, eBay gave further ammunition to those who

question whether its growth rate can support its sky-high stock price.

As has been the case in recent quarters, eBay's results benefited from the decline of the dollar vs. other major currencies. That decline helped swell the dollar value of its overseas sales and profits.

eBay estimated that the dollar decline added about $22.3 million to its top line and about $9.9 million to its operating income. Without those benefits, the company's bottom line would have been in line with analysts' estimates, while its top line would have just beaten expectations.

Additionally, the pace of growth of two of the company's three major business segments dropped in the third quarter, suggesting that the company may be starting to mature.

The revenue that eBay gets from the auctions and listings run through its U.S. site grew by 29% in the third quarter from a year earlier. While many companies would envy that growth, it was the slowest rate of growth in at least five quarters for the company, and significantly off the 41% year-over-year growth rate the company posted in the year-ago period.

Meanwhile, revenue from online payment transactions via the company's PayPal service grew by 56% -- again, the slowest rate of growth for that business in at least five quarters.

eBay did see its revenue growth from international auctions and listings pick up in the quarter, growing at an 82% rate over the third quarter last year. While that was down from the 105% growth rate the company recorded from its international transactions in the year-ago quarter, it was up from the 76% growth rate the business segment posted in the second quarter.

But the growth rate for international transactions was likely boosted by the effect of foreign exchanges rates.

The number of item listings on eBay's sites per user declined in the third quarter, noted Pacific Growth Equities analyst Derek Brown in a research report issued Thursday. So, too, did per-user gross merchandise value, which represents the gross amount of goods and services sold through eBay's sites, Brown said. Data such as these may indicate that eBay's business may be starting to experience "fatigue," he said.

"We continue to caution investors in light of eBay's full multiples, lingering signs of possible platform 'fatigue' we see in eBay's core business, as well as feedback we have received from the channel and changes we are seeing in the competitive landscape," Brown said.

The analyst reiterated his underweight rating on eBay's shares.

(Pacific Growth does not have investment banking business with eBay.)

Still, eBay has much to crow about. Its sales for the year to date are up 54% from the same period last year. Meanwhile, its earnings per share are up a whopping 83% over the same period.

And the company showed in the third quarter its continuing ability to keep a lid on costs, even while its revenue balloons.

eBay's gross profit margin, which represents the difference between what the company charges customers for its services and its direct costs of providing those services, jumped to 80.5% of sales in the quarter, up from 79.4% of sales in the year-ago period. In the meantime, the company's operating margin swelled to 31.5% of sales from 29.4% in the third quarter last year.

The company's gross margin expanded even though its fast-growing PayPal business has lower profit margins than its auction business, Dutta noted.