eBay Investors Hard to Please - TheStreet

eBay Investors Hard to Please

The shares lose almost 5% despite the company's reporting a doubling of quarterly earnings.
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Updated from July 24

Shares of online auctioneer

eBay

(EBAY) - Get Report

fell more than 3% on Friday after an analyst downgrade and a warning that the company won't meet Wall Street's third-quarter expectations.

Despite doubling its second-quarter earnings, eBay left some questions for investors and analysts. About 9% of its year-over-year revenue growth came from the declining dollar; the company did not say how foreign exchange rate changes affected its bottom line.

Meanwhile, the company saw increased seasonality and a jump in capital expenditures in the quarter. And the e-commerce giant warned that its third-quarter earnings won't meet its previous guidance or Wall Street expectations.

"While management's tone was positive in discussing (the company's second-quarter) performance, their guidance and outlook for the remainder of the year was tepid," wrote First Albany analyst Youssef Squali in a report issued on Friday.

Squali downgraded eBay from a buy to neutral in his report. (First Albany does not have any investment banking business with eBay.)

Given that it's trading at 84 times its own projected 2003 GAAP earnings, eBay's stock has little room for questions -- or errors.

Before the company's earnings report, eBay shares ended regular trading on Thursday at their highest closing price since the dot-com bust. But following the report, the company's shares traded down in the after-hours markets and for most of the day Friday.

eBay shares fell as much as $6.63, or 5.7%, in regular trading Friday, but a late rally brought prices back up. The company stock closed down $3.50 to $112. 24.

Meanwhile, the company announced a 2-for-1 stock split that will go into effect next month.

The e-commerce leader earned $109.7 million, or 33 cents a share, in its just-completed quarter, on $509.3 million in sales. In the year-ago quarter, the company earned $54.3 million, or 19 cents a share, on revenue of $266.3 million.

The year-ago numbers did not include the results of PayPal, the online payments company that eBay acquired last fall. Neither this year's nor last year's results include the expense of stock options, a cost that eBay has chosen not to recognize on its income statements.

Pro forma earnings, a metric that excludes the amortization of intangible assets and other noncash charges and is primarily useful for its comparability to analysts' estimates, were $120.9 million, or 37 cents a share.

Analysts surveyed by Thomson First Call were expecting the company to post pro forma earnings of 35 cents a share on sales of $505.94 million. eBay's guidance called for 30 cents a share in earnings -- 33 cents per share pro forma -- on sales of up to $500 million.

On the heels of its strong performance, eBay raised its revenue guidance for the rest of the year and increased its earnings outlook for the fourth quarter. Still, the company warned that third-quarter results may fall short of analysts' projections.

The company now expects to earn 29 cents a share -- 34 cents pro forma -- on $515 million in sales in the third quarter. The GAAP earnings number is down a penny from the company's previous guidance. Meanwhile, the pro forma earnings number is a penny below analysts' current expectations, according to Thomson First Call.

eBay's revenue guidance for the quarter is $5 million above its previous estimates. However, analysts were projecting third-quarter sales of $518.21 million.

For the fourth quarter, eBay projects it will earn 36 cents a share -- 40 cents pro forma -- on sales of $564 million. The company had previously projected GAAP earnings of 35 cents a share in the quarter on sales of $564 million. Analysts were calling for 40 cents a share in pro forma earnings on $584.39 million in sales for the fourth quarter.

eBay's stock split comes as the company's shares have risen 70.7% since the end of last year, coming within striking distance of the company's all-time high of $127.50 set during the dot-com boom. The split is the company's third, but the first since May 2000, not long after the company set its all-time high.

Slowing Growth

eBay's revenue in the quarter benefited from strong sales across the board. However, the company's growth rate slowed in the quarter in its core marketplace business, while the addition of PayPal and the decline of the dollar against foreign currencies also helped boost sales.

Revenue from the company's core U.S. site increased 44.7% from the year-ago quarter to $242.4 million. While that growth rate would be the envy of many businesses, it represented the slowest year-over-year rate of quarterly growth in the last five quarters.

Meanwhile, revenue from the company's international sites in the quarter increased 145.9% year over year to $155.2 million. Again, the revenue growth, while impressive, was the slowest the company has posted in at least the last five quarters.

The company's international results were boosted by the decline of the dollar. If currencies exchange rates had remained the same as last year, eBay's net revenue would have been $23.2 million lower than the company reported. Company representatives did not return calls seeking information about how much foreign exchange rate changes benefited its bottom line.

On a conference call with investors and analysts, company officials said they were unconcerned about the slowing growth rates. Officials blamed the slowdown in part on increasing seasonality in the company's marketplace businesses. The summer tends to be a slow month both in Europe and in the U.S., with online activity down, officials said. As the company's users become more mainstream, seasonality will only increase, and will make the variation in the company's results look increasingly like that of an brick-and-mortar retailer, they said.

Revenue from the company's payments products -- formerly Billpoint, but now PayPal -- increased to $101.5 million in the just completed quarter from $4.7 million in the year-ago quarter. However, last year's results did not include PayPal's revenue because the companies didn't merge until last fall. In the second quarter last year, PayPal posted $53.8 million in revenue.

eBay's gross profit margin -- the difference between what it charges for its services and the direct costs to the company of providing those services -- declined by 2.7 percentage points in the quarter to 80.5% of sales. The company has seen similar declines in recent quarters due to the acquisition of PayPal, which has narrower gross margins than eBay.

A decrease in the company's operating expenses as a portion of sales helped offset the gross margin decline. Operating expenses fell 2.8 percentage points as a portion of sales to 50.7%.

eBay generated $22.6 million in free cash flow in the second quarter. A frequently cited measure of companies' true profitability, free cash flow represents the difference between a company's operating cash flow and its expenditures on property and equipment.

Despite having lower profits in the year-ago quarter, eBay posted $30.1 million in free cash flow in that quarter. Company officials blamed the decline in part on investments in a new headquarters for the company, as well in technology and customer support services.

eBay did not estimate how much its issuance of stock options would have affected its quarterly earnings. That estimate won't come out until the company files its official quarterly report with the

Securities and Exchange Commission

. In the second quarter last year, eBay estimated that if it had accounted for the fair value options, its earnings would have fallen to $13.1 million, or 5 cents a share.

Like other technology and Internet companies, eBay is a

prolific dispenser of options, but chooses not to recognize their expense. Last month, the company's shareholders

approved a plan to increase the options it can grant,

despite

warnings raised by analysts that the company's options practices were "excessive."

Although the company did not estimate the cost of new options issued during the second quarter, it provided enough detail in its earnings report to estimate the value of the stock options cashed in by employees over the three-month period. Employees saw an estimated $105.3 million by exercising their stock options in the quarter. Considering that the company had about 4,400 employees at the end of April, the amount that average employees saw from cashing in their options was nearly $24,000 each.

During the second quarter of last year, eBay employees cashed in options worth $86.9 million.

Meanwhile, the company's coffers swelled in the quarter as a result of the employee options exercises. For each option sold, eBay

receives cash up to the strike price of the option. In the quarter, the cash raised by eBay from employee stock and options sales was $255.6 million. That compares with the $41.4 million the company received from such sales in the year-ago period.