Market Measures eBay's Growing Pains

Concerns of fatigue and seasonality sent investors running, but some say it is now undervalued.
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eBay's (EBAY) - Get Report earnings report, the roller coaster that shows up on Wall Street every three months, is back on Wednesday -- and investors remain split on whether the numbers will show the online marketplace running off track or just gearing up for a new phase of growth.

At the start of the year, investors felt that eBay could do no wrong. The stock had rallied steadily to $59.21 last December from $26.65 in September 2003, a rise of 122% that left it at a valuation that could only be justified by an accelerating growth rate. eBay's business was growing so impressively as it expanded internationally, and it had beaten the Street's estimates so consistently, that some investors started to talk about eBay as if it were a miracle stock.

The truth is, miracles may appear on sandwiches for sale on eBay, but they just don't happen in any form on Wall Street. A quarter ago, eBay confessed that

it has growing pains just like any company, and did its best to outline a plan for future growth. Investors focused on eBay's feet of clay -- or more specifically, margins of clay -- and bailed out of the stock.

During Tuesday's session, eBay's stock was trading as low as $31.60, or 47% below its December high. eBay has seen worse -- and emerged stronger than ever. During the collapse of the tech bubble in 2000, eBay's stock fell 79% from the high of March 2000 to the low point nine months later. But a little more than a year later, eBay was trading above its highs of the dot-com boom, a recovery few companies can rival.

As a result, some analysts are arguing that eBay is undervalued. "The business should grow revenue by 35% this year and EPS by 28%, yet it now trades for about 30 times 2006 estimates," Legg Mason's Scott Devitt wrote in a recent report. "eBay shares deserve to trade at a premium to other businesses due to its growth characteristics, defensible market position, lack of inventory risks and high margins."

Devitt, whose firm doesn't do banking with eBay, made his case in a report entitled "Focusing on the Many Positives: 10 Reasons to Own eBay Stock," arguing that eBay has a lot of room for growth in new overseas markets, with its

PayPal online payment system, and under the company's new management structure.

eBay is being wrongly punished for disclosing a granular level of details that most companies refrain from, Devitt says. "This transparency is actually having a near-term negative impact on the shares as investors are missing the forest for the trees," he said.

Other analysts, such as Derek Brown at Pacific Growth Equities, whose firm does no underwriting for eBay, are holding to a more bearish view. Brown says he expects to see in the earnings report "additional signs of degradation in the underlying metrics of eBay's business," including "platform fatigue" in its largest and most mature markets in the U.S. and Germany.

"With respect to some newer initiatives, we do not expect China to be a material outperformer for eBay in the quarter and see little chance that PayPal off-eBay is a significant source of upside in the first quarter," he says.

Whether bullish or bearish in the long term, most analysts say that eBay broke the most painful news about this quarter last January, when it lowered guidance. Back then, the company's guidance for the first quarter was ratcheted down from as high as 34 cents a share to a range of 32 cents to 33 cents. (That guidance came before a 2-for-1 stock split in February.)

Analysts polled by Thomson First Call are expecting eBay to post a GAAP profit of 17 cents a share in the first quarter, up from 16 cents a share in the year-ago quarter. Revenue is forecast to come in at $1.03 billion, up 37% from $756 million a year ago.

"The guidance the company gave for the first quarter in January was negative," says Brown, setting a low bar that he expects eBay likely to reach.

Mark Mahaney, an analyst at American Technology Research, which performs no underwriting, agrees. "If there is variance vs. Street estimates, it is more likely to be negative than positive. eBay's share price requires a beat-and-raise quarter to rally. The moneymaking call would be sell strength in eBay into the numbers."

That leaves eBay 180 degrees opposite from where it was at its last earnings report, when the whispered consensus was that a strong number wouldn't send the stock higher but a disappointing figure would trigger a selloff. This time, good news could spark a rally.

"They really stumbled last quarter," says Frank Husic, managing partner of Husic Capital Management. "If they manage to beat their numbers this quarter, we could see a big pop in the stock."