Is eBay Reliant on Sub-Prime Lending?

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Online payment and commerce company eBay (NASDAQ: EBAY) has long been a favorite of tech analysts and investors due to its consistent revenue growth and solid profitability.

The analyst community is especially fond of the company's PayPal business. PayPal enables individuals and businesses to quickly send and receive payments online and through mobile devices. It is becoming a larger piece of eBay's overall profitability, with expectations that it will account for over 60% of future earnings.

But optimism on eBay’s future may be overdone. As the company needs to produce exceptional growth to justify its valuation, there is evidence that it could be sacrificing quality of sales to achieve the quantity necessary.

Reliance on issuing low quality credit

The data seems to indicate a legitimate concern about the quality of eBay’s revenue growth. While the company has made many good innovations toward increasing sales, a troubling one is its Bill Me Later initiative.

Bill Me Later is a credit service offered by eBay. Since the company is not licensed to make a loan, it relies on a bank or licensed lender to extend the credit to a customer. eBay then buys and services the loan receivable. That means that the company, not the bank, bears the risk of default.

A major concern is that though the bank is charged with extending credit, eBay assumes all the potential downside. Clearly, an environment where the lender is incentivized to issue as much credit as possible with the buyer ending up owning all the related risk is not the most prudent for long-term success.

Increasing the worry is the substantial increase in the volume of credit extended through Bill Me Later. As of Dec. 31, 2012, there was about $12.4 billion of unused credit available to account holders. This equates to a 29% increase from 2011 and an 82% increase since 2010. The amount of actual credit drawn has increased similarly, with approximately $3.2 billion, $2.3 billion and $1.4 billion in consumer receivables purchased by eBay in 2012, 2011 and 2010.

Given the circumstance, its probably not surprising that the credit quality has deteriorated. The weighted average consumer FICO score, a score that lenders use to assess an applicant's credit risk, related to eBay receivables was 689 at Dec. 31, 2012. This compares to 692 in 2011 and 699 in 2010. The company also reported that at year-end 2012 only about 55.8% of its loans were due from consumers with FICO scores greater than 680, a level deemed as prime. This compares with 59.3% and 63.6% in 2011 and 2010, respectively. The level of delinquent accounts also seem to indicate weakness as loans over 90 days past due ranged from 2.7% to 2.5% of total loans over the last four quarters.

This data is troubling when taken into context. For instance, Discover Financial Services (NYSE: DFS), a major credit card issuer, reported that its delinquent accounts over 90 days past due for the past year ranged from 1.1% to .89% of total credit card loans and that 82% of its loans had a FICO score greater than 660. Both figures indicate better quality than eBay’s reported figures.

The demands of a very optimistic valuation

It’s understandable why eBay might stretch to increase sales. The company’s generous valuation almost demands it. Based on a market capitalization of $67 billion and revenues of $16.4 billion with average cash earnings of $2.9 billion and a profit margin of around 18%, its price multiplier looks to be around 23. This high multiple indicates the market expects eBay to have exceptional growth far into the future. It seems a lot of the hope is being placed on the company’s PayPal business, but competitive valuations in this area indicate that the outlook for eBay may be overly enthusiastic.


MasterCard (NYSE: MA) operates the world’s fastest payments processing network. It reported fourth quarter 2012 results with adjusted net income of $605 million, up 18% versus the same period in 2011, and revenues of $1.9 billion, a 10% increase. The company also noted that it is experiencing momentum in its mobile initiatives around the world and securing business in emerging markets.

MasterCard’s current market multiplier is roughly 27 based on a market capitalization of $64.1 billion, with revenues of $7.4 billion and average cash earnings of $2.4 billion at a margin of around 32%. The company’s buoyed multiplier might be justified as it has no credit risk, since it holds no loan receivables, and its very high profit margin and overseas opportunities are greater than average.

Discover Financial Services

Discover is one of the nation’s largest credit card issuers. It reported net income of $551 million, or $1.07 per diluted share, for the fourth quarter of 2012, as compared to $513 million or $0.95 per share for the fourth quarter of 2011. The company’s credit card loans and Discover card sales volume both grew 6% from the prior year. The company is also shareholder friendly, recently increasing its dividend 40% and repurchasing about 10 million shares in the last quarter.

Discover’s market value is around $21.6 billion and trades at about a 9 multiplier. This is based on revenues of $8.0 billion, average cash earnings of $2.3 billion and a margin of around 28%. Given its results and asset quality, this multiplier is probably closer to the current standard for payment processors that hold credit risk.


eBay has a history of consistent growth and profitability. Its stock market valuation is a testament to the market's faith in a continuation of that trend. However, there is some evidence that eBay may be stretching conservative bounds to meet those high expectations. Investors might be well advised to review the quality of the company’s sales increases as well as the quantity just to be adequately informed.

Bob Chandler has a short position in eBay. The Motley Fool recommends eBay. The Motley Fool owns shares of eBay and MasterCard. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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