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A Dot-Com Darling That's Still Going Strong

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Right before the in the Nasdaq in 2000, I bet many investors believed that their favorite dot-com company would still be going strong years later. However, as many of these companies imploded from their lack of earnings, lack of a credible business plan, and crushing competition, the landscape of so called “Internet stocks” changed. In fact, one could argue that there are really only two strong players left from that dot-com bubble. One of these companies is of course eBay (NASDAQ: EBAY), which has changed from an online auction site to an online marketplace, and (increasingly) a division of PayPal. The other company is Amazon.com (NASDAQ: AMZN), which has its hands in everything from selling items, to providing services to businesses, to offering streaming movies. The big difference between these two companies comes down to their relative values to investors. 

On the one hand you have eBay, which reported revenue up 15% and non-GAAP EPS up 14% in its recent earnings announcement. While Amazon has the clear lead in revenue growth, with an average growth in sales of 30% in the last nine months, eBay has the clear lead in earnings growth, as Amazon's EPS has dropped significantly as the company invests for the future. Both of these companies compete with the world's largest retailer Wal-mart (NYSE: WMT) for sales, and this offers yet another challenge: neither of these companies has physical locations.

It's certainly true that Wal-mart can't hope to match either Amazon or eBay's growth rate, but Wal-mart also sells a multiple of what either of these dot.com's sell on a regular basis. In addition, Wal-mart isn't done growing, as analysts are calling for over 9% growth in EPS from the company in the next few years. With all of this competition, you might think that eBay would have a problem keeping up, but the company is uniquely positioned to benefit from a growing trend in a way that neither of these other two companies can hope for.

The trend that eBay is benefiting from is mobile computing. Customers are increasingly using their smartphone to shop and compare when they are looking for a particular item. eBay is benefiting directly from this, as the company's Marketplaces division saw 800,000 new users sign up for the site from mobile devices. The company's Marketplaces unit is the core of eBay, this division saw 9% revenue growth, and gross merchandise volume increased 11%. The reason behind this positive momentum is actually quite simple: eBay isn't trying to be everything to everyone.

While Amazon offers Amazon Prime and tries to build its movie library, eBay just relies on the strength of its sellers to attract customers. eBay also has created mobile apps that are available on the most popular mobile operating systems, and they are easy to use. Since about 2/3 of eBay sales are fixed price items, it is easy for shoppers to compare on an eBay app and decide if they should go through a store, Amazon, or eBay. The company figures it can let Amazon compete with Apple in producing tablets and trying to win the digital content wars, as long as it encourages buyers and sellers to come to eBay to conduct their business. There is another reason that eBay has an advantage over both Amazon and Wal-mart, and for that matter almost any other retailer: eBay is one of the only businesses that I can think of that makes money selling other people's stuff.

While consignment shops and other similar stores sell items for people, eBay has become the de facto location for people to sell their items online. Buyers know that they are protected, and eBay's stellar reputation leads them to trust the site. The company makes money in multiple ways from each listing, and this leads to out-sized margins that other retailers can't hope to match. In the last three months, eBay's operating margin was 19.6%. By comparison, Wal-mart's operating margin was under 6%, and Amazon's margin was less than 1%. eBay's business model leads the company to make much more than other retailers, and the company carries no inventory to do so. Of course, part of the reason many investors like eBay's business is the aforementioned PayPal division. This unit offers investors something not available anywhere else.

I've argued in the past that PayPal over time will become more important to eBay than the company's Marketplaces unit. That time is quickly approaching, as PayPal is consistently outgrowing the other divisions. In the last quarter, PayPal reported revenue up 23%, active accounts were up 14%, and total payment volume jumped 20%. While originally PayPal was somewhat limited to eBay transactions, the division has been branching out into the physical payments arena as well. The company offers PayPal Here as a payment solution for small businesses to accept credit cards. In addition, the company has solutions at places like Home Depot and Abercrombie & Fitch that allow customers to pay using PayPal at their stores. This is a service that already has over 117 million users, and this user count has been consistently growing by double digits. From growth at the Marketplaces unit and PayPal combined, eBay does something else its larger competitors can't match, and that is create huge free cash flow from each $1 of sales.

eBay's free cash flow might be one of the best indicators that the company could be a better value than either of its larger competitors. eBay produced $0.23 of free cash flow from each $1 of sales. Wal-mart generated about $0.03 of free cash flow using this measure, and Amazon is showing negative free cash flow. Even if we eliminate half of Amazon's fulfillment expenses, the company still wouldn't come close to matching eBay's free cash flow generation. With analysts calling for about 14% growth from eBay in the next few years, this doesn't sound as good as the over 35% growth expected at Amazon. Of course eBay also sells for just 17 times projected earnings versus over 130 times projections at Amazon. Though Wal-mart is doing well, the stock sells for a multiple slightly less than eBay's, and the company is both growing slower and can never generate the free cash flow per $1 of sales that eBay can. As you can see, eBay is one of the few surviving dot-com darlings, and based on recent results, the future has never looked brighter.


MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com. Motley Fool newsletter services recommend Amazon.com and eBay. 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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