Auctions and payments provider eBay (EBAY) has been a great success story for many Valuentum members, having registered a 70%+ gain since the company was added to the Best Ideas portfolio. We’ve often used eBay as an example of the Valuentum process in action (see here) and below:
“(eBay) initially flashed a (Valuentum Buying Index) rating of 10 in late September 2011 (at $32 per share), and we added it to (the) Best Ideas portfolio. The VBI rating changed to a 6 in December 2011 and then back to a 10 in May 2012. Because the rating never breached a 1 or 2, we did not remove the position from our portfolio. In fact, we tactically added to it. eBay is probably one of the better examples to use for illustrating the prolonged outperformance driven by undervalued stocks that are beginning to generate good momentum. We like to capture the entire pricing cycle and not truncate it as most value investors do (eBay’s Valuentum Buying Index rating is highly-rated with a score of 9 at present).”
On Wednesday, the global commerce and payments leader reported that revenue in its fourth quarter advanced 13% and non-GAAP earnings jumped 16%, the latter to $0.81 per diluted share. Total company Enabled Commerce Volume (ECV) jumped 22%, Marketplaces and PayPal achieved record mobile results, and PayPal revealed accelerating momentum in its merchant business. Profitability was solid, with the company’s operating margin jumping to 22.6% in the fourth quarter from 21.9% in the same period a year ago. The firm’s free cash flow was also quite impressive, coming in at $1.4 billion in the quarter (about 30% of revenue), and eBay ended the year with $12.8 billion in cash and cash equivalents.
Looking ahead, eBay’s outlook came in slightly lower than our projections, but we think management is being conservative, particularly with its full-year 2015 guidance (nearly two years away from being actualized), which pegs net revenue in the range of $20.5-$21.5 billion and non-GAAP earnings per share growth greater than 10% above the targeted 2014 range of $2.95-$3.00. We expect future bottom-line results to be buoyed by the authorization of an additional $5 billion stock repurchase program.
The company’s results and outlook, however, weren’t the big news of the day. Instead, investors were focused on a new proposal sent to management from Carl Icahn:
“The company…has received a notice from Carl Icahn indicating that he has nominated two of his employees to its Board of Directors and submitted a non-binding proposal for a spinoff of its PayPal business into a separate company. The notice stated that companies controlled by Mr. Icahn had, earlier this month, acquired shares and derivative securities that give him an economic interest of approximately 0.82% in the company.”
A spinoff of PayPal has long been discussed, and eBay said as much in its response: “eBay’s board…has explored in depth a spinoff or separation of PayPal…(and)…has concluded that the company and its shareholders are best served by the strategic direction of the company and does not believe that breaking up the company is the best way to maximize shareholder value.”
Still, we’re more excited at what the news of the spinoff will bring than the idea of the spinoff itself! We understand the board’s and Carl Icahn’s respective views, but whether or not the company spins PayPal off as a separate entity is largely irrelevant at this juncture. What is relevant is that the market (in evaluating the separation) will begin to better understand eBay’s significant underpricing on a consolidated basis. It is our view that this headline alone will drive investors and analysts back to their valuation models to derive a sum-of-the-parts valuation of the firm, which is much higher than the Street’s current expectations. We think eBay is worth $78 per share on a consolidated cash-flow basis, and we would expect fair values and price targets to converge to that level in coming months. Shares of eBay trade at $54.41 per share at the time of this writing, implying significant upside.
Valuentum’s Take
We like what the news of the spinoff of PayPal will bring more than the idea of the spinoff itself. With greater attention to be placed on eBay’s valuation, we think the market will inevitably assign it a higher multiple, one that is better in-line with our cash-flow-based fair value estimate of the firm. The company continues to be a holding in the Best Ideas portfolio.