eBay Needs to Grow Up

eBay's (NASDAQ: EBAY  ) various businesses are growing quite nicely at the moment, but I'm surprisingly disappointed with the company nonetheless. Recently, it has become very obvious that investor capital is flowing into the pockets of insiders. C'mon eBay, it's not 1999 anymore.

Not all buybacks are created equal
The company reported in its second quarter earnings release that it has repurchased approximately $466 million of its common stock during the second quarter of 2013. That might not necessarily be a bad thing. We at The Motley Fool actually applaud properly executed stock repurchases, as they can create immense amounts of value for shareholders.

Loews is one such company that consistently creates value by repurchasing its shares on the open market at attractive prices. White Mountains Insurance is yet another company that consistently buys -- when it has excess capital -- its own shares when they trade at a discount. And Berkshire Hathaway's Warren Buffett recently announced his own intention to repurchase meaningful amounts of stock when it trades below 1.2 times book value.

Investors need to know, however, that not all buybacks are created equal. So I decided to take a closer look at eBay's repurchase behavior over the past few years.

The repurchase riddle
Over the past 12 quarters, going back to Q3 2010, eBay has bought back $3.6 billion worth of stock. The stock has approximately doubled over that time frame, so you might be thinking that was a great use of capital. Unfortunately, the diluted share count only decreased by 1% over those 12 quarters. The count went from 1.328 billion shares to 1.313 billion at the end of the recent quarter.

How can a company buy back $3.6 billion of stock and only reduce its share count by 15 million shares? That would imply a cost of $241 per share on average. We know the stock price was in the range of roughly $25 to $50 per share during that time.

The answer is that eBay issues a lot of stock to its employees. During the second quarter, their reported free cash flow was $658 million and they used 70% ($466 million) of it to repurchase shares. In Note 15 of their annual report, management clearly discloses the goal of their share repurchase program: "These stock repurchase programs are intended to offset the impact of dilution from our equity compensation programs."

As an investor in eBay, I'm not pleased with this. Here are my three recommendations for eBay's management team:

  1. Stop acting like a tech start-up. You've got over $11 billion of cash on your balance sheet. Pay people what they deserve in cash and let them purchase stock on the open market alongside the rest of us who decide to put our capital at risk.
  2. Treat stock repurchases like any other investment. Be strategic with your share repurchases, and you'll actually create value. I found a copy of The Outsiders by William Thorndike listed on eBay for only $17.18. This would make an excellent gift for the management team and board of directors. Buying back stock at regular intervals regardless of the price is a recipe for value destruction. Your stock hit a low during 2009 and there were zero repurchases. As the stock climbed from $10 to over $50 per share, repurchases have increased dramatically.
  3. Align the interests of owners and employees. This is quite simple at companies like Berkshire Hathaway, where the largest owner is also the operator of the business. Real owners put their hard-earned capital at risk when they purchase stock on the open market. eBay investors, for example, suffered in 2009 when the stock dropped to around $10 per share. Eligible employees, on the other hand, benefited from a stock option exchange program where underwater options could be exchanged for restricted stock.

Truly great businesses have management teams that are able to balance the needs of employees with those of outside investors. Issuing stock to employees at low prices, and then using shareholder capital to repurchase those same shares at higher rates isn't a recipe for outstanding returns over the long term. Surely, eBay can do better.

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Read/Post Comments (14) | Recommend This Article (37)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 25, 2013, at 10:13 AM, NobodysFool2011 wrote:

    What do you expect from a company who hires a Bain transplant as CEO? I'm certain there's far more creative accounting going on at eBay than this obvious enrichment at investors cost. eBay has been burning merchants with fee increases for the last 3-4 years, it's no surprise the money they're robbing from sellers to pump the stock is being diverted into executives purses.

  • Report this Comment On July 25, 2013, at 11:47 AM, bobamber wrote:

    I assume eBay is no different from other tech giants in this respect - Google, Fecebook, Apple, Amazon... unless you have an information proving it wrong. If that's the case, then keeping great engineers would be extremely challenging for eBay if it listened to your advise.

  • Report this Comment On July 25, 2013, at 1:12 PM, NobodysFool2011 wrote:

    @bobamber - eBay and "great engineers" is a misnomer. eBay is a glitch ridden parasite of e-commerce. Maybe if they actually paid competitive salaries and benefits to engineers instead of heaping the rewards on c-level do-nothing, eBay might be something other than the Titanic of tech.

  • Report this Comment On July 26, 2013, at 2:48 AM, PhilipCohen wrote:

    “eBay’s various businesses are growing quite nicely at the moment” … LOL

    Oh no, not another "reduction" in eBay user fees ... bit(DOT)ly/YvxFEg

    And, eBay Inc. is demonstrably the greatest calculated criminal facilitator of auction "wire fraud" on consumers that the world is ever likely to know ... bit(DOT)ly/11F2eas

  • Report this Comment On July 26, 2013, at 5:59 PM, dgmennie wrote:

    I have been on eBay for over ten years. It was much better in the 1990s than it is now. The eBay rules have purged the most interesting sellers and their usede offerings, making way for an INCREDIBLE amount of counterfeit, overpriced, and otherwise unacceptable merchandise. While there are still some interesting, honest small-seller auctions to be found, the vast bulk of the offerings are now peddled by pros and semi-pros who deal in vast quantities, listing thousands of items at a time.

    They don't call it "feeBay" for nuthin' -- if they ever start requiring sellers to collect state sales tax the game will be over.

  • Report this Comment On July 26, 2013, at 6:00 PM, zergessc wrote:

    eBay does what I (and I'm certain many) need it to do. I fined used boat parts, collectables, and other items I can't find necessarily find in a normal retail outlet. I don't need it to "grow up" into anything.

    I worked at a marina in my youth - best job I ever had. That business grew up into a marina - not much has changed. The docks are still full and it's making money. Analyst are too hard coded with some book they read while getting their MBA. I've been using eBay since it's inception to buy and sell. The only single billing issue I did have once was quickly resolved.

  • Report this Comment On July 26, 2013, at 6:34 PM, frozintime wrote:

    I completely agree they are burning bridges all around them and it is a matter of time before the cookie jar slams shut on them and their stockholders. They are completely mistreating all of their smaller non-brand new merchandise sellers. They are trying to emulate amazon, and its not going to happen with the model they are using. In doing what they are doing, they are also turning all of the ex sellers into anti ebay advocates....mark my words. The fee increases are totally unjustified, and their money grabs are based on lies that anybody can see. You cannot lie to, treat your sales people worse than your customers, and not have it come back to bite. Its coming as the last fee increase was monumental.....all in the name of "simplicity" and "amazon neutral".....they are not amazon and have set fire to the base of sellers that made them unique.

  • Report this Comment On July 26, 2013, at 8:21 PM, hanover67 wrote:

    I enjoyed your analysis of Ebay's stock repurchase program. I've wondered how well these are executed because many of the companies whose stock I own claim to have repurchase plans yet report higher and higher (dilutive) numbers of shares outstanding. And, if they do reduce shares outstanding, at what price?

  • Report this Comment On July 28, 2013, at 12:29 AM, enginear wrote:

    Always believed Ebay was lucky to grow the way it did. They managed to excite people about selling junk at higher prices (than flea markets and throw away newspapers) at first, moved on to junk retailing, and have finally gotten into low quality merchandise retailing, and odd gimmicks (and sort of held on to all that went before). Net result in my opinion is higher prices for the crummy stuff we used to get for (almost) free. Some sellers and some Ebay employees are making out well, but they have not done anything 'disruptive' like Google, Microsoft, Amazon. They put flea markets on the web. What's that really worth?

  • Report this Comment On July 29, 2013, at 10:08 AM, StockGamingCom wrote:

    The main differentiator for eBay was its auctioning. However, there are a lot of "buy at this price" sales. So, what percentage of goods are sold via auctions and is this declining? If so, then Amazon will be a serious competitor.

  • Report this Comment On July 29, 2013, at 10:35 AM, mrplow2000 wrote:

    There is still a place for ebay, nothing I can think of offers the same market place (yet).

    BUT its completely stagnated. If they don't start changing they will be the next Altavista. Many people think their purchase of Paypal will keep them alive, but this is the same situation. If they keep charging huge fees and offering a dated service it is only a matter of time until something new, better and cheaper comes along. In fact I am sure it already exists just has yet to be markets correctly.

    Even just looking at the fundamentals there are more tempting offers out there.

    http://simplistickr.com/EBAY

    $11 Bn cash no dividend - what is that about?? Work out what their next acquisition is and buy that instead.

  • Report this Comment On July 29, 2013, at 5:37 PM, MoolaMonster wrote:

    A lot of companies' stock buy back program conveniently matches dilution from stock compensation. I believe this is a very common practice, and is not limited to tech start-ups. Management at all levels deserve stock based compensation. I disagree with Point 1: "Pay people what they deserve in cash and let them purchase stock on the open market". This won't happen. Companies like eBay who have emerged from the "proof of concept" phase for their main product need to innovate. Their PayPal division certainly needs to continue to innovate. eBay has no choice but to grant lucrative stock-based compensation with the hopes of sparking elusive entrepreneurship within.

  • Report this Comment On September 09, 2013, at 10:57 PM, NetAnaylyst wrote:

    Tthe experiences I had as a small seller on ebay starting back in April triggered by a couple of low DSRs (1's and 2's) destroyed my faith in ebay and left an extremely bad taste in my mouth. Keep in mind I've been selling here since 1999 (14 years) and have 4625 positive feedbacks. After they slapped 21-day holds on my Paypal funds and put Seller Limitations on me, I lost any desire to "comply' "acquiesce" or "cooperate" with them. When I read much much worse accounts on these discussion boards of much worse experiences happening to other ebay sellers, my resolve was cemented. What I experienced was quite mild compared to what some small sellers have experienced, and I simply want ebay to be held accountable for the adverse impact they have had and are having on many good decent honest sellers, and I am far from alone in this sentiment. Peoples lives have been disrupted in many, many cases by egregious unfair ebay actions. While it is true that Mixhael Moore going to Flint, Michigan and doing a documentary about all of the laid-off General Motors workers did not result in GM coming back to Flint and rehiring them, it served as a public expose of corporate corruption. I think a number of suspended ebay sellers who have suffered unwarranted and severe financial setbacks because of ebay are entitled to see ebay's corporate corruption exposed.

  • Report this Comment On September 10, 2013, at 9:09 PM, NetAnaylyst wrote:

    Corporations are not only beholden to their stockholders (for whom they may very well be bending and massaging the numbers), but they must abide by the laws of each of the 50 states ( which means PayPal holds of more than 10 days are VERY MUCH ILLEGAL for ebay to impose in many states, check with state banking regulators, I did). Corporations also HAVE TO ABIDE BY AN INCREDIBLE NUMBER OF RULES AND REGULATIONS IMPOSED BY THE FEDERAL TRADE COMMISSION. So maybe there's nothing illegal or amiss once an investigation gets conducted. BUT I DOUBT IT. So maybe there are no improprieties going at ebay, but come on, do you really believe that BASED ON THEIR BLATANT ABUSE OF SMALL SELLERS SINCE 2008? Where there's smoke there's fire, and I'm firmly convinced that a corporation capable of doing some of the things they've done to thousands of sellers is capable of doing a whole lot more. And yes, this is exactly the sort of thing to write to your Congressmen and Senators about.

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