One company has entirely lived up to the Internet hype: eBay
More than live up to it, eBay has surpassed the hype, continually outperforming expectations and raising the bar each time it did. The stock has moved in tandem.
One difference between eBay and everyone else? It was profitable from the start, and it was profitable due to transactions rather than advertising. It had a business model that it largely controlled, rather than one controlled by advertisers' purse strings. And I should stop using past tense now, because it still does.
But today, I'm thinking back to 1999, because in the summer of that auspicious year, I made 10-year projections for eBay. Yes, 10 years. As the market soared all summer, and as estimates from brokerage houses claimed trillions in online commerce would soon transpire, I put on a pot of coffee and worked out eBay financial estimates from 2000 to 2009 for a Motley Fool research report.
Today, we're more than three years into the projections -- about 35% there. So, how am I doing? I thought it would be instructive to take a look and show that: (1) you, too, can model a company's long-term performance to help with investment decisions, and (2) you needn't be 100% right, or even extremely close, to still have your investment thesis play out.
When I calculated projections in September 1999, eBay was valued at $23.5 billion. At the time, my numbers argued for a $100 billion valuation by 2010, meaning gains of 316% (before dilution) over 10 years. That's well above the average doubling that the S&P 500 has historically achieved every 7.5 years.
Today, eBay is valued at $29.6 billion, up 28% since September 1999, after share dilution. It's 30% to the $100 billion mark with nearly seven more years to go.
Now, many of you are surely skeptical as you read this, and you should be. "$100 billion by 2010? Great pie-in-the sky guess, buddy. Are we back in 1999? Didn't Fantasy Island go off the air long ago?" Well, we'll look at the projections from 1999, see how right or wrong they are so far, and then I'll consider what updating is needed. First, a summary of first-quarter results and a look at eBay's valuation.
Another record quarter
First-quarter 2003 free cash flow was $146 million, up from $80 million one year ago and $138 million the fourth quarter of 2002. Excluding tax benefits from stock options, free cash flow was $105 million on GAAP net income of $104 million, or $0.32 per diluted share. Sales were $476 million, up from $245 million in the same quarter last year, and $396 million the previous quarter.
Alongside a balance sheet and cash flow statement (praise to eBay for providing these), management gives very detailed numbers with each quarterly report. Numbers scrutinized by everyone include domestic transaction revenue, up 11% sequentially (from the previous quarter), and 49% year over year -- both very strong results. International transaction revenue grew 28% sequentially, showing continued strong acceptance overseas, and 168% year over year.
Payment revenue (mostly from the recent purchase of PayPal) rose 20% from the fourth quarter, to $93 million. Total transaction revenue rose 17% sequentially and 118% year over year. Total revenue, including ads and services, rose 15% sequentially and 94% year over year. All this goes to say eBay grew strongly across the board, and management sees this continuing. It has raised guidance -- again.
The company estimates that GAAP-diluted earnings per share could be as much as $1.27 this year, which is $0.15 higher than its most recent guidance. Pro forma earnings could reach $1.41 per share, while 2003 revenue could top $2 billion. The $94 stock trades at 67 times new pro forma estimates and 75 times new GAAP estimates.
So, eBay has about a 70 forward multiple, while earnings are growing about 60%. If you believe that earnings multiples should be near growth rates and great companies demand premiums, perhaps you can see why the stock has gained 40% this year as estimates keep rising.
With $1.5 billion in cash and equivalents, the company's enterprise value is $28.7 billion, putting eBay at 70 times trailing free cash flow -- and 96 times free cash flow when excluding tax benefits from options. Management stands behind its goal of $3 billion in 2005 sales.
Projections made in 1999
One year before eBay outlined its long-terms objectives on September 20, 2000, I outlined my own projections for the company by starting at the top: gross merchandise sales. This is the number that ultimately drives all of eBay's business. Everything flows down from it. The total value of merchandise sold on eBay dictates eBay's take.
Gross merchandise sales were $745 million in 1998, and were on their way to $2.8 billion in 1999 when I made these projections. Here's how they've panned out so far:
eBay Gross Merchandise Sales Fool Projected (in '99) Actual2000 $5.21 billion $5.45 billion2001 8.85 9.322002 14.70 14.862003 23.37 ?I was close enough on these projections that the rest of my financial model for eBay, so far, could have played out. Could have. It didn't exactly. Take a look.
eBay Total Revenue Fool Projected (in '99) Actual2000 $354.2 million $431.4 million2001 611.1 748.82002 1,029.1 1,214.12003 1,636.4 2,000 co. estimate2004 2,503.7 ?2005 3,730.5 3,000 co. estimateI was short across the board on revenue, so far, and now eBay predicts $2 billion in 2003 sales, so I'm significantly short with my 2003 estimate. Although I had figured gross merchandise sales accurately, I had underestimated eBay's net revenue earned on merchandise sales.
Partly, I hadn't guessed that PayPal would be acquired. Without PayPal's addition to revenue, my sales estimates would have been much closer to the achieved results as of 2002. Yet, the end objective here has still been achieved: Approximate how large the company might become in order to help make an investment decision. Aim to be in the ballpark over many years.
It appears I started conservatively, but by 2005, I have a sales projection that surpasses eBay's current $3 billion goal by $700 million, as you can see above. Since eBay should top $2 billion in sales this year, I'm actually about as comfortable with my own $3.7 billion sales projection for 2005 as with eBay's current $3 billion goal. They could top $3 billion in 2005 handily, given current trends. If this continues to appear likely, it might argue for holding onto the stock.
Let's move down, because the further down the income statement your projections go, especially with a young company, the greater your chance for surprises and inaccuracies. Look how far off I was with my earnings from operations estimates.
eBay Earnings From Operations Fool Projected (in '99) Actual2000 $49.1 million $35 million2001 108.4 140.42002 255.8 354.22003 440.6 ?One should aim to be conservative rather than aggressive when making financial estimates, but I was apparently too conservative on eBay's operating earnings. I might feel somewhat better because so was eBay -- they continually increased their own estimates all these years. If I had done so, too, I'd naturally be closer to accurate the last few years.
Even so, these old '99 estimates aren't a disaster because they're lower, rather than higher, than what happened. Again, it pays to be conservative. However, I also underestimated eBay's operating expenses through 2002, being too aggressive on cost-savings and having underestimated sales.
eBay Operating Expenses Fool Projected (in '99) Actual2000 $223 million $300 million2001 372 4732002 576 6462003 900 ?
Luckily, I estimated a high 40% tax rate, which lowered my net income estimates. These two items (expense and tax estimates) balanced each other out to bring my net income projections closer to the results actually achieved the last three years.
So, when you model projections, if you're "off" in various places (as naturally you will always be), your numbers can nonetheless still end up being close to "right." The goal is to land in the ballpark and have a working numerical thesis for why you own a stock. If you're not willing to outline numerical reasons for owning a stock, you should buy index funds.
Ultimately, the eBay projections have served their purpose for Motley Fool research investors and me. The projections provided an argument for keeping eBay through the market downturn and for the long run, and that has been profitable.
One complaint to eBay
Easy on the share count dilution, eBay. You can't call yourself a start-up that needs to motivate its employees with large share grants anymore. You're a success. Your stock is currency. You can't just give it away, diluting longtime shareholders. Your track record is less than wonderful:
eBay diluted weighted
average share count1999 273 million2000 2802001 2802002 2932003 314
That's 15% dilution since 1999. Granted, a good portion of this is acquisition-related, and PayPal is worth some dilution. Also, eBay should have enough cash to buy back shares when that eventually seems a good use of capital. Meanwhile, whoa, we're keeping an eye on share count. We want to see dilution that is reasonable and keeps shareholder interests at the forefront.
Want to see the best stock ideas that the Motley Fool research team has to offer each month? Subscribe toThe Motley Fool Select today and get one month free. The Fool has a full disclosure policy, and Jeff Fischer owns shares of eBay. Having served their purpose and been reviewed (yes, accountability in the financial analysis industry), Jeff will be updating all his eBay projections now. Someone put on some coffee.