Fool.com: eBay Sprouts Up [Rule Breaker] July 25, 2000

Rule Breaker Portfolio
eBay Sprouts Up

eBay's second-quarter sales rose 94% to a record $94.7 million as registered users rose from 12.6 million to 15.8 million. Cash flow jumped to $28.3 million. All in all, the company reported strong results. In fact, eBay is beginning to appear about as dependable as a Rule Breaker can be. Will it be a Rule Maker soon?

By David Gardner
July 25, 2000

eBay (Nasdaq: EBAY) reported second-quarter results today, after the closing bell. If you have not yet seen the results, click here to get up to speed. What follows below are some of my thoughts reacting to this report.

First off, as TechieSpeaking points out in this post, eBay has an extremely well-known brand among Internet users. In a second-quarter survey of 100,000 adults, 16.1% of them had purchased from Amazon.com (Nasdaq: AMZN), making Amazon the most frequently trafficked e-commerce site. eBay, however, sits a close second, with fully 15.8% of online purchasers purchasing from eBay. This is amazing, I think.

Amazon generally gets sales for all the newest, hottest items across many key product categories. When it came to Harry Potter and the Goblet of Fire, Amazon does by far more sales (over 200,000 in pre-sales) than any other site online. (We actually bought ours in the Little Professor bookstore in Long Beach, NC, though. High fives to the li'l guy for still staying in business.) However, eBay's focus on used items, memorabilia, and collectibles is generating virtually the same level of consumer transactions as Amazon, and it's actually generating higher gross merchandise sales. These early figures validate eBay's mass-market appeal. The site is not just for hobbyists and collectors.

(Add in the acquisition of Half.com, officially completed just two weeks ago, and eBay now has "fixed-price functionality" as part of its offering, as well -- for those who don't want to have to deal with changing auction prices over a week's time.)

The fifth Rule Breaker attribute is that a company have a strong brand. Harris Interactive's poll shows both Amazon and eBay to have not just a high transaction base, but a high degree of mindshare. This brand awareness is what induces new customers to try one of these sites out for their first online purchase, as opposed to lesser-known ones. And it is a key mark of early-stage Rule Breakers, and one that paves the way toward long-term sustainability and eventual profitability. (Check back tomorrow to see our take on Amazon's numbers. We hope they will be good -- the stock has hurt us this year.)

So how many first-time purchasers used eBay this quarter? The company's announcement listed a registered user base of 15.8 million, 183% ahead of the same quarter last year (with 5.6 million registered users back then). But what about last quarter, for context? Because the company announcement did not contain this info, we had to dig Foolishly into last quarter's report to discover that eBay had 12.6 million registrants at the close of March, which was up from 10 million in December. So new registrants grew 25% this quarter from last quarter -- impressive.

Quarterly sales of $97.4 million were a record, as was net income of $11.6 million. That puts net profit margins (net income divided by sales) at 11.9% -- nicely into the double-digits at this early stage in the company's history. For the March quarter, sales were $85.8 million, with net income of $6.3 million, making for net profit margins of 7.3%. Quarterly sales therefore grew a somewhat disappointing 13.5%, quarter-over-quarter, although seasonal factors are cited by the company.

Sales growth was not as fast as new registrant growth, suggesting that older registrants did not buy with the same fervor or in the same amounts from April-to-June. (Were they out enjoying summer?) We'll want to watch this carefully, going forward. But 13.5% in a fairly stressed environment for Internet commerce businesses is still real growth, and not shabby.

Anyway, all key trends are headed in the right direction. Further, let us look at operational cash flow, which we first wrote about in The Motley Fool Investment Guide, wherein it is writ:

"Cash flow [from operations] is a measure of the movement of money through a business.... What does positive operational cash flow mean? It means that in the course of running its business, the company has managed to generate cash rather than consume it (which would be indicated by a negative number). You want your companies to crank out free cash from operations, making the necessary funds available for internal expansion, acquisitions, dividend payments, or whatever. A company that has negative cash flow has to borrow money in order to maintain and grow its business." (p. 141)
Cash flow is therefore a deeper, more important, and less manipulatable number than net income. Let's take a look at eBay's cash flow, which went positive this year:

  • 1Q (3/00): $10.5 million cash flow from operations
  • 2Q (6/00): $28.3 million cash flow from operations

    That is outstanding.

    If the much-ballyhooed Internet e-commerce crunch does come to pass, eBay will certainly benefit. Smaller competitors without its resources will have to fold or get bought out, thinning the field further. eBay, with $839 million in cash and equivalents and already profitable and (more importantly) extremely cash-flow positive, will excel in such an environment.

    Of course, if the crunch doesn't occur, perhaps the rising tide will continue to float lots of boats, but no boat more so than eBay's. This "common sense" look at eBay by Squiggyj from our Fool community is a typical demonstration of just how far beyond all of its existing competition eBay really is. On a keyword search of "Beatles," eBay has twice as many listings as all other auction competitors (including Yahoo!, Amazon, etc.) combined.

    There's my quick look, on deadline, at the numbers. Fools DO tend to look at the reported numbers and less at the analysts' projections, and whether (yawn, sigh) the company "met or exceeded" Street "expectations." Rather than get hung up on hopping quarterly hurdles, long-term investors are best served by looking at the facts of a business, seeing whether the business is still as good or better as it was when we bought, and asking, "Does the future from today's vantage point look good?"

    In other words, compare a company to your own impressions of it when you bought. And compare it to its existing competitors right now. Do not get carried away with what CNBC is reporting the analysts are saying about its comparison to earnings. Notice that I haven't even told you in this report whether eBay "met or exceeded" analyst estimates. Find out for yourself, if you like. For profitable companies (not all Rule Breakers are yet profitable), I stay focused on trends in growth, margins, and cash flow, not what Sammy J. Sassafrass from Borg Wiener was saying they'd do.

    This Rule Breaker continues to trend toward possible Rule Maker status one day. One notes that the company is not yet covered on the Rule Maker team's master list, and appropriately so. Despite its strength, eBay is still a very green and promising young shoot. However, to my way of thinking, it's just a matter of time.

    At this point, eBay is about as solid and dependable a company as a Rule Breaker can get. Fool on.

    Your Turn:
    Will eBay become a Rule Maker? Post your feelings on the Rule Breaker Companies discussion board.





  • Rule Breaker Portfolio

    7/25/2000 Closing Numbers
    Ticker Company Day Chg % Chg Price
    AMGNAMGEN INC-1 1/8-1.51%$73.63
    AMZNAMAZON.COM-1 1/8-2.90%$37.63
    AOLAMERICA ONLINE-1 1/16-1.89%$55.06
    ATHMAT HOME CORP CL A-3/8-2.33%$15.75
    CRAPE CORP - CELERA GENOMICS GRP-5 3/16-4.72%$104.81
    EBAYEBAY INC1/82.04%$56.25
    SBUXSTARBUCKS CORP-1 5/32-2.91%$38.56

      Day Week Month Year
    To Date
    Since
    8/5/1994
    Annualized
    Rule Breaker -2.23% -5.44% 4.41% -20.21% 1,196.98% 53.57%
    S&P 500 .70% -.39% 1.37% .36% 221.66% 21.60%
    S&P 500(DA) .70% -.39% 1.37% .36% 235.91% 22.49%
    NASDAQ 1.21% -1.58% 1.60% -.98% 459.52% 33.41%

    Trade Date # Shares Ticker Cost/Share Price LT % Val Chg
    8/5/19944020AOL0.460$55.0611,880.18%
    9/9/19972640AMZN3.188$37.631,080.39%
    12/16/19981160AMGN21.444$73.63243.33%
    12/17/19991260CRA39.756$104.81163.64%
    7/2/1998470SBUX27.955$38.5637.95%
    2/26/1999600EBAY50.263$56.2511.91%
    12/4/1998900ATHM28.040$15.75-43.83%

    Trade Date # Shares Ticker Cost Value LT $ Val Ch
    8/5/19944020AOL$1,847.65$221,351.30$219,503.60
    9/9/19972640AMZN$8,415.03$99,330.00$90,914.97
    12/17/19991260CRA$50,093.00$132,063.80$81,970.75
    12/16/19981160AMGN$24,875.50$85,405.00$60,529.50
    7/2/1998470SBUX$13,138.63$18,124.38$4,985.75
    2/26/1999600EBAY$30,158.00$33,750.00$3,592.00
    12/4/1998900ATHM$25,236.13$14,175.00($11,061.13)
      Cash: $44,060.03  
      Total: $648,259.40  



    Note
    The Fool Portfolio was launched on August 5, 1994, with $50,000. It was renamed the Rule Breaker Portfolio in October 1998. The investing strategy began with the first investments of the Fool Port and has evolved with time and experience. In July 2001, the portfolio began adding $12,500 each quarter (We missed Jan. 2002, so we added $25,000 in April 2002). We skip a quarter if we have enough uninvested cash or cash available in stocks we would prefer to sell to make new investments. All transactions are shared and explained publicly before being made, and returns are compared in each week's column to the S&P 500 (including dividends where noted) and the Nasdaq composite. For a history of all transactions, please click here.