Rule Maker Portfolio Five Reasons to Admire eBay

Even while still breaking the rules, eBay appears to be well on its way to becoming a Rule Maker. The pieces are in place: competitive advantages cemented by network effects, a high-return software-style business model with consumer franchise strength, a globally relevant service, the benefits of a low-cost provider, and a managerial focus on making the eBay service as convenient as possible.

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By Matt Richey (TMF Matt)
April 26, 2001

Over two years ago, Tom Gardner wrote about the awesome potential he saw in eBay's (Nasdaq: EBAY) horizontal network business model. Since then, this high-profile company has steadily delivered on the promise of its model and is now generating $600 million in run-rate revenues (current quarter revenues times four).

Typically, we require that a company surpass the $1 billion annual revenue threshold before considering it for official Maker status. But in the case of eBay, we would be foolish to ignore its manifest-destiny trajectory for Rule Makerhood. In fact, the Rule Maker managers collectively ranked eBay #5 in our Rule Maker Top 25 Report.

I see five stand-out attributes to eBay's business that make it, in my estimation, the premier emerging Rule Maker on the public markets.

1. The ultimate sustainable competitive advantage: network effects. eBay's person-to-person trading network grows in value and strength with each new user. Sellers attract buyers, more buyers attract more sellers, and the result is a trading network that can't be duplicated by the competition -- ever. So much has been written about the dominance of eBay's global trading platform -- especially on this site -- that this business strength may evoke a yawn from regular readers. "Network effects, network economics... yady yada yada."

But in a world where competitive advantage typically erodes over time (often quickly), the value of an almost-guaranteed permanent business advantage cannot be underrated. eBay is well on its way to becoming a legalized monopoly.

2. The ideal combination of a high-profit, lightweight software business and a durable consumer franchise. As I see it, eBay mixes the best business merits of Rule Makers Microsoft (Nasdaq: MSFT) and Coca-Cola (NYSE: KO). eBay's software-based trading platform gives it the Microsoft-like advantages of high profit margins, no inventory, and unlimited scalability.

But eBay is exposed to much lower innovation risk than Microsoft. Will Windows be relevant in ten years, in twenty years? Who knows. Will eBay be the leading electronic consumer trading platform in twenty years? Almost certainly. Millions of consumers buying and selling on eBay make that business much more predictable.

 In this way, eBay has the long-term staying power of Coca-Cola's franchise. High profitability, high scalability, high predictability, a brand name known and loved by millions of consumers -- what more could you ask for as an investor?

3. Global business with no cultural barriers. Not all businesses travel well. Gap's (NYSE: GPS) casual American fashions aren't well received in every country around the world, especially Europe. In contrast, the most valuable businesses in the world serve a basic human need that applies globally, regardless of culture. Citigroup's (NYSE: C) financial services find demand wherever money is in vogue. Nokia's (NYSE: NOK) wireless handsets serve people's basic need to gab wherever they go. Coca-Cola's beverage portfolio of colas, juices, and water are found wherever anyone is thirsty.

In the same way, eBay's person-to-person commerce platform appeals to all people, as far as the Internet extends. Already, eBay has sites in 12 countries, and the company's goal is to be in 25 countries by 2005.

4. Synthetic low-cost provider advantage. This one is a bit off-the-wall, but eBay is clearly benefiting as a mass market provider of lower-cost second-hand goods that compare favorably in value to full-priced new products. Here's an example: During the most recent quarter, eBay's gross merchandise sales of books, music, and videos grew 20% quarter-over-quarter, whereas growth in this category nationally has been flat of late.

What this means is that through lower prices, eBay is able to tap consumer demand that otherwise would go untouched. All low-cost providers benefit in this way. Recently, Rich wrote about Southwest Airlines (NYSE: LUV), the low-cost provider of the airline industry, and how its lower fares have opened up air travel to a new group of customers, thereby creating a larger market opportunity for the company. Because eBay is THE source for second-hand goods, it is a legitimate low-cost provider -- in a sense, at least -- across many of its product categories.

5. Management's emphasis on convenience initiatives. A few years ago, I was much less bullish about eBay's prospects primarily because I thought the auction concept was simply too inconvenient for mass use. But the company proved me wrong by creating a host of tools and services that make person-to-person trading highly convenient.

For example, Buy It Now is a feature rolled out late last year which allows the seller to pick a price at which the buyer can simply pay up and end the auction on the spot. Another service that's impressed me is eBay's Motor vehicle inspection service, which, through a partnership with Saturn, allows an automobile seller to get a 136-point inspection which is then made available from a link on the seller's auction page.

Of course, the biggest improvement in person-to-person trading convenience came through the acquisition of Half.com -- an incredible coup of an acquisition if there ever was one -- which provided eBay with a speedy and substantial entry into the fixed-price trading business. Half's platform is very intuitive and friendly; the customer experience is not too different from Amazon's.

For all these reasons, I believe eBay should be on the short list of companies that we consider for addition to the portfolio at some point, given the right price. That's a question I'll take a closer look at next week.

Matt Richey keeps his eye on the selection of Porche Boxsters available through eBay Motors. If he ever decides he wants to get his license taken away for sure, he'll look into getting one. At the time of publication, owned shares of eBay. The Motley Fool is investors writing for investors.


 

Rule Maker Portfolio


4/26/01 as of ~8:30:00 PM EDT

Ticker Company Price
Change
Daily Price
% Change
Price
AXPAMER EXPRESS0.801.95%41.90
CSCOCISCO SYSTEMS(0.52)(3.31%)15.21
INTCINTEL CORP(0.39)(1.34%)28.64
JDSUJDS UNIPHASE CORP(2.08)(10.25%)18.21
JNJJOHNSON & JOHNSON1.551.65%95.55
KOCOCA-COLA CO(1.30)(2.70%)46.90
MSFTMICROSOFT CORP(0.56)(0.80%)69.13
NOKNOKIA CORP ADS0.451.49%30.70
PFEPFIZER, INC1.593.89%42.50
SGPSCHERING-PLOUGH1.554.16%38.79
TROWT.ROWE PRICE GRP INC0.351.02%34.82
YHOOYAHOO INC(0.42)(2.25%)18.26

Overall Return -- total % Gained (Lost)
  Day Week Month Year
To Date
Since
Inception
(1/6/1998)
Rule Maker(0.09%)(5.69%)10.38%(23.58%)(19.99%)
Comparable S&P 500n/an/an/an/a11.98%
S&P 5000.47%(0.68%)6.39%(6.50%)26.35%
S&P 500 (DA)0.46%(0.67%)6.30%(6.41%)28.12%
NASDAQ(1.21%)(5.94%)10.58%(17.63%)27.65%

Internal Rate of Return -- Annualized Rate of % Gained (Lost)
  Since Inception (1/6/1998)
Rule Maker(8.88%)
vs. S&P 5005.04%

Trade Date # Shares Ticker Cost/Share Price Total % Ret
2/3/9866PFE27.4342.5054.92%
2/3/9859MSFT49.3569.1340.07%
5/26/9866AXP36.0041.9016.39%
4/3/015JNJ87.3095.559.45%
2/13/98147INTC27.4428.644.38%
2/3/9856TROW33.6734.823.41%
8/21/9844SGP47.9938.79(19.18%)
2/15/00117NOK40.9530.70(25.04%)
2/27/9827KO69.1146.90(32.13%)
6/23/98182CSCO24.7215.21(38.16%)
2/17/99106YHOO57.6018.26(68.30%)
2/15/0032JDSU100.7518.21(81.93%)

Trade Date # Shares Ticker Total Cost Current Value Total Gain
2/3/9859MSFT$2,911.79$4,078.67$1,166.88
2/3/9866PFE$1,810.57$2,805.00$994.43
5/26/9866AXP$2,375.95$2,765.40$389.45
2/13/98147INTC$4,033.23$4,210.08$176.85
2/3/9856TROW$1,885.70$1,949.92$64.22
4/3/015JNJ$436.50$477.75$41.25
8/21/9844SGP$2,111.70$1,706.76($404.94)
2/27/9827KO$1,865.89$1,266.30($599.59)
2/15/00117NOK$4,791.64$3,591.90($1,199.74)
6/23/98182CSCO$4,498.75$2,768.22($1,727.50)
2/15/0032JDSU$3,224.00$582.72($2,641.28)
2/17/99106YHOO$6,105.72$1,935.56($4,170.16)
 
Cash: 
Total: 
$86.56
$28,224.84
 


Notes
The Rule Maker Portfolio began with $20,000 on February 2, 1998, and it added $2,000 in August 1998 and February 1999. Beginning in July 1999, $500 in cash (which is soon invested in stocks) is added every month.