A Potential Rule Breaker?
And our Foolish Four switch is complete

by Jeff Fischer (TMFJeff@aol.com)

ALEXANDRIA, VA (Feb. 23, 1999) -- The Rule Breaker Portfolio looks less familiar today because our Foolish Four transactions were completed. For the first time, Caterpillar and Goodyear are members of the portfolio; beyond that, Chevron rejoined the ranks, and DuPont remains. We had to say good-bye (and thank you very much!) to Ma Bell and Lucent Technologies, both successful Foolish Four investments. We also kissed off International Paper and Exxon. Good riddance.

For today's transaction statistics, you can visit yesterday's trade announcement, which now holds the trade stats, too. And if you have questions about the Foolish Four, visit the Foolish Four area and its message board. Post and ye shall be enlightened.

The portfolio gained over 3% today as Amazon (Nasdaq: AMZN) and America Online (NYSE: AOL) rose on comments from analyst Mary Meeker. Following AOL's most recent split, the portfolio now owns 2,200 shares at a cost-basis of $0.91 per share; the $1,900 investment has increased 9,600% and is worth $193,000. We look for leading companies in important and emerging industries -- companies that have a sustainable advantage, good backing and smart management, a strong name, exceptional past performance and... heck, we're looking for Rule Breakers. That sentence summarized most of the Rule Breaking criteria.

Starbucks (Nasdaq: SBUX) rose 5% as CEO Howard Schultz announced that the company should earn about $1.20 to $1.25 per share this fiscal year. Those numbers are along the lines of what the company expected last fall, too, but they do allow for some upside surprise. The previous "bogey number" was $1.20 per share, and some estimates called for $1.18. It now appears that $1.20 will be the low number, and that reassured investors. The company also announced a 2-for-1 stock split effective March 19. (For questions on splits or anything Foolish, visit our FAQ.)

Let's now consider a potential Rule Breaker, eBay (Nasdaq: EBAY), running it through the necessary paces.


eBay has been public five months and is already well known. It's been written about extensively and its stock has soared ten-fold from its initial offering price. It is the top dog, first-mover auction site on the Internet, with more auctions taking place on its site than on all the competition combined. The site has had over 50 million items offered for sale since inception, it has 1.6 million items for sale right now (at www.ebay.com), and it was recently sainted the second-most visited Internet site (by time spent) on the Web, behind Yahoo!

eBay receives over 600 million page views per month and has close to 3 million unique registered users. Sellers on the auction site pay a small fee to place an item for sale (the fee depends upon the asking price for the item) and buyers pay nothing extra to buy. They merely need to be a registered user.

eBay has been profitable since its founding and reported 1998 revenue of $47.4 million, up from $5.7 million in 1997, with net income of $2.4 million last year. The company has very high gross margins -- over 80%. Gross margins represent what it costs the company for every dollar of revenue. With eBay, each dollar of revenue has cost $0.20, resulting in the 80% gross margins. This company has a giant advantage when it comes to margins because it doesn't carry inventory. It doesn't sell anything tangible. It provides the forum for a community to meet and conduct transactions. (Tom Gardner wrote about eBay's business model on January 28 in the Rule Maker Port.)

eBay is top dog in what it does and eBay was and is first mover on many industry initiatives, including having an accountable community of users where members rate each other to keep transactions on the level -- a service in which it excels because its community is so strong. The question remains, then, is this an important and emerging industry?

The answer that we'll initially propose is: Yes. Yes on two accounts.

In its own right, eBay is redefining the retail market with its service, not just the auction market. Any person or entity can sell items over eBay, and because the site has reached critical mass, official companies and organizations can and have done so; you can buy products directly from a manufacturer or wholesaler over eBay, cutting out any middleperson or end-retail component. But beyond the company's potential for upsetting traditional retail channels, eBay has created an entirely new market as well: a worldwide market for old and used items. This market represents most all of eBay's bread and butter to date.

In the past, you needed to open a garage sale and hope that somebody in your area wanted your 1970 day-glo orange lava lamp. Now you can put that baby up for sale on eBay and more than likely find a buyer somewhere in the world. Everything from Coca-Cola collectibles, to Star Wars figures, to Mazda Miata cars sell on eBay. Sotheby's this is not. Exclusive this is not. eBay is a site for anyone and everyone. And, with recent agreements, eBay is ready to take its offerings international officially (although it already is international, of course), into Australia and New Zealand initially.

Why is this industry important? For one, it's endless in scope.

This world is made of used items and most of them are aching to be sold (and, oddly, bought). On eBay, the opportunity exists to sell the most obscure item that you own to a world full of interested buyers. The fact that eBay's auctions go so well already (over 70% of items listed are sold) is a testament to how successful the auctions should be when twice as many users are on the site; not to mention three times as many users; and four; and five; and ten. Eventually, you'll be able to sell almost anything over the Internet. All that you need is to find the right audience. And all that your potential audience needs is the right place to meet you. eBay has been named that place by popular demand. Now membership is growing by record numbers.

The long-term size of the world market for secondhand goods? You tell us.


Is eBay's business advantage sustainable?

One might have reason to believe that eBay's advantages are more sustainable than those advantages that Amazon seized by being a first mover. Why? Because eBay's advantages are rooted in its strong community and the feeling of trust that is inherent while participating in its forum. You don't typically experience that immediate level of comfort, of legitimacy, and of safe-dealing on other auction sites. (And these are qualities that management can't simply create. The community has to agree to create them essentially from day one.)

Next advantage: The more that you use eBay, the more likely you are to continue using it.

Whenever you buy or sell anything on eBay, the person that you transact with is encouraged to rate you. Over time, your ratings become a badge of honor (or shame). The community respects those with high marks. In fact, people using eBay go beyond the call of duty, often, to make sure that they only get high marks when they make transactions. They avoid a bad mark at any cost. Once you've begun to build a reputation on eBay, and once you've begun to know other sellers and reputations, too, you're much more likely to use its auction service over others.

eBay has the early lead in building a reputable community. Its lead (and early momentum) serves very well in creating more momentum. Even spanking brand new auction participants are likely to know that eBay has the most reputable group of buyers, so they'll make eBay their first choice for business -- even if they've never been to the site before, and even if it's their first time online. (Many people have reportedly bought computers and gone online due to eBay alone: many people make a living selling things on the service.)

eBay's lead in technology and utilities, customer base, and community goodwill all make for very formidable sustainable advantages. Meanwhile, its competition hasn't been able to create the same fervor for their offerings. Yahoo! (Nasdaq: YHOO), for example, recently opened an auction site, but it's generic and not nearly as well structured or "sale or purchase" friendly. Yahoo! is probably aiming for spillover auctions (the fringe market) as this is a minor part of its business, while eBay is the recognized top dog, focused only on auctions, and is growing faster than any competitor. That's key.

In this business, critical mass and then exceeding critical mass is critically important in the long term. Wherever you're most likely to sell an item is where you'll put it up for auction first. And you can only put an item up for auction on one site at a time, not several. eBay will be the first choice for most -- and the last choice.

Yet, there is competition and the business model -- though eBay was the first mover -- is still replicable. So, there are many questions and issues remaining before we can think to call eBay a true Rule Breaker. Following today, the following criteria remain for consideration as we run the company through the Rule Breaker grinder:





What are your thoughts on eBay regarding criteria numbers one and two, and regarding the next four criteria that we haven't yet covered? Is eBay a worthy Rule Breaker? Post your thoughts on the Rule Breaker board. We'll see you there.

Fool on!

Check out what's happening with Harry Jones today.

02/23/99 Close

Stock  Change    Bid 
AMZN  +8 11/16 115.19
AMGN  +2 1/4  128.88
AOL   +1 2/3   88.17
ATHM  +9 1/16 109.06
DJT   -  1/16   4.25
CHV   -  21/50 78.75
CAT   -  2/89  46.94
DD    +  27/73 53.50
GT    -  11/17 48.06
IOM     ---     6.50
SBUX  +2 1/4   52.38
TDFX   -1/4   10.81
                   Day   Month    Year  History  Annualized 
      R-BREAKER  +3.80%  -1.71%  10.26% 1006.65%  69.55%
        S&P:     -0.08%  -0.66%   3.73%  190.87%   26.43%
        NASDAQ:  +1.47%  -5.17%   8.38%  229.97%   29.98%
 Note:  Yearly, historical and annualized returns for the 
S&P include dividends

    Rec'd    #  Security     In At       Now      Change
   8/5/94  2200 AmOnline       0.91     88.17    9600.90%
   9/9/97  1320 Amazon.com     6.58    115.19    1650.77%
  5/17/95  1960 Iomega Cor     1.28      6.50     407.65%
  12/4/98   450 @Home Corp    56.08    109.06      94.48%
 12/16/98   290 Amgen         85.75    128.88      50.29%
  4/30/97 -1170*Trump*         8.47      4.25      49.82%
  2/23/99   300 Caterpilla    46.96     46.94      -0.06%
  2/23/99   180 Chevron       79.17     78.75      -0.53%
  2/23/99   290 Goodyear T    48.71     48.06      -1.34%
   7/2/98   235 Starbucks     55.91     52.38      -6.32%
  2/20/98   260 DuPont        58.67     53.50      -8.81%
   1/8/98   425 3Dfx          25.67     10.81     -57.87%

    Rec'd    #  Security     In At     Value      Change
   8/5/94  2200 AmOnline    1999.47 193966.67  $191967.20
   9/9/97  1320 Amazon.com  8684.60 152047.50  $143362.90
  12/4/98   450 @Home Corp 25236.13  49078.13   $23842.00
 12/16/98   290 Amgen      24867.50  37373.75   $12506.25
  5/17/95  1960 Iomega Cor  2509.60  12740.00   $10230.40
  4/30/97 -1170*Trump*     -9908.50  -4972.50    $4936.00
  2/23/99   300 Caterpilla 14089.20  14081.25      -$7.95
  2/23/99   180 Chevron    14250.45  14175.00     -$75.45
  2/23/99   290 Goodyear T 14127.33  13938.13    -$189.20
   7/2/98   235 Starbucks  13138.63  12308.13    -$830.50
  2/20/98   260 DuPont     15253.14  13910.00   -$1343.14
   1/8/98   425 3Dfx       10908.63   4595.31   -$6313.31

                              CASH  $40083.27
                             TOTAL $553324.62

Note: The Rule Breaker Portfolio was launched on August 5, 1994, with $50,000. Additional cash is never added, all transactions are shared and explained publicly before being made, and returns are compared daily to the S&P 500 (including dividends). For a history of all transactions, please click here.


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