This interview originally appeared on the Inside Value website in January 2007.
In Part 2, we dug into the portfolio a bit to get Oak Value Capital managers David Carr's and Larry Coats' thoughts on some stocks. Let's dig a little deeper.
David Meier: How does eBay (NASDAQ:EBAY) stack up?
LC: For eBay, we have studied the business models for years. The most surprising part about eBay and the part that in a lot of ways most intrigued us and convinced us that the visibility of management and the driving force of management, that the power of these integrated business models was clear, was PayPal. PayPal was an acquisition that people were not fully sure why or what it was doing, and PayPal is turning out to be a tremendously brilliant acquisition. We understand the business model of payment processing very well through American Express (NYSE:AXP), as well as through Fidelity Information Services and other companies that have had global payment processing networks.
So when we look at the power of a network and we understand the economics of what a network means, and that if you can truly build a network and through that have a low-cost operation where you can take business on at very low incremental cost to acquire and have a platform that can be migrated around the world, it is very impressive. I am not sure we have ever seen a model that has migrated as rapidly as eBay's. I guess you could argue that Google has, but we are still not completely certain where that model is going to be long term.
For eBay's case, we think its model is more certain where it is and where it is going to be, and if you look at the ability to do the work out of San Jose [Calif.] and then migrate a virtual business model to another country and suddenly enable business to occur in that country that did not occur before and allow cross-border transactions to occur between people, it is a very interesting microcosm of looking at what goes on with global trade on a global basis.
Then when you see how PayPal enables the eBay transactions to take place, and you look at the traction PayPal is getting, as well as the fact that PayPal helps offset all the concerns about fraud on the Internet for Internet purchases. We have watched closely the traction gotten around the world in online purchasing, but there are a lot of trends that are very positive.
Then you layer on Skype. We put no value for Skype in our valuation right now, although clearly the traction it is getting is very interesting and those people who did not fall off the turnip truck before with PayPal have a vision for Skype. So there is some decent optionality on Skype being valuable also.
So when we look at that, it is amazing to see a company like eBay that can roll out businesses around the world so well, have local businesses that operate immediately, and produce lots of free cash flow. It has lots of levers to pull in its quiver of arrows.
For instance, this year in the U.S., there is clearly lots of noise and lots of concern. The U.S. doesn't drive the whole business and it has made some mistakes in pricing and muddled up the core franchise a little bit. But to its credit, it actually has a total business that when it does that, it can understand what happened and make some changes. Those changes appear to have been good so far and we think there are smart people who will make good decisions. We would much rather have a situation like that where something is causing their own damage than one that is really being affected by competitors hugely.
We look at PayPal being picked up on the websites as a payment scheme for Barnes & Noble (NYSE:BKS) and Dell (NASDAQ:DELL) and a number of other large Internet retailers. It indicates to us that PayPal really is growing more ubiquitous. So with our knowledge of media companies and our understanding of free cash flow and reinvestment of free cash flow, we didn't find to be that big a jump to go from understanding, for instance, the value of E.W. Scripps (NYSE:SSP) in its early days as it was expanding and producing returns and trying to value that and comparing that and trying to value an eBay today.
While we would never have owned eBay at an earlier time, the fact that Bill Miller has owned it for a while made us pay attention, because we know he does understand business models and is pretty good at it. So our attention and work with eBay put us in a good position once the opportunity came along. We built the position that I guess what, at an average cost below $27.50. We are not currently buying it at today's prices.
At its core, eBay, as David describes it, if you just step all the way back and look at it, it is for all intents and purposes a tollbooth on various types of e-commerce that are taking place or commerce that is taking place on the Internet.
If you look at the long-term economics that the business has, we think they will unfold. What you have is, as I indicated earlier, a very good business with good management, and it became available to us at an attractive price for a relatively short period of time. We were able to take advantage of that for the benefit of the mutual fund, the Oak Value shareholders, and our clients. But there is a price at which the margin of safety in this company, as in most companies, is attractive, and a price at which it isn't. When we bought it, we thought the margin of safety was more than adequate for the business that we were buying.
DC: But I will tell you, one of the things we have wrestled with often is when you find a good company, if you find a great company -- and in many ways you have talked about your interest in eBay, and I think we would all probably agree, it really has many of the characteristics of a great company.
Valuation is the hard part. We run a worst case, a best case, and a base case. We do our work using a base case of what we think is a very reasonable, rational, and what we usually find to be a very conservative thought process of what will unfold. The risk to us is that if we find a really great one, and there are not that many really great ones, we have to spend lots of time on the maintenance part of our research to understand and make sure we are properly valuing it. We want a good understanding what it really is worth, because we don't want to sell too early. But when it does get to our intrinsic value, we do move on even if it is a great company.
For instance, Berkshire has a price. There is a price at which we would sell Berkshire. It is not a company that is there forever. It so happens that we think it is still undervalued today, so it is still in the portfolio.
In Part 4, David and Larry share what's most important but hardest to determine about a company: the strength of its business model.
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Retail editor and Inside Value team member David Meier does not own shares in any of the companies mentioned. He's ranked 7,979 out of 30,725 rated investors in CAPS. You can view his TMF profile here. The Fool takes its disclosure policy very seriously.
