Is eBay Still Cheap?

It's second nature for value investors to look for companies with durable competitive advantages -- doubly so in uncertain economic times. In fact, a strong moat is so important that it's sometimes difficult to put a value on it.

Small wonder then that eBay (NASDAQ:EBAY) attracts so much attention. Its marketplace business and its payment processor, PayPal, complement each other. Coupled with 88 million active users on the marketplace site, the company boasts a powerful network effect that competitors will have a very hard time defeating.

With a large moat and wads of cash generated from operations, eBay is the sort of business we value investors look for. But is the company undervalued? When shares were trading at $13.96 last December, Motley Fool Inside Value advisor Philip Durell made a no-brainer case for buying shares. That call was borne out when the stock recently hit a 52-week high of $25.48. At the current price, I find the case for eBay becomes much more opaque and hinges on a qualitative assessment of the company's growth prospects.

Where's the growth?
The marketplace business has long been both the company's growth engine and biggest source of revenue. Unfortunately, there are signals that eBay may be close to tapping out revenue growth in mature markets, as net revenue growth in the United States fell to 6% in 2008. In the United Kingdom and Germany, two of eBay's largest markets, growth has also declined significantly.

Moreover, eBay faces stiff competition in the international markets where it needs to go for lucrative long-term growth prospects. Like Google (NASDAQ:GOOG), which has struggled against the locally grown Baidu (NASDAQ:BIDU), eBay is having a hard time getting market share in China, where rival auctioneer Taobao is eclipsing the American giant. Thus, signs would seem to indicate that PayPal, which in 2008 accounted for 28% of the company's revenue, is the more attractive segment of the business. Check out these revenue growth figures.

In 2008, non-eBay-sourced PayPal transactions overtook the number of total eBay transactions for the first time, signaling that PayPal is increasingly self-reliant. At the same time, PayPal continues to increase penetration in the marketplace; it now accounts for 66% of all transactions on the eBay.com website, up from 58% last year.

But one big question looms: Will the slowing growth afflicting the marketplace business damage PayPal? In the latest conference call, management predicted a doubling of PayPal revenue by 2011. Two considerations suggest that those expectations are unrealistic. First, PayPal's year-over-year revenue growth has been slowing since 2003. Second, the consumer credit market is still weak.

Do I hear confidence?
eBay has plenty of cash on hand ($2.57 billion, in fact). However, the purchase and subsequent sale of Skype raises questions about management's ability to rely on acquisitive growth moving forward.

Management has also declared its intent to challenge Amazon (NASDAQ:AMZN) in direct sales over the Web, primarily through its Half.com operation. With players like Overstock.com (NASDAQ:OSTK) and Wal-Mart (NYSE:WMT) already competing for market share, this will no doubt prove tough slugging. I'm not sure that eBay's getting away from its core marketplace and payment processing businesses is a winning strategy for the long term.

At this point, an investment is a vote of confidence in management and continued high growth rates for PayPal, and that's a confidence I don't have. However, a number of catalysts could increase the company's value -- be it a strong acquisition, headway into a new international market, or signs that PayPal can consistently post strong revenue growth. While eBay certainly isn't cheap, this remains a business well worth watching.