eBay Executes On Internet’s Promise

There was a time not long ago when Internet companies could get funded or even go public with business plans that ranged from untested at best to delusional at worst.

Push-technology companies, free ISPs, below-cost e-tailers, incubators…virtually none of these saw their strategies or markets develop as originally envisioned. Once they could no longer count on an unlimited supply of money, many went broke, sold themselves for pennies on their most inflated valuations or scrambled to cobble together another business model.

One company that has executed its business plan to perfection is online auction leader eBay . Indeed, eBay arguably is the most successful pure Internet company in the world.

Last Thursday eBay trounced Wall Street estimates for the fourth quarter by reporting revenues of $134 million and net income of $23.9 million, or 9 cents per share. Consensus forecasts called for sales of $125.5 million and net income of 7 cents per share.

As the table below shows, Q4 was no fluke for eBay. The company has been profitable for more than three years, while other important metrics keep growing.

                         1999                 2000
                      Q3     Q4     Q1     Q2     Q3     Q4 

Revenue              58.5   73.9   85.8   97.4  113.4  134.0

Revenue Growth       170%   139%   100%    97%    94%    81%
 (over year-ago)

Gross Profit Margin   70%    71%    73%    75%    79%    82%

Net Income            1.4    3.8    6.3   11.6   15.2   23.9

Net Income Per Share  0.1    0.2    0.2    0.4    0.5    0.9

On a year-to-year basis, only eBay’s quarterly revenue growth is slowing. But that’s to be expected as sales volume climbs. The company’s sequential quarterly growth has remained in the range of 16% to 18%.

eBay’s fortunes stand in stark contrast to the current travails of former ‘Net high-flyers such as CMGI and priceline.com, once touted as can’t-miss candidates by a herd of underwriters, analysts and investors, and now struggling to prove they can even survive, never mind make a profit.

The key to eBay’s success is simple: Its business model not only is perfectly suited to the Internet, it is based on an unerringly accurate assessment of the dynamics of the online auction market and how it will evolve.

Just read this passage from eBay’s July 1998 S-1 filing. After citing numbers showing the exponential growth of registered users and auctions hosted, eBay officials offer this observation:

“The Company believes that this critical mass of buyers, sellers and items listed for sale creates a cycle that helps eBay continue to grow its user base. Sellers are attracted to eBay as a result of the large number of potential buyers, and buyers in turn are attracted to eBay by the broad selection of goods listed on eBay.”

And that’s exactly what has happened. eBay has grabbed more than 70% of the online auction market, a figure that isn’t likely to diminish because neither buyers nor sellers are motivated to take their business to a less-popular auction network. Why would they? Because eBay has outages once in awhile? That kind of minor inconvenience may drive away a handful of hotheads, but serious buyers and sellers will stay where the action is because it is to their benefit.

Further, for all the talk in the past few years about first-mover advantage on the Internet, eBay is one of the few companies that has made it stick.

The real beauty of eBay’s business model is that it is easily – and profitably – scalable. Look at the gross margin figures in the table above. They just keep going up. As eBay keeps growing, so does its operating profitability. That’s how the Internet was supposed to work in everybody’s dream business plans; eBay is one of the few ‘Net players to execute.

Though EBAY, which closed Monday at $49.44, are down 61% from their 52-week high of $127.50, shares are still

pricey. With a current market capitalization of $13.2 billion, eBay is valued at 30.7x trailing 12 months’ revenue of $431 million and 19.9x projected 2001 revenues of $665 million. On an earnings basis, those figures are 232x TTM net income of $57 million and 120x projected 2001 earnings.

Recent (painful) experience tells us that eBay can’t sustain its lofty valuation. In fact, just two weeks ago, shares were at a 52-week low of $26.75, which would have been a good time to jump in. While I’d wait for a better entry point than the current share price, make no mistake: eBay is one of the big winners in the Internet economy.

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