eBay Inc. (EBAY) reported third quarter earnings that beat the Zacks Consensus by 5 cents or 16.1%. This was much better than the average positive surprise of 7.26% reported in the four preceding quarters. As a result, shares jumped 7.13% in after-hours trading.
A few analysts have been raising estimates over the past few days, as it became apparent that the negative foreign exchange impact would not be as severe as initially expected. Business metrics continue to improve overall, with weakening gross margins the only downside in the quarter.
Revenue
Gross revenue of $2.25 billion was up 1.5% sequentially and 0.5% year over year, beating the Zacks Consensus by 3.0% and exceeding the high end of management guidance. The company is accounting for its stake in Skype under the equity method, so reported revenue does not include any contribution from Skype.
Around 88% of total revenue was transactions-based, while the remaining 12% came from marketing services. Both transactions-based revenue (up 0.5% sequentially) and marketing services revenue (up 1.5% sequentially) contributed to the revenue upside versus guidance. They were also up 0.5% and 0.7%, respectively from a year ago.
Revenue by Segment
The company reports revenue under the Marketplaces and Payments segments. The Marketplaces segment essentially refers to revenue earned from the sale of goods available on eBay properties. The Payments segment refers to revenues generated through Paypal. Consequently, both segments derive revenue from transactions, as well as marketing services.
Marketplaces revenue increased 0.9% sequentially and 3.4% from the year-ago quarter. The sequential revenue increase was the net impact of a 0.3% increase in transaction revenue and a 4.6% increase in marketing services revenue. The year-over-year increase was due to a 3.0% increase in transaction revenue and a 5.9% increase in marketing services revenue.
Vehicles volume declined 1% sequentially and 10% from the year-ago quarter. Vehicle volumes have witnessed year-over-year declines in each of the last 5 quarters. Active users increased to the highest level in 6 quarters. Marketplaces generated 63% of total revenue.
Payments revenue increased 2.6% sequentially and 21.8% from the year-ago quarter. Revenue from transactions was up 3.5% sequentially and 22.9% year over year, with the revenue generated per transaction declining both sequentially and from a year ago. However, revenue per user increased both sequentially and year over year, indicating that users are making smaller transactions, but coming back for more.
Additionally, the number of users continued to increase from both previous and year-ago periods. Although the cost per transaction increased slightly, management was able to contain the transaction loss rate. Revenue from marketing services was down 12.9% sequentially, but up 3.7% from the year-ago quarter. The Payments segment generated 37% of total revenue.
Revenue by Geography
Around 47% of total revenue was generated in the U.S., representing a sequential increase of 2.5% and a year-over-year increase of 4.4%. The balance came from international markets, which was flattish sequentially (up 0.7%) and down 2.7% year over year.
Management stated that sales into Europe which is a net importer from both the U.S. and Asia were stronger than expected. What was more heartening, the important markets of U.K. and Germany remained strong. Although China and Hong Kong remain the fastest growing regions, sales growth was tempered by currency in the last quarter.
Margins
The pro forma gross margin for the quarter was 71.5%, down 114 bps sequentially and 30 bps year over year. Flattish volumes in both segments combined with an increasing number of active users and increasing cost per transaction processed negatively impacted the gross margin in the last quarter.
Marketplaces margins are generally much higher than Payments margins. However, 60% of transactions in the last quarter were under the fixed price format, exposing the company to the severe price competition in the online retail market.
Operating expenses of $1.07 billion were higher than the previous quarter’s $1.06 billion. The operating margin was 24.0%, declining 102 bps sequentially and 30 bps from the year-ago quarter. All expenses were flattish sequentially as a percentage of sales, so the decline in the operating margin was primarily on account of the weaker gross margin.
Excluding the impact of restructuring charges and the amortization of intangible assets on a tax adjusted basis, the pro forma net income was $470.6 million or 20.9% net income margin, compared to $458.8 million or 20.7% in the previous quarter and $428.6 million or 19.2% in the year-ago quarter.
Including the special items, the GAAP net income was $431.9 million ($0.33 per share) compared to $412.2 million ($0.31 per share) in the June 2010 quarter and $349.7 million ($0.27 per share) in the September quarter of last year.
Balance Sheet
The company has a solid balance sheet, with cash and short term investments of $5.36 billion, up $465 million in the last quarter. eBay generated $747 million in cash from operations and spent $167 million on capex, netting a free cash flow of $580 million (up $61 million during the quarter).
Outlook
Management expects fourth quarter 2010 revenue of $2.39-2.49 billion (up 8.5% sequentially and 2.9% year over year), GAAP EPS of 37 to 40 cents and non GAAP EPS of 45 to 48 cents.
For the full year, management expects revenue of $9.05-9.15 billion (raising previous guidance by $200 million), GAAP EPS of $1.30 to $1.33 (up from $1.23 to $1.28) and non GAAP EPS of $1.67 to $1.70 (up from $1.60 to $1.65).
Conclusion
eBay reported another good quarter and the negative currency impact was much less than cautioned by management, causing them to raise full-year guidance after lowering it in July. The fixed price format, while impacting margins negatively, is making the company more competitive and management’s focus on technological improvements will further improve customer satisfaction.
Shares have responded positively to the news and we believe there could be further upside, if eBay performs strongly versus peers in the seasonally stronger fourth quarter. We therefore have a Zacks #2 Rank on eBay shares, meaning that we recommend investors to accumulate shares at this point.
We believe eBay will continue to see higher volumes, the impact of which will be partially offset by higher costs, weaker pricing and shrinking margins.
Our longer term rating on eBay shares stays Neutral.
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