eBay Inc. (EBAY) reported third quarter earnings of 40 cents, in line with the Zacks Consensus Estimate. Despite encouraging revenue growth and the positive impact of recent acquisitions, demand trends appear sluggish.
As a result, rising costs and a much higher tax rate impacted results in the last quarter. Additionally, revenue guidance was not too exciting. As a result, shares dropped 4.01% in after-hours trading, after declining 2.04% during the day.
Revenue
Gross revenue of $2.97 billion was up 7.4% sequentially and 31.8% year over year, exceeding consensus expectations of $2.91 billion and eBay’s guidance range of $2.85-2.95 billion. eBay’s strategy of moving traffic to bigger sellers appears to be paying off, as the improved customer experience seems to be having a positive impact on demand.
Nearly 86% of total revenue was transactions-based, while the remaining 14% came from marketing services. Both transactions-based revenue (up 7.6% sequentially) and marketing services revenue (up 6.0% sequentially) contributed to the revenue upside versus guidance. They were also up 27.8% and 60.8%, respectively from a year ago.
Revenue by Segment
eBay reports revenue under the Marketplaces and Payments segments. The Marketplaces segment essentially refers to the 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.
eBay’s core gross merchandise volume (“GMV”) during the quarter excluding vehicles volume was flattish sequentially and up 16.5% year over year. We think eBay witnessed slightly softer demand than in the June quarter, although the business continues to show much improvement when compared with last year. Payment volumes strengthened again, growing 1.9% and 30.9%, respectively, from the previous and year-ago quarters.
The mobile business remained extremely strong in the last quarter. eBay is now expected to generate mobile GMV to $5 billion this year (previous expectations were $4 billion). This compares with $2 billion generated in 2010. Mobile payments through the Paypal Mobile Express Checkout system and the Zong acquisition are expected to boost mobile payment volumes going forward. The total mobile payment volume is likely to go from $750 million in 2010 to $3.5 billion this year (eBay estimated $3 billion at the end of the last quarter).
Marketplaces revenue for the quarter dropped 0.6% sequentially, while growing 17.1% from the year-ago quarter. The sequential revenue increase was the net impact of a 0.3% increase in transaction revenue and a 4.2% decline in marketing services revenue. The year-over-year increase was due to a 14.2% increase in transaction revenue and a 32.5% increase in marketing services revenue.
Marketing services continued to benefit from the addition of GSI in the June quarter. The declining revenue from marketing services is something to watch. Vehicles volume also suffered, declining 4% sequentially and flat to down slightly from the year-ago quarter (the second time in five quarters). Active users in Marketplaces were 97.2 million, up by more than a million during the quarter. Marketplaces generated 56% of total revenue.
eBay’s top-rated sellers now account for 45% of GMV in the U.S., with same store sales growing 23% year over year. Therefore, sellers are gaining from coming to eBay and driving more traffic to eBay properties. Technology improvements and deduplication of listings are helping the process.
Payments revenue increased 3.2% sequentially and 32.1% from the year-ago quarter. Revenue from transactions was up 4.2% sequentially although down 9.2% year over year, with the revenue generated per transaction declining sequentially and increasing year over year. The revenue per user followed the same pattern, declining sequentially and increasing from last year.
Additionally, the number of users increased yet again from both the previous and year-ago quarters. The year-over-year comparisons indicate enhanced user satisfaction, which is bringing back old users, generating new ones and also encouraging users to spend more. The sequential comparisons on the other hand indicate slightly slower demand.
Revenue from marketing services was down 9.2% sequentially and up 29.5% from the year-ago quarter. The sequential slowdown could indicate declining interest, but we need to watch this number for a few more quarters to come to any proper conclusion. The Payments segment generated 37% of total revenue.
GSI– During the quarter, eBay closed the acquisition of GSI, which brought in the remaining 7% of revenue, up from a 1% contribution in the preceding quarter.
Revenue by Geography
Around 48% of total revenue was generated in the U.S., representing a sequential increase of 14.3% and a year-over-year increase of 34.9%. The balance came from international markets, which were up 1.8% sequentially and 29.1% year over year.
Overall, the U.K., Australia and China experienced strength, while the growth in the U.S. and Germany slowed.
The pro forma gross margin for the quarter was 69.0%, down 276 bps sequentially and 186 bps year over year. While volumes were a positive in the year-over-year comparison, their impact was limited in the sequential comparison. The higher take rate for the Payments segment was offset by higher transaction expenses, partially on account of a growing transaction loss rate.
Marketplaces margins are generally much higher than Payments margins. However, 63% of transactions in the last quarter were under the fixed price format. The share of the fixed price format has been more or less stable to slightly growing for the last four quarters, which basically means that the company is now much more exposed to the severe price competition in the online retail market.
Operating expenses of $1.40 billion were higher than the previous quarter’s $1.36 billion. The operating margin was 22.4%, down 81 bps sequentially and 153 bps from the year-ago quarter. Higher cost of sales was the primary reason for the decline in operating margin from both the previous and year-ago quarters.
Excluding the impact of restructuring gains, the amortization of intangible assets, acquisition-related gains and Skype-related charges on a tax adjusted basis, the pro forma net income was $523.2 million or 17.6% net income margin, compared to $610.0 million or 22.1% in the previous quarter and $470.6 million or 20.9% in the year-ago quarter.
Including the special items, the GAAP net income was $490.5 million ($0.37 per share) compared to $283.4 million ($0.22 per share) in the June 2011 quarter and $431.9 million ($0.33 per share) in the September quarter of last year.
Balance Sheet and Cash Flow
The company has a solid balance sheet, with cash and short term investments of $4.01 billion, down $384.1 million in the last quarter. eBay generated $809.1 million in cash from operations and spent $283.5 million on capex, netting a free cash flow of $525.6 million (down from $542.9 million in the last quarter) Free cash flow also declined slightly in the June quarter. Other important uses of cash were $308.2 million on acquisitions and $32.8 million on share repurchases.
Outlook
Management expects fourth quarter 2011 revenue of $3.20-3.35 billion (up 8-13% sequentially, up 28-34% year over year), GAAP EPS of $1.47-$1.53 and non GAAP EPS of 55 to 58 cents. Revenue guidance was in-line with the Zacks Consensus Estimate of $3.28 billion, although the EPS is stronger than the estimated 51 cents.
For 2011, management expects revenue of $11.5-$11.6 billion (previous $11.3-$11.6 billion), GAAP EPS of $2.42 to $2.48 (previous $2.41 to $2.44) and non GAAP EPS of $1.98 to $2.01 (previous $1.97 to $2.00).
Conclusion
Despite the not-so-great sequential performance, eBay’s business continues to show all signs of a turnaround. Both Payments and Marketplaces are showing improving trends versus the year-ago quarter, an indication of the changing business profile.
We think eBay has taken all the necessary measures, beginning with the fixed price format, moving on to wooing big sellers and customers, and then improving the technology and navigation of its properties.
To this, the company has now started adding key capabilities through acquisitions. For instance, GSI brought fulfillment services, while Zong brought capabilities in online payment systems.
At the same time, we remain concerned about increasing competition from major online retailers, such as Amazon.com (AMZN), as well as many other smaller players. Additionally, Google Inc (GOOG) has been making some plays in the online retail space that potentially increase competition for the company. We also think that eBay’s payments business will sooner or later be impacted by online payment platforms from Mastercard Incorporated (MA) and other banks, not to mention Google’s digital wallet.
We are impressed with eBay’s strategy and execution, despite the fact that it could face near-term hurdles and of course increasing competition. Our sentiments are reflected in the Zacks #3 Rank, implying a Hold rating in the short term (1-3 months). Our long-term rating remains Outperform, since we expect the turnaround story to continue.
