Sohn Conference | May 8th 2017 - Dylan Adelman The Wharton School - Sohn Investment Conference

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Sohn Conference | May 8th 2017 - Dylan Adelman The Wharton School - Sohn Investment Conference
Sohn Conference | May 8th 2017

            Dylan Adelman
           The Wharton School
       dylana@wharton.upenn.edu
Sohn Conference | May 8th 2017 - Dylan Adelman The Wharton School - Sohn Investment Conference
Introduction                                                                                       Dylan Adelman
                                                                                          dylana@wharton.upenn.edu
A contrarian thesis inside of a contrarian thesis?

• The standard contrarian thesis on eBay is excellent. The company is a
  stable grower falsely seen as a melting ice cube, has temporary unpopularity,
  is aggressively repurchasing undervalued shares, has a fast-growing earnings      eBay Financial Snapshot ($b)
  stream from StubHub, and trades at a reasonable valuation.
                                                                                  Share price (5/03/17)     $33.15

• This is not the standard contrarian thesis. Two additional factors indicate     Shares outstanding         1.083
  that eBay has 46% upside from current levels. These factors relate to eBay’s    Market capitalization      35.90
  post-spinoff operating agreement with PayPal (“Merchant of Record”) and         Net cash                    2.20
  to its Classifieds Group segment (“Classifieds”). 5-year IRR equals 24%.
                                                                                  Enterprise value           33.70
• 46% upside? This excludes the merits of the standard contrarian thesis.         EPS (LTM)                  $1.91
  eBay’s Marketplaces and StubHub segment are given more conservative             Free cash flow (LTM)       2.165
  valuations than sell-side consensus estimates in this presentation.
                                                                                  P/E                       17.36x

• Bonus Prize: Part I of this pitch doubles as a short thesis on PayPal.          FCF yield                 6.03%

                                                                                                                     2
Sohn Conference | May 8th 2017 - Dylan Adelman The Wharton School - Sohn Investment Conference
Part I
Merchant of Record
Sohn Conference | May 8th 2017 - Dylan Adelman The Wharton School - Sohn Investment Conference
“It’s important to realize that losing even half the eBay
volume might have destroyed PayPal as a business […]
  eBay owned the platform and the checkout line. In
  hindsight, it’s a miracle they didn’t thrash PayPal.” –
        David Sacks, First COO of PayPal (2014)
Sohn Conference | May 8th 2017 - Dylan Adelman The Wharton School - Sohn Investment Conference
Merchant of Record                                                                               Dylan Adelman
                                                                                        dylana@wharton.upenn.edu
Not quite the Shakespeare play.
            eBay-PayPal Relationship                                     Everyone Else in 2017

• eBay acquired PayPal in 2002 to serve as its merchant    • All major e-commerce sites are merchants of record.
  of record. This provided costless new users to PayPal      Some of these payment processors, such as Alibaba’s
  while giving eBay an in-house payments processor.          AliPay, have gained traction outside their websites.

• As eBay’s merchant of record, PayPal intermediates       • The downsides to being a merchant of record are the
  every transaction. Buyers pay PayPal, and PayPal pays      risks of chargebacks and customer service costs. The
  the seller. PayPal takes a ~3.5% fee from the buyer        upside is a 2.5% spread on gross merchandise volume.
  and pays a ~1% fee to the acquiring merchant bank          For the largest e-commerce sites, being a merchant of
  that processes in bulk. The spread is PayPal’s profit.     record is thus a substantial profit center.

    eBay can become a merchant of record by serving as its own payment intermediary, rather than
      outsourcing to PayPal. This would provide a 2.5% profit spread on eBay’s ~84 billion GMV.
                                                                                                                    5
Sohn Conference | May 8th 2017 - Dylan Adelman The Wharton School - Sohn Investment Conference
Merchant of Record                                                                            Dylan Adelman
                                                                                     dylana@wharton.upenn.edu
Someone forgot to disclose “key customer risk.”
                      Benefits to PayPal                                    Benefits to eBay
• In response to a proxy for splitting eBay and PayPal
  led by Carl Icahn, management noted on 3/24/14:

“Tightly integrated with eBay, PayPal can grow faster and more profitably
 than it would as a standalone company. Adoption and use of PayPal on
   eBay enables innovation and growth off of eBay. For example, eBay
                                                                                 ?
 delivers about 30% of PayPal's new users at virtually no cost, more than
  30% of PayPal's revenues and approximately 50% of PayPal's profits.
PayPal's growth and leadership in mobile payments has occurred precisely
     because of this strong base of PayPal users on eBay.” – 3/24/14

                     Why does eBay continue this one-sided relationship?                                        6
Sohn Conference | May 8th 2017 - Dylan Adelman The Wharton School - Sohn Investment Conference
Merchant of Record                                                                                  Dylan Adelman
                                                                                           dylana@wharton.upenn.edu
It pays to read the footnotes.
eBay’s July 2015 spinoff of PayPal was the first step to ending this one-sided relationship. The pre-spin
relationship between both companies is frozen by an operating agreement that is valid until July 2020.
• Question: once eBay can end the merchant
  of record relationship with PayPal, how do        “Following the three (3) year anniversary of the Effective
  we know that they actually will?                Time, eBay shall be permitted to declare itself as a Merchant
                                                  of Record for transactions effected by third Persons in up to
• Answer: because of this cheeky clause in         two (2) Covered Jurisdictions as selected by eBay in its sole
  Section XIV of the operating agreement…           discretion (each, a “Test Jurisdiction”) […] – Section XIV

                                                      “It’s not really a question of if they will do it, but when.
                                                       eBay will become a merchant of record, but the more
                                                     interesting question is whether they will continue to offer
                                                        PayPal as an option at all.” – GLG Payments Expert

The eBay-PayPal operating agreement allows eBay to begin merchant of record trials three years after the spinoff.
Read between the lines: why would this footnote exist if eBay did not want to be a merchant of record?
The catalyst for value realization is the announcement of test jurisdictions as a merchant of record in mid-2018.
                                                                                                                      7
Merchant of Record
The hangover that PayPal can’t sleep off.

        Assumptions
    84.26B = LTM GMV
  3.47% = PayPal take rate
    1.0% = back-end fees           (84.26)*(1.034)*(3.47% - 1%)*(50%)*(1 - 25%)
     50% = SG&A costs                                                                             = 8.57 billion
       25% = tax rate                                 (1.14)*(10%      - 3%)
      3% = terminal rate
     10% = discount rate

Rationale
• 3.47% – this is the last reported figure for PayPal’s overall transaction take rate (in 2014). This number blends in
  the 0% take rate on various Braintree platforms (i.e. Venmo). The true on-eBay take rate is much closer to 4%.

• 1.0% – based on GLG experts’ commentary. This comprises various fees for credit and debit transactions that
  include network fees, interchange fees, acquirer fees, and fraud fees. eBay’s size enables negotiating lower rates.

• 50% – haircut to account for incremental hires, customer service expenses, and ironing out the kinks.
                                                                                                                         8
Part II
eBay Classifieds
“I look for economic castles protected by
 unbreachable moats.” – Warren Buffett
eBay Classifieds                                                            Dylan Adelman
                                                                   dylana@wharton.upenn.edu
Good luck disrupting this, Silicon Valley.
How much would you pay for a business with the
following characteristics?
• Nationwide monopoly in ten countries with zero
  reinvestment required to keep competitive position

• 60% operating margins on ~800M revenue with a
  high degree of operating leverage

• 280 million person monthly user base that is price
  insensitive, sticky, and has no alternative options

• Massive and still-underpenetrated total addressable
  market that will enable top-line growth of 10-15%
  for the next decade

• Recession-proof and holds no inventory

                                        Let’s ask the sell side!                          11
eBay Classifieds                                                                                             Dylan Adelman
                                                                                                    dylana@wharton.upenn.edu
The problem with sell-side bandwagoning.
                     Market View                                                             Reality
• “Concerns about eBay’s growth are valid considering            Classifieds LTM Revenue = $804M   StubHub LTM Revenue = $964M
  that it makes its money from its marketplaces and
  ticketing services. It does not have significant revenue
  outside of the two.” – 4/11/17

• “We've assigned the stand­alone eBay a narrow moat
  rating, down from our previous wide moat rating for
  the consolidated eBay/PayPal entity.” – 10/26/15                  Estimated EBIT margin = 60%     Estimated EBIT margin = 30%
                                                                     Estimated EBIT = $482M          Estimated EBIT = $289M

                                                                        Classifieds contribute 67% more EBIT than StubHub

                    “I was always baffled by Wall Street’s focus on StubHub over Classifieds. I think it’s
                    because they buy their Knicks tickets on StubHub, but never buy any used items on
                    Marktplaats. And why would they? It’s a Dutch website.” – GLG Classifieds Expert

                   The market is not accounting for eBay Classifieds.                                                         12
eBay Classifieds
But really, when will Craig Newmark monetize?

      Assumptions
  804M = LTM revenue
  10% = 2017-27 CAGR                     (804)*(1.110)*(70%)*(1 - 25%)
   70% = EBIT margin          (422*10) +                               = 11.96 billion
     25% = tax rate                               9
                                              (1.1 )*(10% - 4%)
    4% = terminal rate
   10% = discount rate

Rationale
• 422 – free cash flow produced by classifieds in 2017. (804)*(70%)*(1-25%) = 422M.

• (422*10) – value of interim payments before terminal period. Because the growth rate equals the discount rate,
  they cancel out during the projection period. 1.1/1.1 = 1, 1.12/1.12 = 1, 1.13/1.13 = 1, and so on.

• 10% – growth has trended at 10-15% over the last five years. Comparable firms (Schibsted and Naspers) estimate
  15% growth over the long-term due to continued market penetration, monetization, and new listing verticals.

• 70% – based on operating margins of mature peers owned by Schibsted (i.e. Leboncoin and Finn).
                                                                                                                   13
Part III
Marketplaces & StubHub
“[There is] a difficulty that the public marketplace has
in valuing cash cows, let’s call them, businesses that are
growing slowly […] but generate an enormous amount
       of free cash flow.” – John Malone (2016)
Marketplaces
The world’s largest store of pez dispensers.

      Assumptions
  7.28B = LTM revenue
   30% = EBIT margin                    (7.28)*(30%)*(1 - 25%)
      25% = tax rate                                           = 23.40 billion
    3% = terminal rate                         10% - 3%
   10% = discount rate

Rationale
• 3% – Marketplaces can be visualized as a perpetual bond. Current revenue growth guidance is 5-7% annually.
  This projection has revenue growth at 3% in perpetuity for conservatism. Clearly, this is not a melting ice cube.

• 30% – this operating margin adjusts for temporarily inflated SG&A due to the structured data inititave.

• 25% – eBay’s historic tax rate is 20% due to its international earnings mix. 25% is used for conservatism.

• Note that the Marketplaces and StubHub projections are far more conservative than Street estimates.
                                                                                                                      16
StubHub
The best place to buy Hamilton tickets at a 300% markup.

      Assumptions
  964M = LTM revenue
  10% = 2017-27 CAGR                    (964)*(1.110)*(30%)*(1 - 25%)
   30% = EBIT margin         (217*10) +                               = 6.15 billion
     25% = tax rate                              9
                                             (1.1 )*(10% - 4%)
    4% = terminal rate
   10% = discount rate

Rationale
• 217 – free cash flow produced by StubHub in 2017. (964)*(30%)*(1-25%) =217M.

• 10% – grew nearly 40% last year. Management is guiding for 10-15% annual growth. The acquisition of TicketBis
  opens international markets. The underpenetrated and large total addressable market offer a long growth runway.

• 30% – estimate backed out from known Marketplaces margins and likely Classifieds margins. This EBIT margin
  will likely increase over time due to StubHub’s operating leverage, pricing power, and market consolidation.

                                                                                                               17
Part IV
Valuation & Conclusion
Valuation                                                                Dylan Adelman
                                                                dylana@wharton.upenn.edu
Were you expecting a balanced three-statement model?

 Marketplaces + StubHub + Classifieds + Merchant of Record + Excess Cash = eBay
           23.40 + 6.15 + 11.96 + 8.57 + 2.20 = 52.28 billion fair value
                     Current Price: $33.15 | Target Price: $48.27

                                         Upside: 46%
                                                                                       19
IRR                                                                                              Dylan Adelman
                                                                                        dylana@wharton.upenn.edu
The expected average annual return of eBay over the next five years.

       IRR = organic growth + FCF yield + multiple expansion + revaluation
                         IRR = 5.0% + 6.0% + 3.3% + 9.2% = 23.5%

                                       5-year IRR = ~24%
Rationale
• 5.0% – weighted average of estimated 5-year growth rates across Marketplaces, StubHub, and Classifieds.

• 6.0% – current free cash flow yield. This return will be amplified by ~$1B in share buybacks in 2017.

• 3.3% – slight multiple expansion from 17x to 20x EPS due to ~35% of earnings coming from faster-growth
  StubHub and Classifieds segments. Multiple expansion assumed over five-year period: (20/17)^(1/5)-1.

• 9.2% – upside from readjustment to fair value over next five years: (48.27/31.15)^(1/5)-1.

• If multiple expansion and revaluation occur within a year, the one-year IRR will equal 85%.
                                                                                                               20
“My house is filled with this crap
    Shows up in bubble wrap
        Most every day
    What I bought on eBay”
 - “Weird Al” Yankovic (2003)
Special Thanks
 Nad Kilani       Tong Lap Him
 Justin Ang      Rufino Mendoza
Frank Geng       Pratyusha Gupta
Jordan Meer     Deependra Mookim
 The Sohn Conference Foundation
    Global Platinum Securities
     Gerson Lehrman Group
           Casa Balear
Sohn Conference | May 8th 2017

            Dylan Adelman
           The Wharton School
       dylana@wharton.upenn.edu
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