eBay – PayPal: Buy Two Moats For The Price Of One – Presentation by Elliot Turner, Compounding My Interests

I had the privilege of presenting my favorite “Wide Moat” idea at the Value Conferences Wide Moat Summit, which aired live on July 7th, 2015. Embedded below are my slides from that talk. Enjoy:

eBay – PayPal: Buy Two Moats For The Price Of One

IMAX Recap

We focused on a company with the potential to form a moat, not one with a moat. Core thesis:

  • Film is a slow-moving industry where change requires the alignment of a lot of different constituencies.
  • Globalization of film alongside the industry’s focus on fewer releases with greater emphasis on visual differentiation from the proliferation of HDTV.
  • With an expanded theater footprint and time, directors have been able to gear content towards IMAX, leading to more interesting and engaging films. 2015 is already changing the industry’s perspective on seasonality and when/how blockbusters work.
  • Gross margins have trended steadily upward. Bottom line has accelerated slower than hoped, though last year it started its steep ascent and will continue to do so this coming year.

Ebay

Two Networks For The Price Of One

While IMAX was about the potential to build a moat based on a network effect, today we want to talk about two companies with such a network already entrenched, each available at a cheap price.

There’s a reason why great investors like Carl Icahn, Seth Klarman, Dan Loeb, Donald Yacktman and Larry Robbins all own considerable stakes in this company, though given their presence it’s surprising that a) there has not been more enthusiasm about this situation; and, b) the stock has been stagnant for 2+ years.

Ebay

  • We are particularly fond of stocks with sideways charts where ownership has been digesting for some time. While we do not require catalysts for our investments, we like that there is one upcoming which should drive value realization.

Conventional Wisdom Holds The Following Beliefs

  • eBay today is the combination of two companies: a tech dinosaur of sorts in the Marketplaces division and a rapid growth upstart in PayPal.
  • Marketplaces is a declining business after Amazon, startups and big box stores have brought heavy competition to e-commerce.
  • PayPal was undermanaged in the belly of the eBay beast and lost crucial ground in the rapidly evolving, competitive arena of digital payment solutions.
  • Reality is always more nuanced. There are grains of truth here & the company was certainly under-managed. These issues are being met head-on in the spin-off and both business are far more defensible than meets the eye.

Marketplaces – Buy A Growing Business, Priced To Shrink

Cantor Fitzgerald’s overview of the split led its Marketplaces’ section with the following question:

  • •“Can eBay’s growth catch up with that of overall ecommerce (in the low teens currently) considering that the auction business looks likely to remain a melting ice cube for some time?”
  • The phrasing says a lot: eBay is growing, yet it is thought of as a “melting ice cube.” I always thought melting ice cubes shrunk! The implied value of Marketplaces says as much.
  • Revenue has been growing in the high single digits. 2015 will be a flat to slightly up year due to one-time problems after which high single digits growth should resume.

Marketplaces is one of the best online facilitators of global commerce.

This division will also own StubHub; an amazing property, though hard to value independently without segmented financials.

Ebay

The Moat

Signs of a moat:

  • Extremely high free cash flow on a capital lean business model: In 2014 Marketplaces generated $2.7 billion in cash flow on $3.5 billion in assets deployed (we do not know Marketplaces’ balance sheet with precision. This is inferred from subtracting PayPal’s balance sheet from EBAY’s Q1 filing. $3.5 billion is inclusive of $5.7 billion goodwill expected to stay with the Marketplaces division. Strip this out and the company deploys net negative tangible capital).
  • Industry leading operating margins: company guides 2015 for 32-34%, with a long-term target of 31-36%. This is amongst the upper echelon of companies and the highest of the great internet companies including Google, Facebook, Alibaba, and let’s not even mention Amazon.

Network Effects (demand-side economies of scale)

  • Buyers and sellers both know they can reach each other in eBay’s marketplace. Further, they know they can trust that when a transaction is made, their end of the bargain will be delivered upon. Building out that trust takes years of investment and reputation management.

See full presentation below.

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