EBay, Wake Up!

EBay continued to wander aimlessly during the quarter. Even though Q2 revenues exceeded the market’s expectations of $1.99 billion, they were down 4.5% over the year to $2.1 billion. Earnings for the quarter came in at $0.37 per share, falling 14% over the year but again managing to beat expectations of $0.36.

PayPal’s revenues of $0.70 billion contributed 32% of the quarter’s revenues and grew 11% over the year. Payment volume of $16.7 billion grew 12% over the year with US volumes growing 9% and international volumes growing 16%. In key metrics, global active accounts grew 20% over the year to 75.4 million. PayPal is opening its platform to third-party developers and will be the first global payments platform to do so, which should lead to innovation by third-party developers that John Donahoe claims will be “analogous to the iPhone.” This is a good strategy. Integrating the payment platform, especially for social gaming, virtual goods and related areas, so that it can be effectively integrated into apps, would help.

But things don’t seem to be going well for eBay’s marketplace segment. According to a recent Nielsen report, eBay traffic declined in April and May, both sequentially and over the year. In fact, page views for May fell a whopping 32% from a year earlier. Why am I not surprised?

EBay’s marketplace revenues fell 14% over the year to $1.3 billion. While transaction revenues fell 14% over the year, marketing services revenues fell 10%. The international business contributed 57% of marketplace’s revenue during the quarter and on a constant currency basis, international revenues were down 5% over the year. While fixed-price GMV excluding vehicles grew 19% on a fixed currency basis, auctions GMV excluding vehicles remained under pressure, and fell 17% in the quarter. Vehicles GMV fell 25% during the quarter on a fixed currency basis in reaction to the slowing economy. Obviously customers prefer straight-up retail to auctions.

While the site was revamped to improve the search experience, eBay is not doing enough to attract users, especially users who are willing to spend. The company is improving their search platform, and earlier this month they finished building the infrastructure that will allow cataloging eBay items for search to be more easily scalable. EBay is also posting more fixed-price listings. 

Overall, though, their site experience still cannot compare with the personalized feel that Amazon offers. Additionally, Amazon seems to be pursuing a dedicated online retail strategy. Their recent takeover of Zappos, the online shoe seller, for $928 million is a clear indication of their awareness of the need for a verticalized web offering.

Last year, I suggested that the acquisition of Zappos by Amazon could help expand the latter’s margins, which many claim have failed to grow as anticipated. So, while eBay sits on $2.6 billion in cash at the end of the quarter, its competitor has gone ahead and picked up a business that is expected to have nearly $1 billion worth of gross merchandise sale value and that has a loyal customer base. Analysts had estimated Zappos’ revenues for 2008 at around $625 million — a 22% fall over the 2007 revenues of $800 million and far short of their $1 billion revenue target for 2008. However, Zappos did manage to remain profitable with EBITDA of $40 million for 2008. There are reports that they had tried to go in for an IPO but that their main investor, Sequoia Capital, had pushed for a sale instead. Possibly the falling sales were the reason behind Sequoia’s backing out.

If eBay were to also look at online verticalization as a strategy, they would find plenty of opportunities. Take Blue Nile, the online jeweler, for instance. Blue Nile’s annual revenues are under $300 million and the company’s low-fixed cost, low-inventory model is likely to pay off as the jewelry industry consolidates. Figleaves.com, the largest online retailer of branded intimate apparel, is another opportunity: clothing remains the biggest online retail industry. However, if I were to take a guess, I am sure Amazon will get to them faster, while eBay dithers.

EBay could also look at acquiring vertical search engines such as Retrevo, Wize and TheFind to drive traffic and enhance their user experience with innovations like TheFind’s image search and matching engine, or Wize’s scoring engine. While Wize and Retrevo focus on consumer electronics, TheFind is all about lifestyle shopping. The user experience these sites offer has a unique value proposition and could also be great new entry points into eBay’s shopping engine. Acquiring them would help eBay move Shopping.com up the value chain and also circulate a large amount of the ad dollars within the company. No matter what, eBay needs to play, not just sit around sucking its thumb.

EBay should look at getting out of their communications business and into pure retail. Instead, they continue to grow Skype. Though Skype had a good quarter with revenues growing 25% to $0.17 billion, it still does not fit in with eBay’s portfolio. On a constant currency basis, Skype’s revenues grew 43% over the year with registered users growing by 42% to nearly 481 million. Skype-to-Skype minutes grew by a whopping 72% to more than 25 billion during the quarter. Skype out minutes grew 57% to 3 billion. Skype’s margins also expanded 480 basis points to 23.6% for the quarter. With numbers like those, companies such as Google could very well be interested in picking it up, and eBay could put some of this money from the sale of Skype to good use.

Earlier in the year, there were indications that John Donahoe’s turnaround strategy for eBay included spinning off Skype through an IPO. But there has been no action to that effect. In 2007, eBay took a $900 million write-down on account of Skype, thus acknowledging that they had significantly overvalued it. It seems as though the dispute with Skype founders Janus Friis and Niklas Zennstrom over the peer-to-peer technology that Skype licenses for its software is delaying the IPO.

Prior to the lawsuit (eBay sued Skype’s founders to prevent them from taking the technology they still own following the licensing dispute), Donahoe was looking at a $2 billion market price for Skype, in line with the market’s valuation of $1.7 billion to $2.2 billion. As of now, any potential buyer would have to wait for the suit to be settled before putting money in, and the IPO would also likely attract fewer investors.

EBay definitely has a tough time ahead. While Amazon continues to eat into its market share, there are players such as Craigslist that are undercutting eBay’s pricing structure. EBay’s Q3 outlook for revenues of $2.05 billion to $2.15 billion with EPS of $0.34 to $0.36.

The stock is trading at $21.47 with a market capitalization of $27.63 billion. While it has recovered from its 52-week low of $9.91, unless the company indicates where they are going, I would not touch the stock with a ten-foot pole.