Stock of eBay Acts Like ... eBay,
But How Can Shares Stay Lofty?

If you are among those investors bidding up eBay Inc. shares as avidly as the Web site's collectors lately have pursued Iraqi currency notes, be careful.

Under one scenario for meeting long-term growth forecasts, eBay could need more than one of every three adult Americans by the year 2010 regularly bidding on, listing or buying goods on its site.

It probably won't get that many people using its site, but the alternative could also prove daunting -- boosting the amount of shopping the average eBay user does well beyond the current growth rate, for many years to come.

With eBay shares by widespread agreement priced for perfection, that is the lay of the land, some skeptical analysts and investors say. While even eBay skeptics aren't expecting trouble soon, they say some simple math shows that Wall Street's very bullish long-term growth expectations for the company may be a stretch. At the same time, many Wall Street analysts may be overlooking potential rivals that could challenge the company.

"This is very similar to the late '90s, where we did crazy things to justify valuations" of Internet companies, says George Sutton, an analyst at Craig Hallum Capital Group LLC, a securities brokerage firm and investment bank in Minneapolis with no ties to eBay and who has followed the company in the past but isn't currently. "I don't think this is any different."

How pricey are the shares? Even as the rest of the stock market struggles along, eBay shares continue to flirt with 52-week highs. The company has a market value of $28 billion -- more than the combined value of retailers Bed Bath & Beyond Inc., Best Buy Co. and May Department Stores Co. Shares of eBay trade at about 81 times this year's estimated earnings, nearly five times the valuation of the broader market. The company's shares were up 55 cents at $90.75 in 4 p.m. Nasdaq Stock Market trading Monday, in anticipation of strong first-quarter results scheduled for release Tuesday.

To its credit, eBay is one of the Internet's few truly profitable enterprises. But investors buying shares at these high prices may not be aware of the huge numbers of users and giant increases in shopping activity that the more-bullish projections require. "This is priced for 50% growth as far as the eye can see," says Nick Moore, a portfolio manager until last week at Jurika and Voyles, a hedge fund in Oakland, Calif., that doesn't have an eBay position. While eBay has many positive attributes, he says, at its current stock price "it's an accident waiting to happen."

Among the optimistic revenue-growth projections is one from U.S. Bancorp Piper Jaffray, which predicts eBay's revenue will hit $9.9 billion by 2010. Morgan Stanley is more enthusiastic, forecasting $11.4 billion. Those figures represent, respectively, eightfold and ninefold increases from last year's $1.2 billion in revenue, when eBay had 27.7 million "active users" (those who do more than just register) and 61.7 million total registered users.

Assuming that shoppers continue to spend an average of $513 a year in eBay purchases and eBay continues to get almost all of its revenue in the form of seller fees on millions of transactions, an eightfold increase suggests eBay would need a whopping 222 million active users and 494 million total registered users by 2010. (It would need fewer total users if the portion that is active grows.)

Now, eBay executives have predicted that the company's international business will overtake its domestic operations -- jumping to, say, 60% of total revenue from 25% last year. But that means it still could need about 89 million active users and 198 million total registered users on its home turf by 2010. Since the U.S. Census Bureau projects 236 million adults in the U.S. that year, the upshot is that the San Jose, Calif., company could need almost 38% of the adult population to be active eBay users to meet the more-bullish 2010 Wall Street estimates.

EBay executives declined to comment on its future performance, citing a quiet period prior to the release of its quarterly results. In the past, it has told analysts to expect $3 billion in 2005 revenue, not including revenue from its acquisition of the PayPal electronic-payment service. That is a goal even some skeptics think is attainable.

There is, of course, another way eBay potentially can meet long-term revenue forecasts. It could sharply boost the amount each user spends on DVD players, baseball cards and other stuff on the site or expand into new categories of goods. Indeed, eBay executives have said that increasing the frequency of eBay purchases is vital to the company's future.

This is how it might work, according to U.S. Bancorp's Safa Rashtchy: If eBay manages to boost "user spending" -- revenue it brings in from each active user -- by a 13% compound annual growth rate through 2010, it would need 15% annual growth in its audience, or half the increase it would need if user spending doesn't grow a dime from last year.

But 13% annual growth in user spending far exceeds increases seen in the past. Last year, the revenue eBay pulled in from each active user was $44, a 5% increase from $42 in 2001. In other words, eBay will have to nearly triple the annual growth rate in user spending to meet forecasts.

After going through the math last week, Mr. Rashtchy says he isn't sure his revenue goal of $9.9 billion in 2010 is achievable after all. Current user-spending growth rates are "not gonna cut it," he says. "If you bring it down to what's required to get there, you run into some problems." He says he based his 2010 forecast on what seemed like a reasonable slowing of annual revenue growth, to about a 30% compounded annual growth rate between 2002 and 2010. EBay's revenue grew 62% last year and the company has forecast 58% revenue growth for this year. Mr. Rashtchy, whose firm doesn't have an investment-banking relationship with the company, has a "market perform" rating on eBay.

Mary Meeker, an analyst at Morgan Stanley with an "overweight" rating on the stock, didn't respond to requests for comment about how she calculated her $11.4 billion revenue forecast, which appears in a January report on eBay. Morgan Stanley has an investment-banking relationship with eBay, according to recent Morgan Stanley research.

Of course, many users will likely shop more on eBay. But some investors think it will be hard for the company to radically increase the amount users spend on the site the further it gets away from its core base of enthusiasts. Also, encouraging more shopping from users could boost marketing costs, which could crimp profits.

Last year, eBay's net income nearly tripled to $249.9 million. Earlier this year, the company raised its sales and profit forecasts for 2003. "People are paying for growth, predictability, execution and the profitability of this business," says Rajiv Chaudhri, president of Digital Century Capital, a New York hedge fund whose largest stock holding is eBay.

According to some skeptics, another possibly unappreciated risk is competition. The term isn't usually uttered with much seriousness in connection with eBay, given that online-auction sites run by Amazon.com Inc., Yahoo Inc. and scores of others have failed to make a dent on the company. But within the Internet industry, there is chatter that search engines by Google and Overture Services Inc. could pose more serious threats.

Google and Overture operate advertising services that display links on popular Internet search engines when users punch in "keywords" that businesses have rented -- "computer monitor" or "DVD," for instance. Increasingly, these services are catching on as ways to drive customers to the Web sites of small merchants -- the same audience of sellers that make up the backbone of eBay.

Some merchants say they prefer advertising on Google and Overture because it lets them sell through their own Web sites, instead of having to pay commissions for sales made through eBay's site. "I'm not against eBay per se, but there's a lot of clutter," says Ron Henderson, president of Auntie's Beads, a Grapevine, Texas, business that sold about $3 million in jewelry through its own Web site last year, doing very little business on eBay.

Google is widely believed to be considering an initial public offering of stock that could give it more resources to compete against eBay, though Google says it has no immediate plans to go public. EBay executives, for their part, say they don't see any cause for worry, pointing out that eBay is one of the biggest advertisers on Google and Overture.

"If there is an alternative [to eBay] that comes about, it will be from a company that we don't see yet," eBay Chief Executive Meg Whitman says in an interview. "I think Google is a great service and great company, but at the moment I don't see them as a threat to the core marketplace."

Write to Nick Wingfield at nick.wingfield@wsj.com

Updated April 22, 2003

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