Capital Allocation Changes Positive for eBay

Narrow-moat eBay's EBAY fourth-quarter update was a mixed bag, with a weaker-than-expected GMV/revenue outlook for 2019 and lingering questions about how to reaccelerate these trends overshadowing expected margin gains in 2019 and a capital structure "evolution" that includes $7 billion returned to shareholders the next two years, including $5 billion in share buybacks and the initiation of $0.56 annual dividend in 2019. Removing buyer/seller friction and generating more search engine optimization pages through catalog-structured data strike us as appropriate goals. 2019 guidance calling for marketplace GMV growth of just 1% and constant-currency revenue growth of 1%-3% (implying $10.7 billion-$10.9 billion) and commentary about buying experience confusion among existing users and lower-than-expected return on marketing investments make eBay a "show-me" story beyond 2019. While we anticipate modest top-line acceleration in 2020 as payments and promoted listing advertising develop, eBay's core marketplaces growth is going to have to narrow the gap with other e-commerce platforms before the market assigns a higher valuation.

Admittedly, 2019 operating margin guidance of 28%-29% is a positive compared with the 27.2% posted in 2018, with two points of benefit from marketing and other cost reduction efforts partly offset by payment infrastructure investments. However, we agree with the Jan. 22 proposal from activist Elliott Management that eBay can reduce costs further by eliminating middle management layers, right-sizing support functions, and consolidating facilities. However, until eBay commits to these efforts, we see high-20s operating margins as a realistic medium-term assumption.

We're not planning changes to our $36 fair value estimate. We see shares as fairly valued using our base-case assumptions but acknowledge that a combination of core marketplaces acceleration, expense reductions, or the potential portfolio divestitures could present positive catalysts.

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