Tuesday, July 1, 2014

Ebay, Part 1: The Balance Sheet

    One of my favorite guilty pleasures is looking at guitars on EBAY.  I've never purchased an instrument on line (and probably never would).  But, this activity got me thinking about EBAY as a company and potential investment, which first led me to the stock's chart.  Shifting to a weekly time frame, we get this picture:

Ebay was trading between the upper 40s and upper 50s for most of last year.  Momentum has been declining and the CMF indicates volume is starting to flow out of the stock.  This is not an encouraging picture from a technical perspective.

     Then there is the relationship between EBAY and the SPYs:

The chart above shows EBAY/SPY.  The declining nature of this relationship indicates the SPYs are outperforming EBAY.  Clearly there is something about the company the market does not like, which led me to look at EBAYs' financials.

     In the following analysis, I downloaded a spreadsheet of Ebay's balance sheet, income statement and cash flow from Morningstar.com.  

     Let's start by looking at the company's balance sheet starting with the liquidity position and beginning with the composition of its cash:

Over the last five years, Ebay has changed the composition of its cash holdings, slowing increasing the percentage of investments relative to cash.  In 2009, the percentage of securities to cash was 19%.  This percentage increased to 50% in 2013.  The 10-K offers the following explanation of the firm's investment policy:

Short-term investments, which may include marketable equity securities, time deposits, certificates of deposit, government bonds and corporate debt securities with original maturities of greater than three months but less than one year when purchased, are classified as available-for-sale and are reported at fair value using the specific identification method. Unrealized gains and losses are excluded from earnings and reported as a component of other comprehensive income (loss), net of related estimated tax provisions or benefits.

Long-term investments may include marketable government bonds and corporate debt securities, time deposits, certificates of deposit and cost and equity method investments. Debt securities are classified as available-for-sale and are reported at fair value using the specific identification method. Unrealized gains and losses on our available-for-sale investments are excluded from earnings and reported as a component of other comprehensive income (loss), net of related estimated tax provisions or benefits.

Certain time deposits are classified as held to maturity and recorded at amortized cost. Our equity method investments are investments in privately held companies. Our consolidated results of operations include, as a component of interest and other, net, our share of the net income or loss of the equity method investments. Our share of investees' results of operations is not significant for any period presented. Our cost method investments consist of investments in privately held companies and are recorded at cost. Amounts received from our cost method investees were not material to any period presented.

We assess whether an other-than-temporary impairment loss on our investments has occurred due to declines in fair value or other market conditions. With respect to our debt securities, this assessment takes into account the severity and duration of the decline in value, our intent to sell the security, whether it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis, and whether we expect to recover the entire amortized cost basis of the security (that is, whether a credit loss exists). We did not recognize an other-than-temporary impairment loss on our investments in 2013, 2012, or 2011.

The 10-k does not break down investment holdings, except to note they are short-term.

Next, let's turn to the company's liquidity ratios:

All of EBAYs' short term liquidity measures -- from the more liberal current ratio (assets/liabilities) to the more conservative cash ratio (cash/short term liabilities) -- are declining.  What's important about this decline is it can't be attributed to a shifting of assets from cash to investments.  If that were the case, we'd see a decline in the cash ratio but an increase in the quick ratio.  Instead, all are moving lower.

     However, this is not a fatal development.  In fact, it's by design.  The defensive interval ratio has never fallen below 1 in the last five years.

 In addition, the company has a large credit facility.  From their 10-K: We also have a $3.0 billion revolving credit facility, under which we maintain $2.0 billion of available borrowing capacity in order to repay commercial paper borrowings in the event we are unable to repay those borrowings from other sources when they come due. As of December 31, 2013, no borrowings or letters of credit were outstanding under this revolving credit facility and, accordingly, $1.0 billion of borrowing capacity was available for other purposes permitted by this credit facility.  

     The next issue to discuss is the growth of receivables, which is shown in this chart:

Receivables have increased as a percentage of assets from 37.69% in 2009 to 55.61% at the end of last year.  As a result, we've seen a decrease in cash from 58.44% to 38.76%.  Over the same period, Ebay has been increasing its payment business, which explains some of the increase.  However, the increase doesn't explain the entire growth, seen on the chart below in comparison to the growth in receivables.

In two years, receivables and payments grew at similar rates.  However, in 2011 and 2012 receivables growth far out-stripped the growth in payments.

     Another way to look at the growth in receivables is receivables as a percentage of various assets:

It's obvious that Ebay is expanding its revenue streams and is developing payment systems for this purpose.  However,  Ebay's core competency is online auctions.  In getting into the payments business, Ebay is become a de facto lender -- albeit to a large number of extremely small creditors.  Peter Lynch called this type of activity "de-worsification," which implies the company is expanding its business into a market segment that it knows little about.

     On the balance sheet, we also have the LTD/assets ratio, which is clearly under control:

     And finally, there is book value.  I use two methods of calculating this number: the straight assets-liabilities and a revised method in which I strip out all goodwill and assume receivables are sold at 75 cents on the dollar.  Both of these values have been increasing a solid rates for the last five years:

     Ebay's balance sheet is financially solid.  Over the last five years they have shifted a larger percentage of their cash assets into securities with the hopes of increasing their short-term yield.  Despite declining liquidity ratios, their defensive interval is still solid, indicating they have more than enough cash on hand.  Book value has been growing at a good clip and the LTD debt/assets ratio's highest level over the last 5 years is 11%.  The one area of concern is the growth in receivables, which could indicate the company is relaxing credit standards at the expense of prudent management.  It could also be a sign the company is moving away from its core competency of online auctions.