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Morningstar | Elliott's Enhancing eBay Plan Makes A Lot of Sense--Will Management Follow-Through?

Narrow-moat eBay shares rose 6% on Jan. 22 after activist shareholder Elliott Management (which owns a 4% stake) published its "Enhancing eBay" plan focused on making eBay a "better and more valuable" company. Also, news broke that activist shareholder Starboard Value has also taken a position in eBay and has been speaking with management the past several months. We share Elliott's views that eBay is undervalued--our DCF-derived $36 fair value estimate assumes 6% average annual top-line growth the next five years, with adjusted EBITDA margins averaging 27% over the same timeframe--but believe many of the strategies that Elliott has outlined regarding eBay's current portfolio composition, core marketplaces execution, operational improvements, and capital allocation could position the company for high-single-digit revenue growth and adjusted EBITDA margins of nearly 30%, the assumptions behind our bull-case valuation of $53 per share (a shade behind the $55-$63 per share valuation projected by Elliott).

In our view, most, if not all, of Elliott's proposals have merit, starting with: (1) more efficient general and administrative, marketing, and product development spending; (2) revitalizing its core marketplace through improved seller and other technologies; (3) spinning-off noncore assets like eBay Classifieds and StubHub; and (4) adopting a capital allocation plan prioritizing total shareholder returns but still leaving flexibility for marketplace-adjacent M&A activity. We're not planning to change our $36 fair value estimate until there is greater visibility regarding which initiatives (if any) management is willing to act on but believe the implementation of many would improve fundamentals over the short and long run while giving investors greater confidence in its investment story.

Looking closer at Elliott's plan, a reduction eBay's general and administrative expenses (which we forecast at 11.0% of revenue this year on a reported basis) strikes us as the easiest way for the company to improve near-term margins (by reducing middle management layers and right-sizing support functions), with facilities consolidation and better marketing and product development spending coordination also offering margin expansion opportunities. Accelerating eBay's core platforms will not come easy with its small and medium size sellers increasingly testing Amazon as a distribution platform in recent years, but we share Elliott's opinion that the path to improved engagement (and by extension, revenue growth in the high single-digits) is improved seller technology tools combined with better technical execution for promoted listings and payment intermediation. A separation of eBay Classifieds (which Elliott values at $8 billion-$12 billion using publicly-traded comparable company and transactions valuation multiples, compared with a current market valuation $4.5 billion using eBay's consolidated trading multiples) and StubHub (which it values at $3.5 billion-$4.5 billion versus a market valuation of $2.2 billion using consolidated valuation multiples) might seem harmful to the network effect underpinning our narrow moat rating, but each business unit operates differently than eBay's core marketplaces and have only offered limited cross-selling synergies to this point. We've also believe the market would respond favorably to an improved capital allocation plan, including the initiation of a dividend (Elliott's proposal of a dividend yielding 1.5%, or just over $300 million at current levels, strikes us as achievable), an expanded buyback program (returning 80% of free cash flow after dividends to shareholders beginning in 2020), and earmarking $600 million-$700 million for acquisition activity that enhances its core marketplaces (including the potential purchase of niche category marketplaces).