Thursday, May 18, 2006

Ebay: A dollar for 50¢?

Ebay’s current price has sparked me to consider a few things. First, am I “correct” on eBay? My general thesis on the company is that it is an undervalued market leader. The other question that comes to mind stems from the first one. If I am correct, why am I correct and the market wrong? It certainly isn’t that I possess some supernatural intellect or clairvoyance. (Trust me.) All I know is that I have looked at eBay’s operating performance numbers and to me the numbers just don’t spell 30 bucks per share.

What numbers am I referring to? Well primarily I’m referring to eBay’s free-cash-flow (FCF) figures. Recognizing that there is a plethora of ways to arrive at FCF and keeping in mind that exact numbers give a false sense of preciseness, I estimate that eBay produces about $1.4 billion in FCF. And over the last few years the company has been able to grow those figures at extraordinary rates – by at least 40% and by as much as 90%.

Using the discounted cash flow (DCF) method, I arrived at an estimated intrinsic value for eBay of about $60 per share. Of course, this method of valuation is very sensitive to the assumptions made. To come up with my estimate, I assumed a discount rate of 9% which is my optimistic view of what the market itself will return over the next decade or so. I also assumed that eBay’s FCF growth rate would substantially decrease over the next 10 years - falling from 25% in the early years to 12.5% in the later years. And then I assumed a terminal growth rate of 3%, about the historic rate of inflation. With those factors, all of which I think are reasonable, I came up with an estimated value of $60. So the market must be missing something…possibly. Click chart for larger view.

But what if I’m wrong and the market is correct? Perhaps I’m missing something. One way or another the market is saying that eBay will not be able to perform in the future as it has in the past. The market seems to be saying that some external (or internal) force will do one or a combination of several things. The forces will depress eBay’s margins or retard its sales growth or cause it to have to substantially increase its capital expenditures.

I think one thing the market is saying is that it doesn’t like eBay’s purchase of Skype for $2.6 billion. I agree with the market here. I like the company, I just don’t like the price eBay paid for it. That said I doubt that any failure in Skype will be enough to sink eBay. The market may also be saying that the Google-monster will surely do eBay in. I doubt that pressure from competitors like Google or Yahoo will be significant enough to substantially hurt the company. Not in the long run anyway. And certainly not enough to justify the $30 price tag eBay now sports.

In my own analysis, I assume that eBay’s FCF growth falls off a proverbial cliff and I still came up with a value that is at least twice the current market price. In other words, I think eBay represents the dollar being sold by Mr. Market for 50¢. Yet exploring the reasons Mr. Market is selling eBay so cheaply are worth some thought.

Tuesday, May 09, 2006

QUICK! Google or Ebay?

I had a thought. If I had a (figurative) gun to my head and needed to answer this question...

Whose business moat is larger and more treacherous to cross? Google's paid search and Ebay's online auctions?

...what would my answer be?

I won't tell you what my answer would be (hint: I and my clients own shares of Ebay) but, I think the knee-jerk answer is probably the correct answer in this case.

Wednesday, May 03, 2006

PACCAR (Yawn!): Just Another Boring Undervalued Stock

I came across a nice synopsis of PACCAR (PCAR) on the Seeking Alpha blog. PCAR is one of our holdings but hasn't done much lately. The article is worth a read.

Please DON'T See "Akeelah and the Bee"!

I saw a great movie this past weekend. Akeelah and the Bee, is about an gifted 11 year-old whom finds her way to the National Spelling Bee Championship. Along the way she finds that she has people in her corner who help her conquer her demons and want to see her succeed.

I liked the movie because it addressed a little known phenomenon in the African-American community in which academic achievement is considered a white people thing. There were several references to large and complicated words as being white words. Akeelah is torn between fitting in and reaching her true potential. I won’t give away the ending but let me provide a hint. It’s an inspirational story with a moral and a happy ending.

Even though I enjoyed the movie, the plot wasn’t the most interesting facet of Akeelah. What most interested me about the movie was the way in which it was marketed. You didn’t see the typical deluge of trailers and movie posters plastered every which where. Instead, what you saw were green and yellow neon coasters, coffee sleeves, and signs placed strategically around your local Starbucks [SBUX].

Long the number one purveyor of your favorite java concoction, Starbucks has been expanding its reach into other, seemingly unrelated businesses. The company has seen success in satellite radio, production and sales of CDs, and is now getting into the marketing of movies. Recognizing its power as a place where “communities meet” and “word-of-mouth” is created, Starbucks is making an effort in earnest to capitalize on that unique position.

As a frequent customer of Starbucks [Full disclosure: I’m currently drinking a caramel macchiato and writing this blog in a New Jersey based Starbucks. So I’m a little biased toward the company.] I’m all for the long-term success of the chain in these non-caffeinated aspects of its business. I emphasized long-term because I need this company to slip up somehow. The business is so excellent and execution so on point that the market has rarely priced the stock to a level where I felt comfortable buying it. [Click graph to view a larger image.]

Akeelah is a great movie. Critics (namely my favorites Ebert & Roeper) are already calling this movie an Oscar contender. Which is actually a little disappointing. I’m glad Starbucks and Ken Lombard, the head of Starbucks Entertainment, picked a great movie – one that falls right into line with their culture. I’m confident they will continue to pick great films. But can’t they mess up at least once so the market can depress the stock? I want to buy!

Maybe this weekend’s box-office is a good sign as Akeelah came in eigth-place. Well behind the critically unacclaimed [Two thumbs down from E&R] Robin Williams’ film RV. I hope this is the slip up I’ve been waiting for. As a value investor I wait for disappointing news that is temporary and then wait to see how the stock reacts. Akeelah is a great movie (and a great product) that I’m hopeful will not do well. This would be a perfect example of a good company with a temporary setback. If that happens let’s hope that the manic depressive market punishes the stock, and at that point I’ll probably be a buyer.

We’ll see what the stock does after today’s conference call.

Tuesday, May 02, 2006

Right About Being Wrong on JetBlue

A sound selling discipline is an oft-neglected part of a sound investing approach. A sell discipline will get the investor out of situations that show little promise and allow him to be available for situations that do. One of the sell criteria we employ at Brick Financial imparts us to sell a stock if “we have made a mistake in calculation or judgment.” Last August the clients of Brick Financial saw the criteria at work.

In August I wrote,

“We were cautious when we bought [JetBlue: (JBLU)] back in the spring of 2003… at the time it was trading at about 35x earnings which we thought was expensive… What we did not fully appreciate were some of the challenges that JetBlue faces. One was its vulnerability to rising oil prices. Although all transportation businesses were affected, airlines seemed to be especially so, and JetBlue was no exception. The other issue was the realization that although JetBlue’s operating and labor costs are presently low - as planes age, as employees become unionized, as new markets become more scarce – the company’s costs are bound to rise...

We made several mistakes on this purchase... [ultimately] we did not provide ourselves a wide enough margin of safety [and] we should have weighed JetBlue’s rich valuation more heavily in our analysis…”

Since then, JetBlue has declined from a split-adjusted price of $12.71 to $9.69 at today’s (May 2nd) close. That move represents about a 24% decline. The company’s last two quarters were net losses, with the latest loss reaching $32 million. I would not say that I am clairvoyant, but some of the concerns I covered last summer have come to fruition. Larger competitors are pilfering the company’s business model and the company’s costs are catching up to it. The company, though nimble compared to other carriers, could not escape the ever-increasing rise in oil prices. It has also been forced to scale back on its expansion plans, sell some of its planes and shorten many of its routes.

A recent Wall Street Journal article underscores the company’s difficulty:

“ ‘We haven't done a good job at managing our business’ with aviation fuel costing more than $2 a gallon, said David Neeleman, JetBlue's founder and chief executive officer. The company's fuel bill rose 85% in the first quarter compared with a year earlier, and the average cost per gallon jumped 43% to $1.86. But the ‘silver lining’ in the record fuel price is that it is ‘helping us focus on becoming a better company,’ he said.”
A sound sell discipline, and the ability to admit I was wrong, saved some money.