Investors and online retailers need to pay close attention to the situation at eBay (NASDAQ: EBAY) right now. The online marketplace is getting ready to spin PayPal, its payment solution, off into a separate company.
That should concern us because PayPal generates around 44% of eBay’s revenues. eBay reported a TTM revenue of $17.9 billion on Dec. 31, 2014, of which $7.786 billion came from PayPal. Get the picture, folks; without PayPal, eBay’s value and revenues drop by nearly half.
That puts eBay in a very vulnerable position because its other business, the online marketplace, has only been growing by around 1% a year. Most of the revenue growth at eBay is coming from PayPal. eBay could survive without PayPal, but it would not grow very fast without the payment solution.
eBay Has Lost Its Momentum
If eBay wants to remain relevant and regain its momentum, it will have to restructure its business in a big way. eBay’s core business is no longer growing; it is facing aggressive competition from rivals like Walmart (NYSE: WMT) and Amazon.com (NASDAQ: AMZN).
Much of Amazon’s recent growth has been driven by third party sales and its Fulfillment by Amazon (FBA) operation. VentureBeat estimated the value of Amazon’s third party sales at $17 billion in 2013. Tech Crunch reported that the volume of merchandise moved by Amazon’s FBA business increased by 65% in 2014.
Since third party sales are eBay’s core business, you can see the problem here. eBay is trying to restructure its core business by offering a solution similar to Fulfillment by Amazon. For those of you unfamiliar with it, FBA is a service in which Amazon warehouses, packs, and ships merchandise on its website on behalf of customers. The problem is that eBay’s answer to FBA looks like too little too late; its Valet service is limited, and it is not clear if eBay has the resources to match Amazon’s capabilities.
eBay’s Future as an Acquisition Target
Despite its lack of momentum, eBay has two assets that make it an attractive acquisition target.
First, its third party seller business generates a lot of cash and float in the form of fees and memberships. eBay reported making $5.677 billion in cash from operations and a free cash flow of $1.272 billion on Dec. 31, 2014. That might attract the attention of cash loving value investors. On some level, it looks like a classic Warren Buffett value play: a good company with loyal customers and a lot of cash that it is struggling and ignored by Mr. Market.
Second, eBay owns a very attractive online piece of real estate. Statista.com reported that eBay attracted 111 million visitors a month in the third quarter of 2014. It was still the second most popular retail website in the United States. Only Amazon.com had more unique visitors to its site.
eBay is still attracting more visitors than Apple Inc. (NASDAQ: AAPL), Walmart, Target (NYSE: TGT), and Best Buy. Any company that were to buy it would gain access to all those visitors.
That makes eBay a lot like Sears (NYSE: SHLD), a retailer that might be more valuable for its real estate and its brand than its actual operations. eBay is a great brand with a great piece of real estate. Once it and PayPal separate, the acquisition hounds are likely to come sniffing around eBay.
So Who Would Buy eBay?
Okay, so eBay looks like a juicy acquisition target, but for whom? Well, there are some big players that come to mind.
The first and, I think, most likely is Alibaba Holdings Group (NYSE: BABA), the biggest online retailer in the Asia Pacific region, where it controls 46.6% of the market. Alibaba’s presence in U.S. online retail is miniscule and likely to remain that way because of the high cost of entry to the American market.
The cost of entry to the U.S. market for Alibaba would be high because it has no name recognition here. Alibaba would also have to match Amazon’s network of fulfillment centers to operate in the USA, something that would cost a fortune. Without the fulfillment centers, Alibaba would not be able to match Amazon’s shipping and customer service capabilities.
Buying eBay would give Alibaba the name recognition and make it the number two online retailer in the U.S. eBay’s third party selling business model would also be very compatible with Alibaba’s. Since Alibaba has been making a lot of high profile investments in the U.S. recently, a play for eBay could be possible.
Another contender is Walmart, which is ramping up its online retail operations in a big way. Walmart has experimented with third party selling, and it is quietly building a network of fulfillment centers to match Amazon’s. Walmart is also making a big push to be America’s alternative to Amazon.
Like Alibaba, Walmart has a lot of cash, and it has been willing to shell out money for technology companies it wants. That being said, Walmart has been very acquisition adverse for a long time; its management team prefers organic growth generated by its own operations.
Other contenders include Sears, where CEO and hedge fund manager Eddy Lampert has been trying to build up a huge online retail operation. eBay would be a poor fit for Sears operations, but Lampert has never been known for logic. Other large hedge funds might be interested in eBay, particularly as a cash cow.
Why Uncle Warren Might Want eBay
A very dark horse contender for an eBay acquisition would be Berkshire Hathaway (NYSE: BERK.B). Uncle Warren is famously technology adverse, but eBay does meet some of his criteria: it’s a good company with a strong brand that’s well respected on Main Street but undervalued by the market. It also has a business model that generates a lot of float and cash—two of Buffett’s favorite things.
It goes without saying that eBay is the kind of unsexy company Buffett likes. Selling used books, vinyl records, and other collectibles to housewives and hobbyists does not catch Wall Street’s imagination like Amazon.com does, but it still generates a lot of revenue.
Something skeptics should remember is that Berkshire Hathaway already owns a catalog company and wholesaler that has some similar attributes to eBay, Oriental Trading. Oriental Trading sells party supplies, toys, games, novelties, craft & hobby supplies, teaching supplies, and other low-end items through its catalog and website.
Berkshire is already into online retail in a big way; several of its subsidiaries, including Oriental Trading, Borsheims Fine Jewelry, Nebraska Furniture Mart, and Helzberg Diamonds, already operate large online retail operations. So eBay might be a better fit for Berk Hath than you might think.
The bottom line is that there is a strong chance that eBay will no longer be an independent company this time next year. Its attributes make it too rich an acquisition target for others to leave alone.
The author owns shares of eBay stock and conducts retail sales through Amazon.com.