It would be easy to criticize the market for bombing eBay (Nasdaq: EBAY) today.
You could view today's decline as an overreaction to the online auctioneer's report of lighter-than-expected revenue in the third quarter. After all, eBay added more than 2 million users (including me), hosted 23 percent more auctions that it did in the second quarter, easily beat earnings estimates, and remains the runaway leader in its space.
"We are going to stick to our belief that eBay will continue to be a powerful business model," writes Mark Rown, analyst with Prudential Securities, one of at least five Wall Street firms to reiterate upbeat ratings on the stock. "We would view any downward price pressure as a buying opportunity."
Yep. Plenty of reasons to go against the grain today.
Unfortunately, there's an even better reason to go with it.
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It's not the company's merchandise sales of $741 million, a figure below some analyst estimates. That may disappoint some people, but trying to predict the contents of garage sales is an exercise in futility. Retailers know what they're selling, which means they have a definite audience with measurable demand. But who knows what will be on eBay? You can hawk almost anything, making accurate forecasts of merchandise sales and revenue per user almost impossible.
But one somewhat predictable benchmark that has investors justifiably worried: expenses. Third quarter gross margin plunged sequentially (751 basis point drop) and year-over-year (910 basis points) as eBay boosted spending on back-end support and equipment. Don't look for margins to rebound in the near future, since eBay says it will keep infrastructure spending at a high level at least over the next couple quarters.
Investors are slowly waking up to the reality of Internet expenses, yet valuations remain elevated, even after the occasional dip in price.
Therein lies the real problem with eBay stock: it costs too much. Even with today's retreat, shares of eBay remain higher for the week, thanks to a run-up prior to yesterday's quarterly report. but a company valued at more than 350 times next year's estimated earnings deserves little space for error. Even the stock's proponents admit that.
"I think people are slightly disappointed, and rightly so," says CIBC World Markets analyst John Segrich, who maintains a "strong buy" rating on the stock. "eBay didn't blow through all the numbers, but that's what we've been conditioned to expect from Internet stocks. So when they don't, they get penalized."
That penalty is a blip, as far as eBay bulls are concerned.
"In the long term, the eBay story is still intact," Segrich says. "If you're in it for the long term, these things come and go."
Brand leadership is an undeniably powerful advantage for eBay; as America Online can testify, a strong name can overcome price increases and bouts of bad service. But finding another auction site is easier than switching ISPs.
So eBay must spend more just to bulk to up to its current level of demand. And if the company wants to keep expanding its customer base, it needs to maintain that rate of infrastructure building.
eBay isn't the only Internet company to discover the cost of doing business on the Internet is higher than originally estimated. But because an auction site is easier to replicate than a retail operation like Amazon.com, eBay has less wiggle room than other e-commerce giants.
And less latitude from investors.