eBay Inc. Stock Looks Undervalued: Buying Opportunity?

By Andrs CardenalFool.com

Image source: eBay.

The separation between eBay and PayPal is still fairly recent -- both companies started trading independently in July of this year. These kinds of splits can be fertile ground for investors hunting for undervalued opportunities, and eBay is looking attractively priced at current levels.

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A tale of two companiesOne of the main reasons for the separation of eBay and PayPal is that many investors were eager to position their portfolios in a pure play on digital payments. PayPal is growing at a much faster rate than eBay, so growth-hungry investors were pushing for a split in order to bet on a more dynamic PayPal without eBay being a drag on overall company-level performance.

eBay and PayPal are still intimately related, PayPal accounts for nearly 80% of all payment transactions on eBay. However, the payments platform is also growing at a much faster rate than eBay and gaining market share in the e-commerce industry. PayPal registered a 27% increase in constant-currency total payment value (TPV) during the third quarter, while total pro forma revenue on a constant currency basis jumped 19%.

eBay's performance was much more modest last quarter. Forex-neutral gross merchandise value grew 6% versus the third quarter in 2014, and total revenue increased by 5% in constant currency, reaching $2.1 billion.

This dissimilar performance is clearly reflected on very different valuations for the two companies. PayPal carries a price-to-earnings ratio around 40 times earnings for the last year, while eBay is trading at a much cheaper price-to-earnings ratio near 16.

Not only is eBay much cheaper than PayPal, the company even trades at a discount versus the average company in the S&P 500, which carries a price-to-earnings ratio above 19.

PayPal was clearly the star of the show before the spinoff, and it makes sense to consider the possibility that eBay was oversold by investors who wanted to keep only PayPal after the split. From this point of view, eBay could be offering an attractive opportunity for bargain-hunting investors.

Is eBay a bargain? eBay is facing considerable challenges. The company is still trying to fully recover from the password security breach and the changes in Google's search algorithm that negatively affected the business last year. In the words of CFO Scott Schenkel during the company's third-quarter conference call:

Besides, eBay needs to compete against Amazon in e-commerce, and this puts a lot of pressure on the company's performance. Amazon is the undisputed king in the industry: The company made a gargantuan $25.4 billion in total sales during the third quarter, growing by a staggering 30% on a constant currency basis. Even if we consider only online retail in North America, Amazon's most mature market, revenue in this division grew 28% to $15 billion.

Amazon is making a growing share of revenue from third-party sellers; this business represented 46% of paid units in the third quarter, an increase of 400 basis year over year and 100 basis points sequentially. This makes Amazon a major threat for eBay when it comes to competing in the small businesses segment.

On the other hand, eBay's problems seem to be well reflected in current market valuation, and the business offers many compelling attributes. Since eBay is a commerce facilitator as opposed to an online retailer, there is practically no associated cost of inventory in every sale, and eBay makes big profit margins above 30% of revenue at the operating level.

The company has 159 million active buyers in the platform, a 5% increase versus the third quarter in 2014. Growth rates are not particularly impressive, but eBay is well beyond the inflection point in terms of proving its relevancy and staying power. Buyers and sellers attract each other to the platform in search of opportunities, so the company benefits from the positive impact of the network effect in the long term.

Management is trying to capitalize on data intelligence from its transactions to improve product discoverability and provide a better experience to both buyers and sellers. While it may take some time for these initiatives to deliver results, it's important to keep in mind that eBay still has a lot of room for improvement.

Investors in eBay should not expect explosive growth from the company in the short term, but the business model is quite profitable, and eBay operates in a growing industry with plenty of potential in the years ahead. At these prices, eBay stock is offering far more upside potential than downside risk.

The article eBay Inc. Stock Looks Undervalued: Buying Opportunity? originally appeared on Fool.com.

Andres Cardenal owns shares of Amazon.com. The Motley Fool owns shares of and recommends Amazon.com, eBay, and PayPal Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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