eBay: Not yet out of the woods

October 18, 2007: 10:29 AM ET

It could have been so much worse for eBay (EBAY). Two weeks after the giant online auction site acknowledged that it had paid far too much for Skype, the Internet phone service, and would be writing off $1.4 billion in charges, the company surprised Wall Street with relatively strong results in the rest of its operations.

After the market closed on Wednesday, eBay reported record revenue of $1.89 billion in the third quarter, up 30% from last year -- handily beating analysts' expectations of $1.83 billion.

Because of the Skype write-off, however, eBay quarterly results showed a net loss of $935.6 million, or 69 cents per share.The stock closed at $40.60 and moved up more than 5% in after-hours trading, but opened lower this morning after Deutsche Bank downgraded the stock, from hold to sell, citing weakness in its core business.

In a call with analysts yesterday, CEO Meg Whitman focused on the growth in its increasingly popular PayPal checkout and StubHub ticket services, but shied away from talking about eBay's domestic online auction business, which has been faltering lately.

Most analysts remain cautious about the company's long-term prospects. eBay's gross merchandising sales, which measures the total value of goods sold on the site, climbed 14% to $14.4 billion from the prior year quarter, but its growth rate dropped from 17% last year. "We continue to have concerns about the company's profit trajectory and the vibrancy of the core marketplace business," Lehman Bros. analyst Doug Anmuth wrote in a report.

To help spur online sales, eBay announced that it will cut its fees for listing items by 33% for the next three weeks. The idea is to give eBay's top sellers an incentive to add more listings. "We don't know if this will work," Whitman said. "We want to get the holidays off to a fast start."

For the first time since it announced the write-down on Oct. 1, eBay's top executives publicly admitted that making money from Skype, which it paid $2.6 billion for in 2005, had been a setback. "Clearly we are disappointed with the impairment charge," Whitman said. eBay's chief financial officer Bob Swan added that the company tried too quickly to charge customers for Skype, which lets users make free Internet phone calls to other Skype users, but makes them pay for calls outside the network.

On Oct. 1, eBay said that it paid "certain Skype shareholders" $530 million to settle future obligations. That same day Skype co-founder Niklas Zennstrom stepped down as CEO and was replaced by interim chief Michael van Swaaij, eBay's Chief Strategy Officer. The Internet calling service made up 5% of third quarter total revenue with $98 million. With its debts settled, Whitman said the company would find a new chief and refocus Skype's strategy.

Some analysts think eBay would be better off pouring its resources into another acquisition, PayPal. The online payment service, which drives an estimated 25% of the company's revenues, posted $470 million in sales for the third quarter, increasing 35% for that same period a year ago. Wall Street has predicted that PayPal will account for 30% of eBay's growth by 2011.

"The market opportunity for PayPal may very well exceed eBay.com someday," says Scott Kessler, an analyst with Standard & Poor's. "It has the possibility of becoming the standard of global e-commerce."

PayPal is expanding beyond the eBay marketplace and has a preferred payment tool on a range of mainstream e-commerce sites. On Monday, US Airways became the latest airline to offer PayPal as a payment option, joining Northwest, Southwest and Midwest Airlines this quarter. Whitman cited consumer research that ranked PayPal behind Visa as the most trusted method for online payments.

However, the 12-year-old company, headquartered in San Jose, Calif., still needs to address its long-term strategy to accelerate the core auction business. After getting user feedback that the site had become too unweildy and chaotic, eBay launched multiple new buyer-friendly features in the third quarter to lure its inactive users to give it another try.

In the last five quarters, eBay has seen a steady decline of user activity. Both the percentage of confirmed registered users and active users has declined over the year-ago quarter. While eBay's promotion on lower insertion fees is expected to boost gross merchandise sales for the fourth quarter, it doesn't mean buyer demand will last once the holiday spending spree ends.

"They're not out of the woods yet. There's no question that they have had a harder time to generate demand," says Tim Boyd, an analyst with American Technology Research. "There are a lot of issues that still need to be resolved, like the growth of new buyers. There is only so much money you can squeeze out of the American market before you have to find new ones."

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