Novice Investing - Skype Doesn' t Ring Well on eBay

Date: Sunday 20th 2008f July 2008 12:45:37 PM

Skype Doesn' t Ring Well on eBay - 04/14/2008

By: Novice Investing Staff

While this is old news, we would like to point out that buying a business above its fair value entails a lot of risk. Case in point was eBay's $ 2.5 Billion purchase for Skype which was set to revolutionize the internet communication business. The acquisition was announced in October 2005 and early signs in December 2005 showed discouraging results for Skype's acquisition. Considering that Skype was not profitable at the time of the acquisition, $ 2.5 Billion was quite a significant amount of money.

Further, we felt that eBay's management has no better options at that point. eBay's stock price implies a 34.9 % annual earning growth for the next five years. Organically, it is hard to achieve considering eBay's size and thus, their appetite to acquire eBay. Fast foward two years later and eBay had written off $ 1.39 Billion of its Skype acquisition. In essence, eBay is saying that it was paying too much for Skype at $ 2.5 Billion price tag. $ 1.1 Billion is the right pricing for Skype. For your information, Skype delivers an annual revenue rate of $ 360 Million recently. If you look in the revenue basis, Skype is now valued at 3 times revenue. Contrast that with eBay which spotted a $ 40.9 Billion. with annual revenue of $ 7.67 Billion. That is a valuation of 5.3 times revenue. In essence, eBay is saying that Skype is worth less than eBay's as a whole even though Skype is poised to grow fastser due to its small base.

Having said that, eBay is merely trying to put behind its Skype's faulty acquisition and move forward. This year eBay is expected to ring in $ 1.67 per share of net profit with long term growth predicted to be 15.5%. With that in mind, how much is eBay shares worth? Compounding its present earning at 15.5% growth rate for five years give us $ 3.43 per share of net profit by the end of year 5. This has a present value of $ 2.82 per share. Peeking through eBay's balance sheet shows that the company has $ 4.9 Billion of positive net cash or $ 3.69 per share. Assuming eBay's growth level off, we feel that eBay deserve a Price/ Earning ratio of 13 for its fair price. Therefore, eBay's share price is fairly valued at:

13 x $ 2.82 + $ 3.69 = $ 40.35 per share.

With recent price of $ 31 per share, eBay is traded 30.1% below its fair value. However, since this method assumes a 15.5% profit growth over the next five years, it entails some risk. We would not add eBay to our sample portfolio since it does not represent at least 50% potential appreciation. On a good side however, eBay was not as overvalued as it was two years ago. At the time, eBay needed to grow earning by 34.9% to justify its current valuation.

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Disclaimer: The sole purpose of this article is educational. This article is merely the opinion of the writer and is not in any way a buy/sell recommendation regarding eBay Inc. (EBAY) or any other securities.

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