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We've been kicking around the following question in the office this summer: How long can eBay (NASDAQ:EBAY) support its triple digit multiple? At a time when the economy is struggling to keep its footing and the market seems to be shunning excessive valuations, is it reasonable that shares of eBay currently trade for 133 times this year's earnings? Granted, year-over-year growth in sales and earnings is expected to top 42 and 60 percent, respectively. Still, even with those lofty growth assumptions, is it fair to suggest at the very least that shares of eBay are fully valued at current levels? And what would happen if the company missed its projections?

On the flip-side of the valuation argument, proponents of eBay might argue that its business model is so unique that the company deserves its $16.5 billion market cap - so unique, in fact, that eBay might be recession proof. Others might point to the company's squeaky clean balance sheet; its increasing cash position and its modest debt.

And then there's the fact that shares of eBay are up about 82 percent year-to-date. Not by surprise, the stock has performed incredibly well relative to the Nasdaq-100 (NDX.X) and the Internet Sector Index (INX.X) so far this year. The following chart is a depiction of eBay's relative strength versus the Internet Index. Through simple directional analysis, it's easy to see that eBay is definitely the exception within the group.

But how does the stock's past performance relate to its current valuation? Consider this. eBay's three largest institutional investors, through the end of the second-quarter, were: Alliance Technology Fund, Janus Fund, and Munder Netnet Fund. These three funds are down 25 percent, 19 percent, and a whopping 44 percent, respectively, year-to-date. So let's step back and make two observations: First, these three funds are down on the year, although faring better than the Nasdaq. Second, one of their largest holdings is eBay, which, as previously stated, is a big winner so far this year. So does it make sense that these funds, among many others, are willing to prop shares of eBay up in an attempt to keep their performance from falling any further?

The mutual funds that are concentrated in Internet issues, such as the aforementioned Munder Netnet fund, may be even more willing to keep shares of eBay trading well. With the exception of maybe the Online Travel sub-sector (Travelocity (NASDAQ:TVLY) and Expedia (NASDAQ:EXPE)), the Internet sector hasn't fared too well this year, evidenced by the INX's recent breakdown below 140.

There's no doubt that a few funds have been defending their positions in eBay around the $60 level. Since mid-May, the stock has yet to conclusively settle below $60. But it's again approaching that pivotal point in Monday's session.

There's also no doubt that more than a few bears are beginning to question eBay's lofty multiple and its future growth estimates. And I'm sure that a few more bears are looking closely at eBay as it approaches the $60 level and are just waiting to wrap their claws around this one. In fact, short interest in the stock has been on the rise and according to the most recent data, about 11 percent of the stock's float was short. That's a rather large number of shorts in the stock. And the difficulty in shorting a "crowded bet" is that many of the "weak sisters" within the group get jumpy.

For the shorts to get this one right, there needs to be a catalyst of some sort that shifts the supply/demand dynamic in eBay. Up until this point, demand at the $60 level has overwhelmed the supply coming into the stock. But a fundamental shift, such as an analyst lowering growth projections or an Internet fund going belly up, may be the necessary catalyst to break eBay below $60. Market-related weakness has not been enough in the past to force eBay below $60, but will it this time around? There's also the possibility of a sector rotation, where Internet funds rotate out of eBay and into another performer within the group such as Priceline.com (NASDAQ:PCLN). Of course the aforementioned scenarios are merely speculation on my part. But they may be worth while questions to ask, and the correct answer may lead to some decent short-term profits in eBay.

Eric Utley
Option Investor

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