eBay

eBay is the best opportunity we have seen in the last three years. The company has all of the characteristics
sought by value investors: a stable-growth core business, temporary unpopularity, cash cow buying back
shares, well-aligned management, smart capital allocation, and trading at a good price (6% FCF yield).
Our conversations with multiple buy-side analysts indicate that these factors comprise the collective
contrarian thesis on eBay. We agree that these factors are critical, correct, underappreciated by the sell-
side, and would make for an excellent long thesis on eBay. But our conversations with buy-side analysts
also verified a more important point for our purposes: there are two additional aspects of the eBay long
thesis that are massive and entirely missed by the market. This write-up concerns those two factors, and
concludes with a full valuation and final commentary. Our price target is $48/share for 46% upside.

Please find the original presentation deck from the Sohn Conference here.

Part I: Merchant of Record

eBay spun off PayPal in July 2015. Three details of their post-spinoff operating agreement are of interest
to us. First, the agreement lasts for five years, concluding in July 2020. Second, the agreement requires
continued use of PayPal as eBays transaction aggregator, netting PayPal a fee for each transaction
processed. The third detail is likely the most unappreciated part of the eBay story, and concerns eBays
plans to become a merchant of record.

A merchant of record is the party who intermediates a transaction. As eBays merchant of record, PayPal
intermediates every transaction. Buyers pay PayPal, and PayPal pays the seller. PayPal takes a ~3.5%
fee from the buyer and pays a ~1% fee to the acquiring merchant bank that processes all transactions in
bulk. The spread, less SG&A and fraud-related costs, is PayPals profit from serving as eBays merchant
of record. All major e-commerce sites today are merchants of record, including Amazon and Alibaba.
eBay has been the historical exception due to its ownership of PayPal, which profited handsomely by
processing every individual eBay transaction for a ~2.5% fee on gross merchandise volume (GMV).

But eBay does not own PayPal anymore, so why does this relationship continue? In response to a proxy
fight for splitting eBay and PayPal led by Carl Icahn in 2014, eBays management noted the following:

- PayPal grows faster because of eBay

- eBay accelerates the success of PayPal
- Data sharing leads to more profitable growth
- eBay Inc. provides efficient capital for PayPal
- Commerce and payments are converging

Careful readers would also note the disclosure that eBay delivers about 30% of PayPals new users at
virtually no cost, more than 30% of PayPals revenues and approximately 50% of PayPals profits. The
benefits to eBay are much less clear, but their pre-spinoff relationship is frozen until 2020 all the same.

When the operating agreement expires in July 2020, eBay will have the opportunity to establish itself as
a merchant of record. But once they can end the relationship, how do we know that they will? One could
certainly speculate about the hiring of Alyssa Cutright to lead eBays global strategy and operations of
billing and payments. One could also research eBays early history with Wells Fargo and the use of
Billpoint as a payments intermediary, perhaps seeing this as a blueprint for a post-PayPal future. Easiest
of all, one could pay close attention to Section XIV of the eBay-PayPal operating agreement:
 Following the three (3) year anniversary of the Effective Time, eBay shall be permitted
to declare itself as a Merchant of Record for transactions effected by third Persons in up
to two (2) Covered Jurisdictions as selected by eBay in its sole discretion (each, a Test
Jurisdiction); provided, that (i) the GMV transacted as a Merchant of Record on all
eBay Covered Properties in each Test Jurisdiction during the fourth (4th) year of the
Term shall not exceed five percent (5%) of the GMV on all eBay Covered Properties in
such Test Jurisdiction during such year, and (ii) the GMV transacted as a Merchant of
Record on all eBay Covered Properties in each Test Jurisdiction during each of the fifth
(5th) year of the Term and the Tail Period shall not exceed ten percent (10%) of the GMV
on all eBay Covered Properties in such Test Jurisdiction during each such year.

This short footnote sets the groundwork for eBays full transition to a merchant of record model in mid-
2020. Provisions for test jurisdictions as early as 2018 give eBay the opportunity to test the merchant of
record model, with full rollout possible at the expiration of the operating agreement in 2020. eBay has a
financial incentive to pursue such action due to the substantial value it would create. Our calculations for
the upside from such action are based on the terminal value of such action discounted back from 2020:

84.26 billion 1.03! 3.47% 1% 50% (1 25%)

= .
1.1! (10% 3%)

Rationale for assumptions

- 84.26 billion = trailing 12-month GMV as of Q1 2017
- 3.47% = PayPal aggregate take rate (last disclosed in 2014); this number blends in the 0% take rate
on various Braintree platforms (i.e. Venmo), meaning the true on-eBay take rate is closer to 4%.
- 1.0% = back-end fees for debit and credit transactions (network fees, acquirer fees, fraud fees, etc.).
- 50% = incremental SG&A costs for creating a merchant of record arrangement within eBay,
including costs for incremental hires, customer service expenses, and ironing out the kinks.
- 25% = tax rate (eBays historic tax rate is closer to 20%)
- 3% = terminal rate
- 10% = discount rate

The catalyst for this value realization will be the disclosure and detailed explanation of plans to become
a merchant of record. We expect this to transpire no later than mid-2018, as eBay will begin exploring
test jurisdictions at this time. Earlier catalysts might include management discussions on future earnings
calls or disclosures by PayPal of this risk in their financial statements. This upside is PayPals downside,
and the merchant of record transaction could make for a separate, compelling short thesis on PayPal.

Part II: Classifieds

Classifieds are local markets for the exchange of services and secondary goods. They are basically
hyper-local versions of eBay. Americans are generally familiar with Craigslist, the dominant classifieds
service in the United States. eBay owns a dozen major classifieds services worldwide, ten of which are
dominant in their national markets. High-level information about eBays classifieds holdings is quite
promising: eBays classifieds services have the most popular mobile applications in eight countries, 29%
yearly growth in page views, 270 million unique monthly visitors, and over 50 million ads posted each
month. Classifieds are a higher-quality business than eBays main marketplaces business (and indeed,
one of the highest-quality businesses we have ever seen) for several reasons:
 1. Monopolistic: 10 of the 12 classifieds services owned by eBay are national monopolies.
Marktplaats.nl dominates the Netherlands, Mobile.de dominates Germanys automotive
market, Kijiji dominates Canadathe list goes on. Classifieds have the most powerful
moat in business: network effects. Each new user benefits from the presence of existing
users -la social media, and each new user widens the moat between the winner and its
competitors.

2. Higher Margins: eBays classifieds services have ultra-high operating margins near 60%
(an estimate based on comparable companies, as eBay does not disclose classifieds data),
versus 30% for its core marketplaces segment. Margins are higher for classifieds because
the segment requires effectively zero marketing and maintenance expense. Moreover, the
high fixed costs of the segment offer massive margin expansion. Most important, the
monopolistic nature of the business creates huge untapped pricing power. Examples from
comparable businesses in other countries (Schibsted and Naspers) indicate that operating
margins could exceed 70% as the segment matures.

3. Faster Growth: the classifieds services are growing 15% top-line. Some platforms, such
as the U.S.-based mobile offering Close5, are growing at >100% top-line. This compares
favorably to eBays core marketplaces segment, growing at 5% FX-neutral annually. This
fast growth will continue for years due to roll-ups of smaller competitors and expansion
into adjacent countries and verticals. Moreover, as the segment becomes a larger overall
share of eBays total profits, the firm will deserve a higher multiple from faster growth.

But crucially, the market is missing the value of eBays classifieds holdings. In 8000+ pages of sell-side
analyst reports published since the spinoff of PayPal in July, only one analyst (at UBS) took any time to
discuss eBays classifieds holding in depth. Interestingly, this analyst placed a price target on eBay that
was 50% higher than the second-highest price target. We also note that the buy-side analysts with whom
we spoke have shown zero interest in eBays classifieds portfolio and assign trivial value to its assets.
One Seeking Alpha contributor recently noted that concerns about eBays growth are valid considering
that it makes its money from its marketplaces and ticketing services. It does not have significant revenue
outside of the two.

This lack of appreciation for the Classifieds segment is especially interesting when one compares it with
the new darling of Wall Street analysts, StubHub. Classifieds LTM revenue is $804 million versus $964
million for StubHub. Classifieds likely commands margins near 60% (again, very reasonable based on
competitors data; see here for margin details on Leboncoin, a comparable service owned by Schibsted).
Meanwhile, StubHub commands margins closer to 30%. Revenue times margin equals an estimated
EBIT of $482 million for Classifieds and $289 million for StubHub, meaning that Classifieds contribute
67% more EBIT than StubHub to eBay. But you wont find that in a sell-side report.

Two plausible explanations for the under-appreciation of eBay classifieds are managements lack of
detailed disclosure on the segment and the lack of U.S.-based comparable companies. Gathering the
relevant data for valuing each of eBays classified businesses required an arduous search for tiny pieces
of information that we believe most analysts would not have endured. Moreover, U.S.-based analysts do
not appear to understand the nature of classifieds markets because there are no comparable companies in
the U.S. The only major U.S. classifieds service is Craigslist, which is private.

So what is the Classifieds segment worth? We have calculated the following valuation:
 804 1.1!" 70% (1 25%)
422 10 + = .
1.1! (10% 4%)

Rationale for assumptions

- 804 million = trailing 12-month revenue as of Q1 2017
- 422 = free cash flow produced by Classifieds in 2017, (804)*(70%)*(1-25%) = 422 million
- (422*10) = value of interim payments before terminal period; because the growth rate equals the
discount rate, they cancel out during the projection period, i.e. 1.11/1.11 = 1.
- 10% = growth has trended at 10-15% over the last five years. Comparable firms (Schibsted and
Naspers) estimate 15% growth over the long-term due to tailwinds from further market penetration,
monetization, and new listing verticals like real estate and employment classifieds.
- 70% = operating margin, based on mature peers owned by Schibsted (i.e. Blocket and Finn).
- 25% = tax rate (eBays historic tax rate is closer to 20%)
- 4% = terminal rate
- 10% = discount rate

eBays Classifieds segment has plenty of room for future growth. The segment benefits from a high
degree of operating leverage, has a sticky and price insensitive user base, is recession-proof, holds no
inventory, and has several levers for additional monetization that have not yet been deployed. This
segment may well be the long-term growth engine for eBay.

Part III: StubHub and Marketplaces

A full valuation of eBay also requires valuing its StubHub and Marketplaces segments. The market has a
fair understanding of these components, and our valuations for are more conservative than consensus.
The valuations for both segments are not central to our thesis, and they are offered primarily in order to
conduct a sum-of-the-parts valuation for the entire company.

Our valuation for Marketplaces (eBays core segment) is straightforward. Current management guidance
on revenue growth is 5% FX-neutral annually, which matches closely with historical FX-neutral growth
rates over the last decade. We have chosen to exclude FX headwinds from our projections because we
expect those headwinds to normalize or reverse or time. We place Marketplaces revenue growth at 3%
in perpetuity for conservatism. We assume normalized margins of 30%, which adjust from current 25%
operating margins that are temporarily depressed due to costs related to the structured data initiative and
search engine optimization to recover eBays traffic after Googles search engine algorithm update. Our
tax rate is 25% and our discount rate is 10%. Use trailing 12-month revenue of 7.28 billion, we arrive at
the following valuation for Marketplaces:

7.28 30% (1 25%)

= .
10% 3%

Our valuation for StubHub is quite a bit more conservative than market consensus. We do not factor in
any additional pricing power, despite StubHubs take-rate increasing 3% last year alone. We do not
factor in any additional operating leverage that could cause margin expansion, despite the fixed cost
leverage widely known to exist in two-sided marketplaces. We do not factor in market consolidation
benefits despite StubHubs dominance in a winner-take-all market (StubHub has nearly 5x the market
share of its next-largest competitor, Ticketmaster). With these conservative assumptions in mind, we
arrive at the following valuation for StubHub:
 964 1.1!" 30% (1 25%)
217 10 + = .
1.1! (10% 4%)

Rationale for assumptions

- 964 million = trailing 12-month revenue as of Q1 2017
- 217 = free cash flow produced by StubHub in 2017, (964)*(30%)*(1-25%) = 217 million
- (217*10) = value of interim payments before terminal period; because the growth rate equals the
discount rate, they cancel out during the projection period, i.e. 1.11/1.11 = 1.
- 10% = the segment grew nearly 40% last year, and management is guiding for 10-15% annual
growth. The acquisition of TicketBis opens international markets, and the underpenetrated and
massive total addressable market offers a long growth runway.
- 30% = operating margin, backed out from known Marketplaces and likely Classifieds margins
- 25% = tax rate (eBays historic tax rate is closer to 20%)
- 4% = terminal rate
- 10% = discount rate

Part IV: Conclusion

Including 2.20 billion of excess cash, the sum of our valuations is the following (in billions):

23.40 + 6.15 + 11.96 + 8.57 + 2.20 = .

The current enterprise valuation of eBay is approximately 34 billion, implying 46% upside from current
levels ($33.15 as of this writing) and a fair value of $48 per share. This valuation disconnect provides an
ample margin of safety. Downside is further protected by a low valuation on the basis of normalized
free cash flow (trading at 6% FCF yield), continued share buybacks (nearly 1 billion in buybacks are
authorized for the remainder of 2017), and organic growth in each operating segment. Investors should
be further comforted on the downside by the fact that eBay is a highly stable business that is consistently
growing at a low-to-mid single digit rate with a sizable runway for continued growth. Investors in eBay
can sleep soundly knowing that time and the math of compounding are on their side.

Catalysts for value realization include continued share buybacks, additional insider buying, management
discussion of the merchant of record arrangement, a more detailed breakdown of the classifieds segment,
strategic bolt-on acquisitions for the core segments, continued growth in the StubHub and Marketplaces
segments, and pressure on management to act decisively on the merchant of record arrangement.

Thanks for reading.