eBay: Showing Value in Its Free Cash Flow

Investors gain insight and confidence on their investments by applying metrics and analysis that not everyone has ready access to. While so many investors remain focused on the often misleading earnings per share [EPS] and P/E ratio (even fretting about quarterly results down to the penny), free cash flow is the true lifeblood of any company, and is the only accurate way to measure a firm’s cash-generating health. At Complete Growth Investor, we calculate various measures of free cash flow on all of our stocks, from true free cash flow [TFCF], to structural free cash flow [SFCF], to — where appropriate — maintenance structural free cash flow [MSFCF].

True free cash flow is cash from operations minus capital expenditures minus tax benefits from stock options. Structural free cash flow (what Warren Buffett calls “owner’s earnings”) is net income from operations plus depreciation and amortization minus capital expenditures. These are two key ways to measure the health and growth of a business, and both show realities that mere earnings per share numbers often miss. So when we run the most recent numbers on eBay (EBAY), look at what we find. The stock is less expensive than EPS suggests.

For the full twelve months of 2006, eBay’s true free cash flow increased 12.8% year-over-year to $1.58 billion. (Interestingly to me, Google (GOOG) generated $1.8 billion in TFCF last year, so not much more than eBay, although considerably more per share, since eBay’s share count is about four times higher than Google’s.) Structural free cash flow was up 2.9%, not much, but still something. eBay was able to grow free cash flow even though expenses continued to jump much more than sales on a percentage basis.

eBay’s diluted share count increased 2.3% last year to 1.425 billion shares, while its cash, investments and equivalents increased 53.3%, to $3.2 billion, giving the company an enterprise value at today’s $31 share price of approximately $41 billion. That puts the stock at 25.8x TFCF and (less meaningfully) 35.5x SFCF, much better looking than the stock’s trailing P/E of 39x. Management expects approximately 20% sales growth this year, and if expenses are in-line, FCF could grow as much. That would make today’s FCF multiples only a modest premium for a company with an immodest competitive moat

The question is, though, will expenses be in-line with sales growth? Last year, while sales grew 31.1% to $5.96 billion, total operating expenses jumped 43.5% to $3.28 billion. Cost of sales, surprisingly, was a major contributor to the problem, increasing 53.5% to $1.25 billion. Sales and marketing, which is what everyone complains about because eBay is spending so much to advertise, only grew 36.6% to $1.61 billion. It’s still a very significant cost, to be sure (that’s a lot of dough, and much of it is going straight to competitor Google), but at 36% this spending didn’t grow much more than sales, which grew 31%

However, eBay’s 12.8% growth in true free cash flow helped off-set this disappointment, even though some of it was due to management delaying payments. And with 20% top-line growth expected this year, alongside moderating expenses, bottom-line gains are expected to return in earnest, with growth estimates in the mid- to high-teens. Free cash flow should grow at least as much

Overall, in eBay’s case, the true free cash flow numbers suggest a more reasonably priced stock, while the earnings per share multiple would only suggest an expensive one.Source : Internet.seekingalpha.com