Mathew Ingram: eBay's slowing growth is cause for concern

If you heard about eBay's US$4 billion bet on voice-over-internet provider Skype and thought it smacked just a little of desperation, you're not alone - and the online auctioneer's latest results provided more evidence of where some of that desperation might be coming from.

eBay, the company that used to wow the stock market by increasing its profit and revenue by 60 or 70 or even 120 per cent every quarter, has slowed down substantially over the past year or so, and it's not clear that it will ever return to the kind of growth it saw in the past.

That doesn't mean the company is going to go under, but it does mean that investors may have to rethink their approach somewhat. And it's not clear that buying Skype - as expensive a move as it was - is going to change that.

At first glance, eBay's quarter looked good, maybe even great. The auction site reported that revenue rose 37 per cent to a record US$1.1 billion, operating income increased 40 per cent to US$357 million and net income before one-time expenses came in at US$280 million or 20 cents a share.

The company's revenue figure was higher than the guidance it provided to analysts, as was net income before extraordinary items.

eBay's US revenue rose 29 per cent to US$450 million, international revenue rose 43 per cent to US$408 million and payments made through the company's PayPal online transaction unit climbed 44 per cent to US$247 million. Total listings climbed by 32 per cent to 458 million and the number of active users grew 32 per cent from a year earlier to 68 million.

All in all, a pretty good report. eBay's outlook for the next quarter, however, was somewhat underwhelming as far as the stock market was concerned: The company said it would make about 21 cents a share in earnings before one-time items, on sales of between US$1.24 billion and US$1.28 billion. While the revenue figures looked about right to analysts, the profit number was a little below consensus estimates.

Judging by the way the stock sold off by more than 6 per cent in the wake of the company's results, it was obvious that some investors were expecting an even rosier picture.

"With their Q4 guidance, the growth rate probably wasn't as impressive as investors were expecting," said David Edwards, an analyst with American Technology Research.

It may not be fair, but eBay is probably suffering a little from being compared with online-search leader Google. The two companies may not be in the same business (at least, not yet) but they are both leading tech stocks, and compete for the attention of investors. And investors have made it plain that they prefer Google, which just announced its sales more than doubled in the latest quarter, and its net income after extraordinary items rose by 120 per cent. The stock has more than tripled since it went public last year.

"There is definitely a bit of a 'wow factor' here," Hoefer & Arnett analyst Martin Pyykkonen said after Google reported. "The earnings are looking better than you could have imagined in your wildest dreams."

And while eBay had a good quarter with 35- or 40-per-cent growth, not long ago those figures were a lot closer to Google-style levels, which probably helps to explain why eBay's share price, even after rebounding somewhat over the past few months, is still more than 35 per cent lower than it was at the beginning of the year.

The simple fact is that eBay has already grown to the point where it is running up against the limits of growth, and not just in the United States but elsewhere as well - hence the Hail Mary play for Skype, a company with barely US$100 million in sales, whose main business consists of giving a product away for nothing. Ironically, eBay spoke out about one of its Chinese competitors, Taobao, this week, saying the competition's price-cutting wouldn't work over the longer term because "free is not a business model".

After several years of rocket-propelled growth, Pykkonen said there are few additional lines of business that eBay isn't already in, and "fundamentally, they are up against a picture that is going to decelerate".

CIBC World Markets said the company's guidance implies its growth will slow next year to 20 per cent from about 30 per cent in 2005, and that operating profit margins are falling. The brokerage firm said eBay's outlook "highlights [its] decelerating growth rate" and investors would likely continue to be concerned about the stock's valuation as well as "execution risks" related to buying Skype.

"There are too many wild cards around Skype," said Derek Brown of Pacific Growth Equities, who has a "sell" on eBay.

In other words, while the most recent quarter looked fairly good, investors and analysts alike are a lot more concerned about what is to come, and the number of question marks has increased. eBay may have stabilised some of the slowing growth it experienced earlier this year, said Piper Jaffray analyst Safa Rashtchy, but while this is encouraging, "growth has not resumed the pre-fourth-quarter trajectory and is unlikely to get there".

And that is not the kind of thing investors like to hear from a tech stock.