Is eBay Inc (EBAY) Reliant on Subprime Lending?

eBay Earnings ReportOnline payment and commerce company eBay Inc (NASDAQ:EBAY) has long been a favorite of tech analysts and investors due to its consistent revenue growth and solid profitability.

The analyst community is especially fond of the company’s PayPal business. PayPal enables individuals and businesses to quickly send and receive payments online and through mobile devices. It is becoming a larger piece of eBay’s overall profitability, with expectations that it will account for over 60% of future earnings.

But optimism on eBay Inc (NASDAQ:EBAY)’s future may be overdone. As the company needs to produce exceptional growth to justify its valuation, there is evidence that it could be sacrificing quality of sales to achieve the quantity necessary.

Reliance on issuing low quality credit

The data seems to indicate a legitimate concern about the quality of eBay Inc (NASDAQ:EBAY)’s revenue growth. While the company has made many good innovations toward increasing sales, a troubling one is its Bill Me Later initiative.

Bill Me Later is a credit service offered by eBay. Since the company is not licensed to make a loan, it relies on a bank or licensed lender to extend the credit to a customer. eBay then buys and services the loan receivable. That means that the company, not the bank, bears the risk of default.

A major concern is that though the bank is charged with extending credit, eBay assumes all the potential downside. Clearly, an environment where the lender is incentivized to issue as much credit as possible with the buyer ending up owning all the related risk is not the most prudent for long-term success.

Increasing the worry is the substantial increase in the volume of credit extended through Bill Me Later. As of Dec. 31, 2012, there was about $12.4 billion of unused credit available to account holders. This equates to a 29% increase from 2011 and an 82% increase since 2010. The amount of actual credit drawn has increased similarly, with approximately $3.2 billion, $2.3 billion and $1.4 billion in consumer receivables purchased by eBay in 2012, 2011 and 2010.

Given the circumstance, its probably not surprising that the credit quality has deteriorated. The weighted average consumer FICO score, a score that lenders use to assess an applicant’s credit risk, related to eBay Inc (NASDAQ:EBAY) receivables was 689 at Dec. 31, 2012. This compares to 692 in 2011 and 699 in 2010. The company also reported that at year-end 2012 only about 55.8% of its loans were due from consumers with FICO scores greater than 680, a level deemed as prime. This compares with 59.3% and 63.6% in 2011 and 2010, respectively. The level of delinquent accounts also seem to indicate weakness as loans over 90 days past due ranged from 2.7% to 2.5% of total loans over the last four quarters.

This data is troubling when taken into context. For instance, Discover Financial Services (NYSE:DFS), a major credit card issuer, reported that its delinquent accounts over 90 days past due for the past year ranged from 1.1% to .89% of total credit card loans and that 82% of its loans had a FICO score greater than 660. Both figures indicate better quality than eBay’s reported figures.

The demands of a very optimistic valuation

It’s understandable why eBay Inc (NASDAQ:EBAY) might stretch to increase sales. The company’s generous valuation almost demands it. Based on a market capitalization of $67 billion and revenues of $16.4 billion with average cash earnings of $2.9 billion and a profit margin of around 18%, its price multiplier looks to be around 23. This high multiple indicates the market expects eBay to have exceptional growth far into the future. It seems a lot of the hope is being placed on the company’s PayPal business, but competitive valuations in this area indicate that the outlook for eBay may be overly enthusiastic.