Earlier this week, Elliott Management – an investment fund manager with $34 billion in assets under management – tried to wake one of the grandfathers of e-commerce, eBay Inc. (NASDAQ:EBAY).
Elliott, which owns 4% of EBAY, published a letter and plan to unlock hidden value in the sleeping giant. eBay, as we all know, is one of the founders of internet sales with its 24-year-old marketplace and auction platform. Currently, according to the company, it has 177 million active buyers on its site and app with 1.1 billion live listings.
The company, once the Amazon of its day, has had a long history of mismanagement. Bad acquisitions, sloppy growth plans and even a huge security breach of customer information have all been almost commonplace for the company. Still, it has grown relentlessly in the face of all of this.
Elliott Management claims that even so, it hasn’t grown to its full potential as a mature industry leader. One reason, the fund manager claims, is that eBay has focused too much on the businesses it has acquired over the years and not enough on its core platform. Specifically, Elliott believes it should reevaluate and potentially sell of its StubHub and classifieds businesses.
In a five-point plan, Elliott notes that the selloff of these assets and a reorganized focus on its Marketplace group – the thing the company is actually known for – could drive share prices up to $55-$63. That would be a jump of 68%-93% from today’s current price.
Obviously, that would be a huge opportunity. The problem, it seems, is the fifth step in Elliott’s plan. Basically, if eBay’s management or board don’t want to act on this, they should go.
That is often the kind of thing you see in these activist investors plans. But this time it might not be needed. It sounds like there are really two options under consideration, particularly from the company’s board: agree to reorganize and focus on the Marketplace now or go private first and then do it.
Now, obviously, just the idea of unlocking a near triple-digit share price rise excited the investment community. Tuesday, the day this letter was published, shares of EBAY jumped 6%. Even so, they are still well below their early 2018 high of just under $47:
Let’s step back and look at what all of this means…
What Happens Now?
eBay is one of the largest e-commerce companies on the planet. No, it isn’t competing well directly with Amazon. But it has continued to grow consistently for decades. That growth hasn’t really slowed of late.
In fact, the company announced bottom line growth of 19% during its Q3 filing. Its next earnings release for Q4 and its full 2018 year is next week.
It is also passing this growth onto shareholders. The company bought back 29 million shares during that Q3 performance or about $1 billion worth of stock. That’s a large figure for a company with a $31 billion market cap. Elliott even applauded the effort and claims that it should be able to do more if it implements the new plan.
All of this sounds great. But even so, with the rest of the tech sector struggling these last few months, eBay has not been viewed kindly. The vast majority of its analysts have a “hold” or “market perform” rating on EBAY.
With this kind of stagnant stock performance despite decent financial growth, the recent Elliott plan shows three options for the company.
First, it could simply do nothing. Investors that bought on this news would be quickly disappointed. But with the recent rumors of some real consideration by the board, that might not be likely.
Second, it could buy into the idea of refocusing efforts on its higher-margin Marketplace group… potentially even spinning off StubHub and its classifieds businesses. That would result in investors enthusiasm heading into 2019’s fiscal year.
Finally, it could face a private buyout – either on purpose or by force. The former is far more likely, as the idea has been floated several times in recent history. If that happens, shares should rise on the news… at least in the short term. There’s no way it would consider an offer that fails to meet its own price targets. So, there’s no chance of selling for pennies here. After all, the company itself is buying back its own shares as we write.
So, the most likely move for EBAY’s share price is up… at least in the short term. This letter and new plan has basically just wakened the sleeping ecommerce giant. Investors are starting to get interested in unlocking some of that huge potential… and we are a week away from the company’s fiscal 2018 numbers.
This should prove to be a tremendous short-term buying opportunity. But hold up for a minute. Do you really want to sit on shares if the company or outsiders do decide to take it public? That can be a long, exhausting process.
Fortunately, there’s another way to profit from short-term price rises…
A Strategy For Short Term Bulls
A bull call spread is a type of trade made whenever the trader believes the underlying stock will go up in the near term. The way that’s done is by buying a call option on those shares and selling a second call option with a higher strike price but the same expiration date.
What this does is give the trader the option to buy shares at the lower strike price. He sells the option to unload those shares if prices rise above that second strike price. He profits on the difference in prices.
The trade is a net debit found by taking the price paid for the first call and subtracting the price received by selling the second call.
The profit is found by taking the difference in those strikes – what the underlying shares would gain if they rose above the higher strike price – and subtracting the cost to enter the trade – the difference in premiums.
Here’s how that looks:
Source: The Options Industry Council
Let’s dig into a real example for this EBAY situation…
A Specific Trade For EBAY Bulls
If a trader were to buy a March 15 $33 EBAY call for $1.43 per share and sell a March 15 $34 call for $0.94, that particular bull call spread would result in a net debit of $0.49 per share. Since each of those call options represent 100 shares of EBAY, that’s a total cost of $49 to enter this trade.
That $49 is the total cost and total amount at risk for the whole duration of this trade. If shares don’t rise from here, that’s what the trader would have to lose.
If shares do rise, and with the current situation at eBay that’s pretty likely, the maximum profit for this trade is $51. To find that, take the difference in strike prices ($34 – $33 = $1), subtract the entry cost ($1 – $0.49 = $0.51) and multiply by number of shares ($0.51 x 100 shares = $51).
So, if shares end up north of $34 (currently at $32.63), this specific trade would return $51 for the total amount of $49 at risk. That works out to just more than doubling a trader’s money by March 15th if eBay does even hint at making the suggested changes Elliott Management is looking for.
The odds are good that something will give here. And an extra $51 per contract sounds pretty good to us.
— The Option Specialist