• Buy DNDN January 2009 $2.50 call options (ORGAZ)

• Sell DNDN January 2009 $5.00 call optoins (ORGAA)

• Conditions: Spread between ORGAZ buy and ORGAA sell should be less than $0.65, DNDN stock should be over $6.50 at time of trade.

Dendreon was back in the news Thursday and shares were up 24% to $6.98 after three members of Congress asked for an investigation into the Food and Drug Administration panel’s vote against approving Provenge. The letter sent to the House Energy and Commerce Committee requesting a probe into the FDA alleges conflicts of interest and ethical violations for at least two FDA advisory committee members who opposed the approval of Provenge.

In March, the FDA advisory panel recommended the approval of Provenge with a 13-4 vote. Then a few months later, instead of approving Provenge, the FDA asked for more patient data. Such a request could delay the drug for years.

The new letter authored by Mike Michaud of Main, points out that the FDA should not have had members of the advisory committee evaluating Provenge who had financial ties to rival companies. A similar allegation was made in an ongoing lawsuit against the FDA filed by the Care to Live group.

Although we don’t know how the Dendreon story will ultimately play out, the new Provenge news created an excellent options trade for those who are even mildly positive on Dendreon’s prospects. On Thursday the January 2009 $2.50 call options (ORGAZ, don’t laugh, this really is the call symbol) closed at $4.55. The January 2009 $5 call options (ORGAA) closed at $4.00. By buying the January 2009 $2.50 calls and selling the January 2009 $5 calls the risk/reward comes in at a healthy 1:4 ratio. For example, buying 10 contracts of ORGAZ and selling 10 contracts of ORGAA results in a maximum gain of $1,950 (exercise gain minus initial spread) and a maximum loss of $550.

For this options strategy to become a four bagger, Dendreon’s stock simply has to finish over $5 by option expiration in January of 2009. This position is also protected down to $3.05, if the stock closed at $3.05 at option expiration this trade would be flat. A stock close anywhere between $3.05 and $5 would result in a positive return for this trade. If Dendreon closes below $2.50 at option expiration the maximum loss (the spread between buying ORGAZ and selling ORGAA) would be realized.

However, the maximum loss is unlikely to be realized for this position even if terrible news comes out for Dendreon. This can be partially explained by taking a look at the Black-Scholes valuation for each of the options in this trade. The January 2009 $2.50 call option (ORGAZ) closed at $4.55 and had a Black-Scholes valuation of $4.40. The January 2009 $5 call option (ORGAA) closed at $4 and had a Black-Scholes valuation of $2.29. Therefore, even if Dendreon announced tomorrow that they are completely giving up on Provenge (a very unlikely announcement); the high priced ORGAA options will lose value faster than the reasonably priced ORGAZ options.

This trade keys on the spread between buying ORGAZ and selling ORGAA. We like this trade with a spread less than $0.65. Yesterday afternoon this trade was available with a spread between $0.40 and $0.75. With a spread less than $0.65 ($0.55 spread used in the above calculations), this trade has an excellent risk/reward ratio. If positive news comes out for Dendreon, the maximum gain will likely be realized. If the lawsuits and Congressional hearing drag out past January of 2009, then there will likely still be some positive sentiment for Dendreon, and the stock has a good chance of closing over $5 resulting in the maximum gain for this trade. If the stock drops almost 50% by next January to about $3.50, this trade still has a healthy positive return.

At Wall Street Mayhem we really have no idea how the Provenge saga will ultimately play out. However, we think there is a good chance that either positive news comes out or the matter is still unresolved by January of 2009. This trade has a good base risk/reward profile, but risk is further mitigated for this trade by buying the reasonable priced option (from a Black-Scholes perspective) and selling the expensive option.

Full disclosure: Wall Street Mayhem has a neutral to long position on DNDN options

• Sell PWI Near $26.35

• Buy CNE Near $14.82

Today PrimeWest Energy agreed to be acquired by Abu Dhabi National Energy. Under the terms of the agreement Abu Dhabi agreed to buy all of the outstanding shares of PrimeWest for $26.75 per share.

We decided to sell our shares of PrimeWest near $26.35 and roll the proceeds into Canetic Resources (NYSE: CNE). Canetic is another Canadian oil and gas trust that pays a dividend of 15%. Despite record oil prices, the Canadian oil and gas trusts have largely failed to rally in the last year. During this time, output has remained steady and the dividend yield has been on the rise.

We think that the purchase of PrimeWest for a 33% premium shows the underlying value of Canadian oil and gas trusts. Canetic will likely receive more investor interest as the result of the PrimeWest buyout and Canetic could also be a compelling takeover target.

• BUY GMKT near $20.05 (long term portfolio)

It’s no secret that e-commerce is on fire once again. This week Amazon (Nasdaq: AMZN) impressed investors with a second consecutive blow out quarter. It appears that the long awaited promise of e-commerce has finally materialized. Gmarket appears to be poised to benefit from the same e-commerce trends that sent shares of Amazon flying this week.

Gmarket has performed well since we first profiled the company in late April, but the recent strength in Asian internet stocks and e-commerce stocks combined with improving fundamentals, should help push shares of Gmarket considerably higher. Previously, we held Gmarket as a short term pick, but now we have decided to add Gmarket to our long term portfolio ahead of the second quarter earnings report next week.

Gmarket reports gross merchandise value (GMV) a few weeks before reporting earnings so we have some numbers to work with heading into next week. GMV represents the total value of all items sold on Gmarket’s website. For the second quarter of 2007, Gmarket reported a GMV of 780 billion won. This GMV represents an 8% sequential increase in revenue. Last quarter revenue from transaction fees came in at 30.2 billion won. Using the same ratio, transaction revenue should come in at 32.58 billion won for the second quarter of 2007.

Recently, advertising and other non-transaction revenues have been growing faster than transaction related revenues at Gmarket. Last quarter advertising and non-transaction fee related revenue came in at 17.8 billion won, an increase of 114% compared to Q1 2006. If we assume that non-transaction revenue will increase by 50% in Q2 2007 compared to Q2 2006, then non-transaction revenue will come in at about 19.28 billion won. Therefore, after making the preceding growth assumptions, total revenue would come in at 52.4 billion won.

The current won to US dollar exchange rate is 915 won for $1 US dollar. Last quarter the rate was 937 won for $1 US dollar. The weakening US dollar should help Gmarket’s numbers when reported in US dollars. Four US analysts follow Gmarket and all of them report estimates in US dollars. None of these analysts have updated their numbers in the last 90 days despite a weakening US dollar that should help Gmarket’s numbers compared to estimates when the company reports.

Second quarter revenue in US dollars would come in at $57.26 million if we assume a 50% increase in non-transaction revenues compared to Q2 2006 and an 8% sequential increase in transaction related revenues. We think a 50% increase in non-transaction related revenue is a conservative estimate, but even with this estimate, Gmarket would handily beat the consensus analyst estimate of $56.85 million. If Gmarket can increase non-transaction revenues by more than 50%, investors could be in for a Bidu or Amazon type surge in Gmarket shares.

Bidu (Nasdaq: BIDU) reported a great quarter yesterday with revenue coming in at 401.3 million Yuan ($52.7 million). Just like Gmarket, Bidu’s numbers were helped by the weakening US dollar. Last quarter $1 was worth 7.73 Yuan; today $1 is worth 7.56 Yuan.

For Bidu, $52.7 million in revenue was enough to send the stock flying higher, up 19% in the after hours alone. This move propelled Bidu’s market cap to a lofty $7.35 billion. Analysts expect Gmarket to have second quarter revenues of $56.85 million (we think it will be closer to $58 million) and Gmarket has a market cap of $1 billion. Let’s review, Bidu has a market cap that is seven times larger than Gmarket, but it has lower revenues. We all know that the market pays a big premium for growth stocks. Therefore, does Bidu have projected growth numbers that justify the divergence in market cap from Gmarket? Not according to the analysts. The analysts that cover Bidu expect 68.5% revenue growth this year and 48.3% per year growth for the next five years. The analysts covering Gmarket expect 78.4% growth this year and 42% growth per year for the next five years.

For this quarter, Gmarket is poised to benefit from strong demand for e-commerce and a favorable exchange rate. For the long run, Gmarket will benefit from a dominant position in Korean e-commerce and a planned expansion into other Asian markets. Gmarket’s valuation is favorable when compared to other e-commerce stocks and Asian internet stocks. In short, this looks like a great time to buy Gmarket.

Wall Street Mayhem is long Gmarket

• BUY PWI under $18.80

• SELL PWI at $30 or when PWI’s estimated reserve life declines 10% or more

The PrimeWest Energy Trust is a Canadian oil and gas trust which is actively managed to generate monthly cash distributions for unit holders. The Trust’s operations are focused in western Canada, Montana, North Dakota, and Wyoming. The trust produces approximately 68% natural gas and 32% crude oil.

Through the distribution of monthly dividends, PrimeWest has a yield of about 13.5%. PWI’s stock is trading near a 52-week low and is over 45% below its 52-week high of $32.90. Wall Street Mayhem believes that PWI has a compelling valuation at this level and that PWI’s share price should move up while investors also capitalize on the hefty dividend.

Although all oil and gas trusts have performed poorly as the price of oil and natural gas has declined, Canadian oil and gas trusts have been decimated in the last five months. In October of 2006, the Canadian Minister of Finance announced a proposal that will increase taxes on Canadian oil and gas trusts. Starting in 2011, Canadian oil and gas trusts will be taxed at the same rate as regular Canadian corporations. These taxes will significantly decrease the amount of profit that will be distributed to unit holders of Canadian trusts. However, this proposal was unpopular with conservative Canadian politicians and the deadline is still four years away. It is possible that the political landscape in Canada could change significantly in four years which could serve to reduce or eliminate the newly proposed taxes for oil and gas trusts.

Assuming that the new taxes actually go into effect in 2011, PrimeWest still has a compelling valuation under $19. For the past five months PrimeWest and other Canadian trusts have declined much faster than the underlying energy prices which drive their profits. PrimeWest is down about 35% since September of 2006. During that same time frame the price of crude oil dropped from about $65 a barrel, to the current price of about $52 a barrel (25% decrease) and natural gas prices were roughly flat.

PrimeWest has an excellent track record of boosting revenues, reducing costs, and increasing reserves. For the past five years average daily production of natural gas has grown every year. The natural gas production increases are impressive, but more importantly natural gas reserves have grown in each of the last five years as well. The estimated reserve life for PWI has grown from 10 years in 2001, to a current estimate of over 13 years. Since PrimeWest is actively drilling and expanding their proven reserves, they are in essence a similar investment to an integrated oil company, but PWI pays a much higher dividend.

It is impressive that PrimeWest is able to increase production, increase reserves, and still pay a consistent dividend over 10%. Although most of the Canadian oil and gas trusts appear to be good values at this point, PrimeWest is the highest quality investment in this sector due to their track record and the growing life expectancy of their reserves.

PrimeWest is great addition to any long term portfolio because it gives protection against a jump in energy prices. If energy prices decline, then investors have what amounts to a 13% per year cushion against a potential decline in the share price of PWI. If energy prices spike again, PWI shares should soar. Although energy prices have moderated in recent months, demand for oil and natural gas continues to grow.

In September of 2006 China’s oil imports were 24% higher than they were in September of 2005. China’s economy is showing no signs of slowing down and China’s demand for oil will continue to grow for the foreseeable future. Therefore, Wall Street Mayhem believes that every long term portfolio should have at least some exposure to energy related investments.

The combination of the decline in oil prices and the proposed change in Canadian tax laws have made Candian oil and gas trusts an unpopular investment right now, but Wall Street Mayhem believes that these two factors have combined to create an excellent buying opportunity for the long term investor.

• BUY HURC under $31.50

• SELL HURC at $50, set stop loss at $25

Hurco designs and produces software and computerized machining tools designed to increase efficiencies in the metalworking industry. Many investors might think the metalworking industry is rather boring as it is not typically a high growth industry, but considering the rapid expansion of the Asian economies in recent years, Wall Street Mayhem believes that the growth story for Hurco is still in its early stages.

In 2006 Hurco opened a new component manufacturing facility in Ningbo, China. Ningbo is located in the Ningbo Economic and Technical Development Zone (NETD), in order to help develop Ningbo, the Chinese government has decreased taxes and expedited customs clearance for the NETD area. However, the strategic placement of the Ningbo manufacturing facility goes beyond simple cost reduction for Hurco. During the next year Hurco plans to expand the Ningbo facility to include sub-assembly and final assembly operations. After completing the facility expansion, Hurco plans to “build machines that are specifically designed for the complexities of the Chinese market”.

Hurco has a P/E of 13 and a forward P/E of about 9.5. These P/E ratios are low considering that Hurco continues to exhibit strong growth in Europe and it has yet to experience the full impact of the cost reductions due to the opening of the Ningbo facility. Hurco is expected to grow by about 22% in 2007, but Wall Street Mayhem believes that these estimates are conservative. Hurco has consistently executed their growth strategy by growing revenues and profits for the last three years.

Despite this growth, shares of Hurco declined slightly in 2006 largely due to a decrease in the growth rates for both revenues and profits in the April and July quarters of 2006. In the most recent quarter revenue growth was back on track growing about 25% compared to the same quarter in 2005, but profits dropped. However, profits only dropped because in 2005 Hurco did not incur income taxes while in 2006 Hurco was fully taxed. For the full year of 2006 Hurco had an operating profit that was 15.2% of sales compared to an operating profit of 13.1% of sales for 2005.

At Wall Street Mayhem we believe that profit growth will resume in 2007. Growth rates for 2007 will be comparable to the fully taxed growth rates of 2006 unlike the 2006/2005 comparisons. Additionally, in 2007 Hurco will start to fully realize the increased efficiencies of the Ningbo plant and the company should begin to capitalize on the rapid growth of the Chinese manufacturing industry. With a current P/E of 13, Hurco is already value priced compared to competitors and Hurco has a higher anticipated growth rate than the industry average. European demand for Hurco’s products remains strong and should continue to grow in 2007, but the real opportunity for Hurco’s long term growth lies in the Asian markets.

With a market capitalization of about $200 million, Wall Street Mayhem believes that with a return to profit growth, Hurco’s shares have a lot of room to run. Consistent growth in European markets combined with a growing need for sophisticated computerized machine tools in rapidly growing Asian markets, should fuel growth at Hurco for many years to come.

• Buy COST under $54
• Sell COST at $100

Today, Costco posted a 9% increase in same store sales for the holiday period. This comes at the same time that competitor BJ’s Wholesale Club posted disappointing holiday sales and slashed it’s forth quarter forecast. Wal-Mart and its Sam’s Club operating unit also disappointed with a meager 1.6% year over year gain for December sales. At Wall Street Mayhem we believe that Costco’s stellar results were largely overlooked due to tepid overall retail numbers. Therefore, now is a good time to buy Costco.

The corporate culture at Costco is nothing short of outstanding. Employees are well paid, get excellent benefits, and are more efficient than those at Wal-Mart. Although long suspected, this increase in efficiency due to higher pay and better working conditions was quantified by Business Week a few years back http://www.businessweek.com/magazine/content/04_15/b3878084_mz021.htm. These efficiencies translate directly to the bottom line as can be seen by looking at Costco’s selling, general, and administrative costs (SG&A). SG&A at Costco totals a tiny 9.5% of revenue, compared to an industry average over 20%.

The increased efficiencies and happy employees at Costco help contribute to a significantly better consumer experience in Costco stores than in stores of competitors like Sam’s and BJ’s. Costco stores are clean, the employees are friendly, and the checkout process is efficient. Price’s are about the same in Costco, Sam’s, and BJ’s for similar items, but Costco carries more high end items and a better selection of organic and healthy foods. These higher end products are in demand (see Whole Foods post http://wmayhem.com/?p=24) and they typically have slightly higher margins.

Costco is a virtual case study on the importance of treating employees well. Although some short sighted analysts have said that Costco pays their employees too much, the increased efficiencies and steady growth in revenue and profits prove otherwise. Although retail is currently out of favor, Wall Street Mayhem thinks this situation has created an excellent buying opportunity for Costco.

Shares of Costco trade at a current P/E of about 23 and a forward P/E around 18. Although these multiples are higher than competitors Wal-Mart (P/E 18), Target (P/E 19), and BJ’s Wholesale (P/E 18), Wall Street Mayhem thinks that Costco is still undervalued. Costco shares are a classic example of the old saying “you get what you pay for”. Costco is a best of breed company that continually outperforms its peers. Therefore, Costco will always have a higher P/E ratio than Sam’s and BJ’s.

• Sell NTDOY after Christmas 2007 or at $60, set stop loss at $27

Background

NTDOY is not a cheap stock, it gained about 100% in 2006 and it has a current P/E ratio of about 38. NTDOY has a market cap of about $33 billion. At first glance NTDOY appears expensive considering the recent price appreciation and the historical revenue and profit growth numbers at Nintendo. However, at Wall Street Mayhem we believe that NTDOY is classic example of a stock that will continue to outperform for the next few years. The Wii will power massive revenue growth and Nintendo will reap the benefits for years to come.

Long Live the Wii

The Nintendo Wii is the undisputed champion of the holiday season for 2006. The Wii appears to not only be trouncing the Playstation 3 and the Xbox 360 for video game enthusiasts, but it has also opened the world of video games to entirely new groups of people.

Wii Sports is wildly innovative and just plain fun to play. People of all ages and backgrounds enjoy playing Wii sports. The game appeals to just about everyone and it has opened video games to a completely new audience. Through the interactive nature of the Wii controllers, the Wii has managed to transcend the stigma of traditional video games and open up gaming to the mass market. However, Wii Sports is just scratching the surface considering the potential of future games on the Wii. Due to the interactive nature of the Wii controllers, game developers should be able harness the potential of the Wii with fully immersive, truly interactive games. Sony and Microsoft will be left in Nintendo’s interactive dust.

Nintendo’s business prospects closely parallel those of Apple Computer (Nasdaq:AAPL) about two years ago. Two years ago Apple was just entering a massive growth phase for their Ipod. Shares of Apple at that time had already had two consecutive years of returns over 100% and the stock was expensive with a P/E over 35 and a market cap that had quickly grown to about $40 billion. In early 2005, the editors of Wall Street Mayhem liked Apple’s growth potential and we felt they had a truly innovative product with long lasting consumer appeal. However, we did not buy Apple stock in 2004 because we felt that it was too expensive considering the recent run, the P/E ratio, and the ballooning market cap. We are not going to make the same mistake with NTDOY.

The Nintendo Wii is a product that will not only reap massive profits, but it will revitalize the Nintendo brand name for many years to come. For Apple, the Ipod resonated so well with consumers that demand carried over to other apple products. Consumers who bought the Ipod considered buying an Apple computer for the first time. The Wii will have the same consumer resonance as the Ipod. Subsequent Nintendo products will fly off the shelf due to the brand loyalty created by the Wii.

At Wall Street Mayhem we think that demand for the Wii will continue to be strong until after Christmas 2007. The Nintendo Wii hardware is relatively inexpensive and simple to manufacture (unlike the Xbox 360 and the Playstation 3) so Nintendo should be able to catch up to the Xbox 360 in total units sold by Christmas 2007. The Nintendo Wii will really pick up momentum during the Christmas 2007 shopping season as there will be a full range of games for sale and Nintendo will have time to catch up with demand for Wii hardware. Wii Sports 2 will likely be released in time for the 2007 Christmas rush and Wall Street Mayhem believes that it will become the best selling video game of all time.

• Buy NHC under $60
• Sell NHC in about 15 years after the growth of the elderly population subsides

As the baby boomer generation continues to age, the percentage of all health care dollars spent on the elderly should continue to increase. Recent estimates show that the elderly account for 60% of all health care expenditures in the US. Life expectancy is also on the rise and the combined aging of the baby boomer generation and steadily increasing life expectancy should lead to about 60 million elderly citizens in the US by 2020. For the next decade the growth rate of the elderly population in the US will be faster than ever before.

As a result of the growing population of elderly citizens in the US, the demand for assisted living and nursing homes will continue to increase throughout the next decade. Although an increase in demand for assisted living and nursing home care will continue for the foreseeable future, finding profitable investments in this space has not been easy. Due to overextended growth and poor management, some of these companies have performed poorly despite the increased demand for their core services.

NHC has outperformed its peers in the last decade through steady consistent growth and shrewd management decisions. At Wall Street Mayhem we believe that NHC will continue to outperform and they will be able to capitalize on a trend that is still in its early stages. Revenues and profits have grown consistently in each of the last five years. Keep in mind that much of this revenue and profit growth took place largely before the baby boomer generation reached the age of 65. Going forward NHC should experience increased demand and should be able to leverage their considerable experience in this field into a higher top and bottom line growth rate.

NHC is not widely followed on Wall Street despite consistent growth. At Wall Street Mayhem we believe that NHC will receive a slow and steady following in the near future, allowing for many small increases in the share price as analysts jump on board with buy ratings.

The demand for assisted living and nursing care will continue to increase and the best way to take advantage of this trend is to buy NHC which is a best of bread company in a growth industry.

Yes.

• Buy Whole Foods (Nasdaq:WFMI) under $50
• Sell when the brand gets saturated (probably 800 stores sometime between 2015 and 2020) or when shares hit $200 ($30 billion market cap).

Massive revenue growth, management that never misses a beat, unrivaled organic produce supply chain, and a steadily growing dividend all make WFMI a good long term investment. The recent downturn in share price and the ever growing trend of healthy living make WFMI a great investment.

Background

Whole Foods has been a tremendous stock to own for most of the last decade. During this time period WFMI has soared and the stock has typically been very expensive. At times the price to earnings ratio (P/E) for WFMI has traveled north of 100, showing that investors were willing to pay extreme prices for a piece of this industry leader. However, the stock market can be fickle and due largely to a recent downturn in WFMI’s growth rate, WFMI is no longer a Wall Street darling. WFMI’s P/E has cratered to about 35 and the stock now carries a forward P/E somewhere in the mid-twenties.

Although still far from a traditional value stock, at Wall Street Mayhem we believe Whole Foods is still worthy of a premium P/E and the underlying trends propelling their business are alive and well.

The Bad

Revenue and profit growth at WFMI have dropped. Same store sales disappointed last quarter and they were up only 8.6% compared to a 13.6% growth rate last year. Competitors have ramped up organic and health oriented brands and the selection of healthy and organic products continues to grow at most traditional grocery chains. As a result of these problems, on a split adjusted basis the stock has dropped about 50% from its all time highs.

The Good

Granted the picture going forward at WFMI is not quite as rosy as it was a few years ago. Increased competition is a legitimate problem and it is understandable that investors were scared off due to the decreased growth rate. However, at current prices WFMI represents a fantastic long term value for shareholders.

In coming years WFMI should have no problem getting their growth rate back to the long standing 20% level. WFMI currently has only 188 existing locations. Considering the powerful trend of healthy eating and living in the US, WFMI has massive growth in its future. Many major metropolitan areas could support many more stores. For example, New York City has three stores, Seattle has two, and Phoenix only has one. These large metropolitan cities have a disproportionate percentage of wealthy and health conscious people who would love to support a conveniently located WFMI store. Therefore, at Wall Street Mayhem we believe that new location growth, not same store sales growth, will provide value for WFMI shareholders for many years to come.

Whole Foods currently has 86 stores in development and they have already signed leases for 90 news stores. Most of these new stores are significantly larger than existing stores so from a square footage basis WFMI has already committed to growing 75% in the next 1-2 years. That means that revenues at WFMI will be up 60%-70% in the next few years from new store openings alone. Factor in same store sales growth, and WFMI could pull in revenues north of $10 billion a year by 2009. Therefore, even if WFMI never gets back to the lofty P/E ratios they used to enjoy, the stock should outperform for the foreseeable future due to revenue and profit growth alone.

WFMI has proven that it has loyal customers who are willing to pay a premium for quality food. Although the traditional grocery chains are trying to catch up, WFMI should prevail on brand loyalty alone. Factor in an industry best supply chain for organic produce and the entry barriers start to get quite large for WFMI’s competition. Although analysts seem to think that the increased competition from traditional grocery stores could hurt WFMI, at Wall Street Mayhem we believe that with WFMI’s rapid expansion schedule, it is the traditional grocers that will have problems with increased competition, not WFMI.

]]> http://wmayhem.com/2006/12/17/is-it-a-good-time-to-buy-whole-foods-nasdaqwfmi/feed/ http://wmayhem.com/2006/12/14/is-ebay-a-value-stock/ http://wmayhem.com/2006/12/14/is-ebay-a-value-stock/#comments Thu, 14 Dec 2006 20:08:08 +0000 wallstreetmayhem Long Term Picks http://wmayhem.com/?p=17 Well, not quite yet, but with a forward P/E of 26 and growth that is still impressive considering its size, Ebay is an excellent long term investment. Granted, it is not the screaming buy that it was this summer when it went under $25 a share, but Ebay should easily eclipse $50 a share in 2-3 years.

The Ebay naysayer’s point to slowing growth, management missteps, and the alienation of the core Ebay community through fee hikes. Although many of these are legitimate problems at Ebay, Wall Street Mayhem believes that the growth potential of Skype and Paypal will overshadow the problems.

With all the negative press Ebay received when they purchased Skype, one would think Ebay had purchased a dot.com era flop. Analyst downgrades and Skype bashing were all the rage this summer for those who follow Ebay’s stock. Did Ebay really overpay for Skype? The answer is a resounding no. Skype was a bargain and an excellent strategic move for Ebay. Let’s take a look at the numbers. Ebay paid about $2.5 billion for Skype (these numbers vary wildly depending on the news source). Despite many reports to the contrary, Skype is still growing. There at least 136,000,000 registered users, but that number really doesn’t tell us much about the core business at Skype. However, the daily users on-line numbers are very telling. It is estimated that the number of daily users has doubled from about 3 million when Ebay purchased Skype to about 7 million today. What do 7 million daily users and a still strong growth rate mean to Ebay? In short, big money.

A few days ago Ebay announced that in 2007 Skype users will have to start paying $30 a year for unlimited calling. Not a bad deal considering most other options including Vonage and the cable companies start at around $25 a month. Although this new source of revenue will not add up to much considering the massive revenues at Ebay, Skype is just getting started. Next year Skype will introduce services with Google and Yahoo that will allow web surfer’s to click a button and call any business they found during a search. Additionally, Skype could always start including tiny ads for the pc based calls that would really add up with a massive user base. Although Skype’s financial contribution to Ebay is minimal right now, in a few years Skype should contribute a large portion to Ebay’s total revenues and profits.

But who wants to talk on the phone over the computer? Not many people, but with the adoption of Skype phones that allow Skype users to use their Skype phone in much the same manner as a traditional land line cordless phone, Skype growth should stay on track. In 2-3 years Skype’s yearly revenue has a legitimate change to be higher than the $2.5 billion purchase price. Not many aquisitions can boast those kind of revenue numbers. Although there are still some hurdles and plenty of analysts that would disagree, here at Wall Street Mayhem we think that Skype will prove to be a bargain and will help fuel growth at Ebay for many years to come.

For a more in depth explanation of Skype growth check out the blog by Jean Mercier:

http://www.skypejournal.com/blog/archives/2006/04/skype_is_still_growing.php.

Check back in a few days for an in depth post about the virtually unlimited growth potential of Paypal and an analysis of Ebay’s core auction business.

Buy Ebay under $35, buy a ton of Ebay under $30. Price target: $50. Buy and Hold.