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Carl Icahn's next target is eBay (NASDAQ:EBAY), urging the company to split itself up. CEO Donahoe resents the idea, pointing towards the rationale for holding the combined operations within one firm.

Given the relative underperformance of the stock over the past year and Icahn's aggressiveness, the battle is on. This could potentially become lucrative for investors if Icahn wins.

Icahn Focusing On Technology

After buying a $3 billion stake in Apple (NASDAQ:AAPL), Icahn has again focused on a technology name to become active. Icahn acknowledged that he bought an 0.82% economic stake through derivatives and shares in the company, valued at roughly $600 million.

Icahn believes eBay should spin-off the highly successful PayPal payment unit which the company bought for $1.5 billion back in 2002. Being a separate company could spur adoption of PayPal for other online retailers, and spur growth.

Icahn nominated two of his employees for the eBay board which includes prominent names like venture capitalist Marc Andreessen, among others.

eBay Defends The Rationale Of Keeping PayPal

CEO John Donahoe acknowledged that he received a call from Carl Icahn, who initiated a stake in the firm. Icahn is so excited about PayPal he believes it is better off as a separate business.

Donahoe confirms that the idea of a spin-off is not new as management and the board routinely reviews all strategic options. Yet eBay believes the company is better off keeping PayPal within the firm.

He believes PayPal is successful because of its part of eBay and not despite being owned by it. Donahoe believes eBay accelerates the success of PayPal, making its offerings smarter and financing the growth of the business.

There are furthermore synergies of technological capabilities, data, commerce and relationship with banks, retailers and other parties, according to Donahoe.

Battle

Icahn is serious and his track record is strong. He furthermore has a time horizon of years to engage in a battle with companies and won't let management off the hook that easily. While Donahoe's defense is reasonably strong, his argument is weakening every day with PayPal growth value outpacing that of eBay.

To put shareholders on its side, the company announced a new $5 billion share repurchase program, sufficient to retire roughly 7% of the outstanding share base at current levels. The company has a sufficient $9.0 billion in cash and equivalents, while it operates with $4.1 billion in debt, resulting in a sufficient net cash position.

With the strong growth and PayPal being responsible for 40% of current revenues, it already reflects the majority of the company's value, according to some analysts. You can see the resentment of management to a spin-off, cutting the size and value of the company in half.

A Quick Peak At Fourth Quarter Results

At the same time, eBay announced its fourth quarter results as well. Revenues rose 13.5% to $4.53 billion, while earnings rose by 13.2% to $850 million, or $0.65 per share. Non-GAAP earnings of $0.81 per share came in a penny ahead of consensus.

Growth is fueled by the PayPal unit which reported 19.1% revenue growth to $1.84 billion, now making up 40% of total revenues. Payment volumes rose by 25.3% to $52.0 billion in the meantime, reporting solid growth.

Growth at the traditional eBay marketplace was 12.1% to $2.30 billion. Perhaps the high fees in relationship to $21.5 billion in merchandise volume is limiting top line growth.

Timid 2014 Outlook

For the current year, eBay looks for revenues of $18 to $18.5 billion, falling slightly short of consensus estimates at $18.5 billion. At the midpoint of the guidance, revenues are seen up by 13.7% on the year before.

Non-GAAP earnings are seen between $2.95 and $3.00 per share, with GAAP earnings seen between $2.40 and $2.45 per share.

For 2015, revenues are seen between $20.5 and $21.5 billion, suggesting 15% growth at the midpoint of the revenue guidance for 2014 and 2015. Despite the strong topline growth, there appears not to be a lot of operating leverage in the business model, with the company guiding for non-GAAP earnings per diluted share growth of at least 10%. Given the economies of scale and technology scaled business this is surprising, as eBay should be able to reap more operating leverage benefits.

Valuation

By 2015, PayPal could make up roughly $10 billion in revenues assuming by then it makes up half of total revenues. Competitors MasterCard (NYSE:MA) and Visa (NYSE:V) saw very strong returns in 2013, both trading far above 12 times annual revenues. While PayPal's profitability lags these majors, a multiple of even 8 times revenues would result in a market value of $80 billion. This is roughly equivalent to eBay's current market capitalization.

For simplicity we would add another $20 billion valuation for eBay assuming $10 billion in annual revenues, and applying a slight revenue multiple discount compared to Amazon.com (NASDAQ:AMZN).

This alone could warrant a $100 billion valuation, valuing the business at around $75 per share.

What's Next?

Icahn won't let eBay of the hook that easily. Valued at nearly $75 billion in after hours trading it will be hard to see how much potential is left as the company does not break down earnings from eBay and PayPal separately.

One thing is for sure, with the value being attributed to PayPal potentially more than 50% of the current market capitalization, management has done a great job. Remember that it bought the business for $1.5 billion little over a decade ago. The strong mobile position of the unit is a big plus as well.

The majority of the times Icahn has stepped up, initial buyers have been able to profit from his moves piggybacking on his efforts.

If Icahn can succeed and the market picks up his thesis, the combined value of the spin-off could be as much as $75 per share, suggesting some 30% upside. This incidentally is the extent of eBay's market underperformance in 2013.

I might initiate a speculative long position based on Icahn's thesis.

Source: eBay - Icahn's Next Target, Has More Upside