Active investor and billionaire Carl Icahn has a reputation for shaking up management of the companies where he owns a significant stake. He has been actively writing to eBay’s (NASDAQ:EBAY) management and board of directors about spinning off PayPal from eBay. As the management has stayed firm in its opinion, he has now made a tactical change by suggesting partial spin-off by selling 20% stake through IPO.  PayPal is growing rapidly and there may be an impression among shareholders that the division is carrying the whole company and will command a higher valuation as a stand-alone entity. However, given the co-dependent relationship and synergies that exist between PayPal and eBay, we continue to believe that a spin-off may not be a good idea, unless a mechanism is put in place that nurtures this relationship. In this analysis we’ll argue why it is better for eBay and PayPal to continue operating as a combined entity.
Our price estimate for eBay stands at $59.70, implying a slight premium to the market price.
eBay And PayPal Are Growing Well Together
eBay acquired PayPal in 2002 as it made a lot of sense. Despite strong marketing, eBay’s own billing service Billpoint was not able to compete against PayPal, which was gaining market share very quickly. At that time, roughly 40% of eBay’s transactions were happening electronically and it was imperative for it to invest in making online payments faster, secure and easier.  PayPal was doing very well on these fronts. During the last decade, eBay’s payments related revenues have gone up from merely $438 million to $6,628 million, registering a compounded annual growth rate (CAGR) of more than 31%. During the same period, revenues from the marketplaces business have jumped from $1,727 million to $9,419 million, implying CAGR of 18.50%. Clearly, the combined entity has benefited PayPal rather than subduing its growth, which puts Carl Icahn’s claims that ‘eBay is stifling PayPal ‘s growth under doubt. In fact, much of the growth has come in recent years as PayPal’s penetration increased on eBay’s platform and the marketplaces saw a revival. Both entities have a symbiotic relationship which may be affected by a spin off.
That’s not the end of it. The combined entity has been able to harness certain synergies and save operational costs, which was one of the reasons why eBay bought PayPal in the first place. The resulting cost saving feeds the cash pool available for re-investment. Now whether this investment is directed towards PayPal or eBay’s marketplaces business is not important as either way, PayPal will benefit.
Our Two Cents On Icahn’s Suggestions
Carl Icahn’s earlier suggestion was for eBay to spin off PayPal as a separate entity. We disagreed with this view as a significant portion of the investments made in PayPal are being funded through cash flows generated from the marketplaces segment. In addition to this, PayPal owes a notable portion of its success to its integration with eBay. These synergies would be disturbed, or lost, if the company were to spin off PayPal as a separate unit. Now the billionaire investor, softening his stance, is suggesting a partial spin-off of PayPal with eBay retaining the majority of the share. The essence of his argument is that having two highly focused and dedicated businesses will improve PayPal’s competitiveness in the online payments market. There is some merit to this argument as separation from eBay could hamper PayPal’s funding and push it out of its comfort zone, creating an incentive for the management to step up its product development and marketing efforts. The other way to look at this is that the management would be free from bureaucratic shackles of the parent company and invest in more ambitious projects. However, the argument about the symbiotic relationship still holds, and we believe that eBay may not consider this unless strict commercial agreements are put in place to nurture the relationship between eBay and PayPal, going forward.
Partial spin-offs can be done to reduce credit risk. However, eBay is a cash rich company with $9.87 billion in net cash and cash equivalents as of December 31 2013. Icahn hasn’t given any cogent arguments or evidence that may suggest that eBay has stifled PayPal’s growth. Historical data indicates otherwise. The number of accounts and the total payment volume has been increasing at a rapid pace and there is plenty of opportunity to tap international markets. eBay’s growing presence can certainly help PayPal there. On the surface, it looks like a suggestion that’s more likely to result in short-term gains for shareholders and overlooks what may be best for eBay and PayPal in the long run.
- Icahn calls on eBay to sell 20 percent of PayPal in an IPO, Reuters, Mar 20 2014
- eBay picks up PayPal for $1.5 billion, Cnet, July 8 2002
Disclosure: No positions