- It doesn't much matter whether PayPal has an IPO or not, especially now that attention has been brought to eBay’s significant under-pricing on a consolidated basis.
- We are more excited at what the news of the IPO will bring than the idea of the IPO itself.
- Shares of eBay trade in the mid-$50s at the time of this writing, implying significant upside on the basis of our valuation.
Global commerce and payments leader eBay (NASDAQ:EBAY) has been in the news quite a bit lately. First, Carl Icahn came public with his intentions to invade the firm's board of directors in hopes of pushing for change and encouraging a spin-off of its fast-growing subsidiary, PayPal. Then, in probably one of the more ironic situations, another one of Carl Icahn's activist targets, Apple (NASDAQ:AAPL), indicated that it is considering exploring options in mobile payments, which could impact eBay's PayPal business to a degree. Icahn has since backed off from applying pressure on Apple, but the activist icon is currently hoping that eBay will conduct an initial public offering of PayPal, selling 20% to the public. We like the idea very much.
Expecting eBay to Rocket Higher
Though Apple is a giant with near-unlimited resources and a credible threat to PayPal over the long haul, we still like eBay's (and PayPal's) long-term potential. Recently, eBay reported that revenue in its fourth quarter advanced 13% and non-GAAP earnings jumped 16%, the latter to $0.81 per diluted share. Total company Enabled Commerce Volume jumped 22%, Marketplaces and PayPal achieved record mobile results, and PayPal revealed accelerating momentum in its merchant business. Profitability was solid, with the company's operating margin jumping to 22.6% in the fourth quarter from 21.9% in the same period a year ago. The firm's free cash flow was also quite impressive, coming in at $1.4 billion in the quarter (about 30% of revenue), and eBay ended the year with $12.8 billion in cash and cash equivalents. It's difficult not to like the recent performance.
Looking ahead, eBay's outlook came in slightly lower than our projections, but we think management is being conservative, particularly with its full-year 2015 guidance (nearly two years away from being actualized), which pegs net revenue in the range of $20.5-$21.5 billion and non-GAAP earnings-per-share growth greater than 10% above the targeted 2014 range of $2.95-$3.00. We expect future bottom-line results to be buoyed by the authorization of an additional $5 billion stock repurchase program. Though a credible threat, Apple won't be able to impede PayPal's pace of expansion anytime soon (in our view), and we point to Pandora's (NYSE:P) resiliency in the wake of Apple's invasion with iTunes radio as supporting evidence for this view.
eBay's results and outlook provided in its most recent quarterly results, however, aren't the most important thing to us at this juncture. Instead, we are focusing on and very much like that Icahn is actively pushing for the company's undervaluation to be resolved by the marketplace (a tangible catalyst for shares to rocket higher). Here's the latest release from Icahn (source):
IPO 20% of PayPal
We believe eBay could easily conduct an Initial Public Offering of PayPal, selling 20% to the public. eBay would retain 80% of PayPal with control. Before the transaction is consummated the companies could enter into a long-term, commercially viable contract, preserving all synergies. This type of relationship is customary in partial IPOs and would be particularly important for eBay as currently, outside of PayPal, there does not exist a global payment processing solution competent enough to service eBay's users. Luckily for PayPal, competitors such as Google (NASDAQ:GOOG), Apple and many others do not yet have the same comparable scale and product offerings.
Though the likelihood of an IPO of PayPal remains remote, we are more excited at what the actions toward pushing for an IPO will bring than the idea of the IPO itself. We understand the board's and Carl Icahn's respective views (there's been a ton of back-and-forth since the original disclosure), but whether or not eBay conducts an IPO of PayPal is largely irrelevant (to us) at this juncture. What is relevant is that the market (in evaluating the potential upside of an IPO) will begin to better understand eBay's significant underpricing on a consolidated basis, even after accounting for Apple's competitive entrance.
It is our view that the headline and continued activist push toward an IPO will drive investors and analysts back to their valuation models to derive a sum-of-the-parts valuation of eBay, which is much higher than the Street's current expectations. We're puzzled by some of the recent commentary by sell-side analysts that they're not in favor of such an IPO (a mere financial transaction that would not change the substance of the relationship between eBay and PayPal). It's possible that if sell-side analysts were to come out in favor of Icahn, they may lose favor or fluid access with the management team (a classic conflict of interest). This is a distinct possibility as providing management access to the buyside is one of the key jobs of sell-side analysts this day and age.
There are a variety of ways that eBay can reveal its underpricing to the markets, and we continue to believe that Carl Icahn is serving as a necessary catalyst. The pricing of an IPO of PayPal and PayPal's underlying "embedded value" within a consolidated eBay are two different measures, and the difference of which represents the primary gap between eBay's share price (high $50s) and our estimate of the company's intrinsic value (high $70s). Yahoo (NASDAQ:YHOO) has been a case study of the recent success from the coming IPO of Alibaba. We maintain our view that eBay's shares are significantly underpriced. We're expecting them to rocket higher in coming periods, as evidenced by its rating of 9 on the Valuentum Buying Index, our stock-selection methodology.
Additional disclosure: EBAY and AAPL are included in the portfolios of Valuentum's newsletter products. Valuentum is an equity research provider and does not manage capital for clients at the time of this writing.