My Growth Portfolio: Evaluating eBay

Apr.28.14 | About: eBay Inc. (EBAY)


eBAY has a dominant position in online payments as a result of the strength of the PayPal business.

Google and Amazon may challenge PayPal's dominance in online payments in the medium term.

Success with in-store payments could dramatically propel EBAY stock, but challenges remain.

I am a self-directed investor who manages my own portfolio with the objective of achieving early retirement. I have a dividend portfolio, which is currently on track to deliver close to $28,000 in dividend income for 2014 and maximize income return. Additionally, I have a growth portfolio, which I am managing to maximize capital returns from established companies. Finally, I have a small venture portfolio, which has the focus of extracting more speculative capital returns from early-stage companies. I am considering eBay (NASDAQ:EBAY) as a possible addition to my growth portfolio.

Each of eBay's 2 dominant business units (Payments and Marketplaces) have wide moats, which benefit from the network effect. The Marketplaces segment benefits from each incremental buyer and seller that is added to the platform. Additionally, the Payments segment, which is principally PayPal, benefits as more users and more merchants are added to the platform. While Payments is the faster growing segment, Marketplaces contributes greater revenue and greater margins to eBay's business.

EBAY has a market capitalization of $71B, with revenues of $16B and a gross margin in excess of 68%. EBAY generates a net income of almost $2.8B. EBAY currently trades at a forward PE of 16.

There are some compelling arguments to support the investment case in EBAY, many of which revolve around the strength of the PayPal business.

Online payments exposure

PayPal and eBay offer unique exposure to the still-expanding online commerce market. PayPal has a very unique value proposition and competitive position that is unlikely to be replicated by any new entrants into the payments space. PayPal provides consumers the ability to shop freely with unknown merchants online, secure in the knowledge that their credit card numbers won't be exposed to these merchants.

PayPal has a user base of more than 130M consumers, and almost universal acceptance by merchants. This creates a unique network effect, which serves to effectively lock out new entrants looking to enter the space. It will take a player with considerable merchant influence and a large base of users to displace PayPal in the online payments space.

Realistically, that only leaves the likes of Google (GOOG, GOOGL) or Amazon (NASDAQ:AMZN) as potential challengers, each of whom have the disadvantage of delayed starts in the payments domain.

After some false starts in attempting to crack in-store payments with NFC technology, Google has now pivoted to build online wallet users via Google Play. The real threat for PayPal with respect to Google's involvement in payments is Google's willingness to subsidize interchange fees in exchange for merchant transaction data. Such a move may make merchants far more likely to accept Google Wallet as a checkout mechanism.

Amazon's move to offer merchants a single-click checkout which can be integrated within 3rd-party websites is potentially more worrying for PayPal. Amazon has a solid brand reputation with consumers. Consumers will likely have a high level of trust that Amazon will manage their payment information and transaction data in a secure and trustworthy way. Amazon has more than 230M users today, which is a very attractive proposition for merchants, and makes the case easier for them to do the necessary integration to support Amazon Payments. Still, PayPal has a significant headstart in terms of merchant adoption, something which will take Amazon quite some time to catch up.

Shift to mobile

PayPal has made significant inroads in ensuring that it has presence in mobile commerce and mobile payments. PayPal has had a mobile app presence since almost 2008. During that time, the functionality of the app has expanded beyond just payment and transfer to users now being able to fully manage individual account and add funds, amongst other things.

One of the traditional points of friction in paying via the mobile phone has been the inconvenience of entering user names and passwords to authenticate. PayPal is a step ahead here, and has embraced mobile device fingerprint authentication to authenticate users, in partnership with Samsung.

Bridge between online and offline payment

PayPal has also been using mobile payments as a bridge between online payments and offline payments. This serves as a very important beachhead to get users accustomed to using PayPal for in-person payments. Examples of in-person payments that are enabled via the mobile app include the ability to pay select in-store restaurant bills via the PayPal mobile app, and also the ability to order ahead, pay and then pick up in-store. All of these help condition users to use PayPal for in-store payments.

In-store payments exposure

PayPal has been making steady, sustained progress in its efforts to be a major player for in-store payments.

PayPal launched PayPal here, which is a mobile-based POS acceptance solution very similar to Square's Mobile Point of Sale reader. This product enables PayPal to tap into the fast-growing SMB space and payment volumes from small merchants.

The more interesting activity that PayPal has been doing as far as in-store payments has been some of the direct Point of Sale integration in major merchants, such as Home Depot and Jamba Juice.

The elegant point of sale solution allows users to simply input their PayPal credentials directly into the point of sale and have their payment processed, without the need for the mobile device or any other intermediate device.

PayPal is extending its in-store payments strategy even further by having a low-energy Bluetooth beacon which integrates with a merchant's point of sale, displaying a user's photo at the point of check out and simply requiring confirmation for payment.

While a potentially frictionless way to pay, the stability of the user experience is uncertain, given a requirement for users to enroll to accept communications from beacons, and have Bluetooth enabled, something which the majority of mobile device users typically do not do. Nonetheless, PayPal's efforts here are quite encouraging.

Paypal's ability to make significant inroads with in-store commerce is the real ace that could significantly boost the stock. The real potential of the in-store payments opportunity is clear when it is considered that in-store payments represents approximately 80-90% of total payments. In other words, in-store commerce is approximately 8-9 times online commerce. If eBay, through PayPal, is able to capture some of that payment volume, that clearly represents a step change upward for PayPal in terms of payment volume and revenue. However, there remain a couple of significant hurdles in eBay's way to achieve dominance with in-store payments.

Value proposition to customers

While PayPal may be making strong inroads with convincing merchants to adopt its point of sale technology, it's unclear whether consumers will see a compelling enough value proposition to pay with PayPal in-store.

PayPal solved a major customer pain point with online payments. That is, it enabled consumers to transact online with unknown merchants without the fear of exposing credit card numbers.

What value PayPal is providing consumers for in-store payments remains less apparent. The in-store payment experience is not broken. Consumers can pay, as they always have paid, with their credit cards in their wallets.

As other players who have tried to crack the in-store payments experience have discovered, the magic of just being able pay with your phone in-store isn't typically enough of a hook to get consumers excited. Google's efforts with NFC in-store payments and the muted user response provide evidence of this.

PayPal does have a possible ace to play here. Merchants are desperate to reduce the interchange that they are paying to the payment networks, which collectively costs merchants over $48B annually. Given PayPal does have the ability to accept ACH payments, it could conceivably work with merchants to incentivize users to pay with PayPal linked to ACH rather than credit cards, and work with merchants to drive loyalty programs around such a structure. This would assist merchants in reducing interchange, and in turn, help PayPal to attract users to pay in-store with PayPal.

Pushback from the ecosystem

The really big question mark in my mind as far as PayPal's ability to win with in-store payments is just how the incumbents in the payments ecosystem will respond. Both Visa (NYSE:V) and MasterCard (NYSE:MA) have a considerable amount at stake from PayPal taking more in-store payment volume over the PayPal network, particularly if this happens via ACH transactions.

The likely treatment of PayPal as a staged wallet by the payment networks, and the potentially higher fees that PayPal may have to pay for the processing of Visa and MasterCard transactions gives some insights into how dependent PayPal still is on the payment networks. Any attempts to significantly disrupt the networks core business of in-store payments could be met with significant competitive response. PayPal will continue to be hamstrung in the extent that it wishes to take on the networks, given just how dependent the PayPal business is on payment volume that comes from transactions that run over the Visa and MasterCard networks.


The investment case for EBAY is positive as far as PayPal's prospects for continued success in driving online payment volume. With e-commerce and now m-commerce expected to show significant growth going forward, PayPal will benefit from its decade-long lead over Amazon and Google, both of whom will take time to close the gap in spite of impressive assets.

The real kicker for the EBAY investment case will be what share of volume PayPal can get from in-store payments. Merchant adoption is only one part of the story, with the consumer value proposition still unclear. Even if PayPal can convince consumers to pay in-store with PayPal, true disruption of the payment networks is likely to be met with a firm competitive response from Visa and MasterCard.

I will be watching closely for signs of PayPal's ability to make real inroads with in-store payments, at which point, I will likely consider initiating a position in EBAY.

Disclosure: I am long MA, V. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.