Update: eBay - The PayPal Spin-Off Is Resurfacing

Summary

• Rumors surfacing about eBay’s ambition to spin off PayPal and eBay’s comment that the board will continue to assess all the alternatives suggest that something is going on.
• EBay’s management might be contemplating a (partial) sale of the business due to rising competition risks, something we highlighted in a July article.
• We remain Sellers: if eBay doesn’t move extremely fast and unload most of its shares, PayPal is likely to become soon a valuation burden for the group.

According to The Information, eBay (NASDAQ:EBAY) has been "telling potential recruits for the position of PayPal CEO that it's considering spinning off the payments business as soon as next year". This report is quite surprising as eBay fought off Carl Icahn's spin-off request just a couple of months ago. eBay replied that its stance hasn't changed but that the board "will continue to assess all alternatives". As a reminder, PayPal is the group's most valuable asset. It accounts for more than 40% of eBay's revenue, is the main growth driver (20% revenue growth in Q2 vs. 13% growth at group level) and is valued by analysts around $40bn (60% of eBay's market cap). One of the strongest arguments in favor of the spinoff and of a standalone PayPal is the potential to accelerate revenue growth through PayPal's integration on other large marketplaces [Amazon (AMZN), Alibaba (BABA)…].

As explained in our article "eBay: A Short Idea On PayPal's Upcoming Woes", PayPal is a high-quality business and still in a near-monopoly situation, but competition is heating up and is a major threat to the business. Indeed, promising growth prospects and comfortable take rates (3.5% at PayPal in Q2) have been attracting the attention of tech giants Amazon (AMZN), Google (GOOG) (GOOGL), Facebook (FB) and Apple (AAPL), not to mention start-ups such as Square. Expansion of these companies into online payments is not a question of if but when as reported by many media outlets. Increasing competition will obviously put pressure on PayPal's take rates and margins, suggesting that revenue and earnings growth could stall. In our view, rumors surfacing now about eBay's ambition to spin off PayPal and eBay's comment that the board will continue to assess all the alternatives suggest that something is going on and that eBay's management has probably taken notice of the increasing competition risks. That would be a smart decision to contemplate a (partial) sale of the business right now, before Apple, Amazon, Google and Facebook aggressively enter the payment market and put pressure on PayPal's earnings and valuation.

If eBay moves on PayPal, the main question will be whether eBay retains a significant stake or unloads most of its shares. If eBay retains a large stake, it will remain exposed to the above-mentioned risks. And if it does not move fast enough, PayPal's valuation will probably suffer from the announcements around online payments made by Apple and peers in coming months. In all, we remain sellers of the stock as we believe that the upside scenario (eBay moves extremely fast and unloads most of its shares) is unlikely at the moment.

Analyst’s Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Comments

[ALiveH]

you should look into previous attempts of the above-listed companies to compete with PayPal (like Google Wallet). There's been literally 1-2 such attempts every year for the past 10 years and yet PayPal market share continues to march higher and still not close to full penetration. If it was that easy why were previous such attempts to compete w/ PayPal unsuccessful and what's different this time? Oh, and the underlying market is secularly growing at 15% per year - that's not a small tailwind.

good point on the revenue dis-synergies of PayPal+EBay - I hadn't thought of that.

btw, Venmo/Braintree/PayPal one-touch mobile payments looks pretty interesting & unique.

[BTinSF]

So I've got some EBAY Jan 2016 calls. If PayPal gets spun out before Jan 2016, how does that work (especially if you get fewer than 1 share of PayPal for each share of EBAY)?

[AtonRa Partners]

good question, I don't know but I'm sure your broker does. Maybe he already knows how the Agilent - Keysight spinoff (a PayPal spinoff could look like this deal) will be managed.