- eBay platform drives PayPal’s success/growth to a large extent.
- The two platforms enjoy synergies operating together.
- A spin-off with policies in place to nurture current synergies would be the best possible way to generate maximum shareholder value.
- In absence of policies to sustain the current synergies, the combined operations continue to maximize shareholder value.
EBay Inc. (NASDAQ:EBAY) has been in the news for its potential ‘magic egg’ investment, PayPal. It has of late been the fastest growing segment of the e-commerce giant, resulting in proposals calling for its divestiture from eBay. The spin-off as a separate company was brought into focus during the Q4 2013 conference call, by activist investor Carl Icahn. The management was firmly opposed to this, which was followed by Icahn’s second suggestion for a 20% spin-off in an IPO, a mellowed down version of his earlier proposal. With focus on PayPal and calls for its spin-off from eBay, we today look at the segment's performance, the synergies shared between the two and evaluate the benefits of a spin-off of this highly profitable division.
PayPal: eBay’s growth engine
PayPal has been the fastest growing segment at eBay over the last few quarters. The chart below shows eBay revenue growth by its various segments.
It is clear that the major driver of eBay’s current growth has come from PayPal, and it has had a significant impact to eBay topline. The revenues have been propelled by the fact that PayPal has benefited by its association with eBay as it is the default payment option on eBay’s marketplace. This has definitely been a huge contributor to its double digit growth rate year after year. This was highlighted in one of our earlier articles, where we stated that eBay processed over 53% of the marketplace GMV (Gross merchandise value) in Q3 2013.
According to a post on forbes.com, about one-third of new PayPal accounts came from eBay, while 50% of its new mobile accounts came from eBay in FY 2013. These are some of the factors which have enabled its rapid growth, which in turn has contributed to the overall topline growth of eBay. The author also mentions the cheap source of funding that eBay provides for the expansion of PayPal, investing about half of its profits into the latter. PayPal would most likely be unable to access such a funding source if it operated as a standalone business.
If the synergies and benefits of a unified business are indeed so clear, why is Carl Icahn, one of the greatest investors in recent times looking at the possibility of a spin off?
Icahn’s call: Benefits of a spin-off
The benefits of a potential spin-off are clear, as highlighted by Icahn’s letter to the eBay board of directors. Icahn believes that PayPal and eBay, as a combined entity, are negatively impacted by the conglomerate discount, a major reason for eBay historically enjoying inferior valuation multiples vis-à-vis its competitors. Icahn also believes that this will enable the separate managements to focus better on value creation within each segment, apart from PayPal’s freedom to tie up with new partners, which could create tremendous value for the it. He believes that the current structure of combined operations hinders value creation at PayPal as eBay management does not believe in opportunities that lie in combining with partners like Facebook and Apple.
It is clear that PayPal is rapidly growing within the eBay ecosystem, a major factor driving this growth being its link to eBay. With all due respect to Mr Icahn, while the benefits of his call for a spin-off are clear, we believe that this would directly hit PayPal's growth rate, if it lost its default payment option status on eBay’s platform. eBay platforms account for close to 60% - 70% of its transaction value. An uncertainty around the growth rate questions the fundamental reason of a spin-off, to separate the fast growing PayPal from a slower growing eBay. Therefore, we believe that a spin-off would be ideal only if systems and policies are put in place to nurture the synergy which currently exists between the two businesses. A combination of such policies with a partial spin-off would be ideal, bringing us to proposal two of Mr Icahn: 20% spin-off. But as long as this threatens the current synergies at the two businesses, we believe that operating the two as a combined entity is the right way ahead.
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