- eBay recently announced plans to spin-off PayPal as a separate entity.
- The spin-off will lead to better valuations for the two companies, with the conglomerate discount being lifted off.
- The new eBay will appeal to earnings sensitive investors while the growth investors will find PayPal attractive, and the operating agreements will continue to maintain the current synergies between the two companies.
Carl Icahn, one of the greatest investors of our times has eventually got his demands fulfilled, with the eBay (NASDAQ:EBAY) board approving a plan to split the two companies into separate public entities by the end of FY 2015. Carl Icahn had first called for a PayPal spin-off in January 2014, following it up with a call for a 20% spin-off. We evaluate the performance of the current operations of eBay in order to understand the post spin-off entities. Payments will be spun-off as PayPal, and enterprises and marketplaces will form the new eBay post the spin-off.
PayPal Revenue A Major Contributor To Topline
PayPal has been the major driver of topline growth over the last few quarters. The table below looks at the segmental growth rates of eBay’s three segments: Marketplaces, Enterprises and Payments.
The payments segment has consistently been the fastest growing segment at eBay, growing at an average YoY rate of 18% to 20% over the last two years. On a comparative note, the marketplace segment has grown at an average of 11% to 12% while the growth in the enterprise segment has been inconsistent and volatile ranging from 25% in Q2 2012 to 0% in Q4 2013. However, the enterprise segment will form a minor share of the new eBay with a 10% revenue contribution based on the latest numbers from Q2 2014.
Ebay Profitability: Marketplaces Rule The Bottomline
We now take a look at the adjusted operating margins of the to-be formed entities. The new eBay will have higher profit margins compared to the spun-off PayPal segment, as displayed in the chart below.
The operating margins have been adjusted for corporate and other expenses which cannot be allocated to these segments based on the current information available. The combined segments of Marketplaces and Enterprises will have a higher profit margin as opposed to the higher growth PayPal segment.
PayPal-eBay Synergies Post Spin-off
In our earlier post on the eBay-PayPal split, we had highlighted the various synergies enjoyed by the two companies on account of their combined operations. However, Carl Icahn’s point of a conglomerate discount being applied to eBay’s current valuations holds true and with the spin-off eBay and PayPal will be rid of this valuation discount.
Moreover, in the same post we had stated;
“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. 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”
eBay’s press release, announcing the spin-off states,
“The benefits of the existing relationships between eBay and PayPal will naturally decline over time and can be optimized in arm's length operating agreements between the two entities. Arm's length operating agreements can formalize the existing relationships between the two companies and capture ongoing synergies”
These operating agreements will help to maintain the current operating synergies existing between eBay and PayPal, while the spin-off itself will lead to more competitive individual companies.
The spin-off will provide shareholders with more clarity on the investment options available. While the new eBay will suit earning sensitive investors, PayPal will appeal to those seeking higher growth, leading to optimum valuations for both the companies. The operating agreements will continue to harness the synergies of the current combined operations, which we believe is the best way to spin-off the two entities.