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Unleashing Paypal

11 March 2009 By Jeff Segal

It’s hard to imagine Ebay as anything but an auctioneer – the company virtually invented the online marketplace. But Ebay’s analyst day made clear that its future growth lies as a payments system, not a retailer. While its core auction business is practically dormant, its Paypal payments processing division is a growth machine. For shareholders to fully reap the benefits, however, Ebay needs to spin it off.

At Ebay’s first analyst day in three years, the contrasts it gave between its core auction business and Paypal were black and white. The company expects its marketplace segment, which only grew revenues 1% last year, to grow slower than the online commerce market this year. By 2011, it may finally surpass industry growth rates again. On the other hand, Paypal grew its revenues by 26% last year and could see them double over the next three years to $5bn, with margins of 20%.

Over time, that should make Paypal the company’s most valuable business. Indeed, rival payments processor Visa trades at 14 times 2011 estimated earnings. On that basis Paypal would be worth $14bn or $2bn more than Ebay’s total enterprise value today. Moreover, Paypal is growing faster than Visa, so it arguably deserves to trade at a higher multiple of earnings.

Clearly investors are attaching a big discount to Paypal’s worth. They may view Ebay as a conglomerate. Or they may see Paypal’s growth constrained as a subsidiary of Ebay. After all, it may be less desirable as a payments system for internet heavies like Google and Amazon who consider Ebay’s auction business a competitor.

To erase the discount, Ebay needs to set Paypal free. It could simply split the company in two, giving shareholders stock in both. Or it could launch an IPO of Paypal, akin to the deal that storage giant EMC engineered for its VMware software unit. By selling primary shares, Paypal could even raise some cash for acquisitions, though a high-flying stock would achieve a similar outcome.

Ebay argues that Paypal might lose business from Ebay if ties were severed. But with less than a 10% slice of the global online payment market, there’s plenty of room to take up any slack.

Moreover, a Paypal spinoff could give Ebay’s managers more time to focus on drumming up growth at its core business. And, who knows, friendlier relations with Amazon, by way of Paypal, might even lead to a potential merger there. Ebay should get cracking on a Paypal spinoff before investors force one upon them.


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