Quick Thoughts: EBAY – OK Carl, Just Don’t Tell Us “I Told You So”

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–          A PayPal spinoff is a sharp shift from EBAY’s “one-stop” merchandizing outsourcing strategy, relegating often asserted synergies between EBAY and PayPal to arm’s-length contracts

–          PayPal is growing but faces growing threats. AAPL is making payments an iOS default utility while fee advantaged card nets and banks are moving to build their own digital services

–          PayPal acquisition speculation will fly – banks (COF, JPM) and online leaders (GOOG, AMZN, BABA) will be rumored, but may not pay a premium for a brand that they likely see as vulnerable

–          EBAY’s strategy to offer digital merchandizing as a service to retail merchants is interesting but risky. Spinning PayPal, assuming agreements can sustain synergies, does little to change that

Carl Icahn is obviously smiling this morning. After months of protesting that the synergies between PayPal and its Marketplace and Enterprise businesses were substantial and integral to its broader strategy, eBay has executed an abrupt about face. With eBay sales now generating less than 30% of PayPal’s revenue, and with PayPal growing at twice the pace of the rest of the company, now may be as good a time as any to execute a separation. PayPal will be spun off to shareholders as a tax-free transaction some time in 2015.

The new tune is that the two separate companies will now be agile and freer to pursue the ample opportunities in their rapidly evolving target markets, and that those substantial synergies can be perpetuated by long-term, arm’s-length, operating agreements. Those synergies flow in both directions. eBay got strong payments franchise with innovative approaches for using integrated payments to enhance the shopping experience across online and physical stores to sell as part of its package of services for merchants. PayPal got advantaged access to eBay’s nearly 150M customers and its thousands of participating merchants. Both businesses benefited from jointly analyzing the consumer data generated by customers using their services. While soon to step down CEO John Donahoe asserts that these benefits can be sustained over the long haul, I’m a bit skeptical.

More likely – these synergies will simply grow less important, whether PayPal is spun out, or not. Digital payments are growing very quickly but have become very competitive. Apple just effectively neutered PayPal on its iOS platform by requiring all mobile payment apps to default to its own Apple Pay service, and could, conceivably, take the same step for in-app online purchases. While Apple Pay is currently limited to the lucky few who have been able to get an iPhone 6, it will obviously spread to the rest of the 42% of American smartphone users on the platform with time.

Android and desktop online remain open markets, but the field is getting crowded. Visa and Mastercard are pushing their own one-click payments solutions, offering merchants lower fees on the very same cards that consumers typically use to fund their PayPal accounts. Google and Amazon have been aggressive online with their payment solutions, albeit with little success in the mobile realm. PayPal, which was first and boasts the biggest user base amongst general digital payments services, won’t go down without a fight, but that fight will leave bruises on its margins at the very least. PayPal can offer merchants one unique benefit – a bit less than a quarter of its purchase volume is funded through ACH, which, funded directly from the user’s bank account, does not carry the 2-2.5% transaction fees imposed by credit cards. However, I suspect that many of these customers have a selling relationship with eBay, complicating the mechanics of the split.

With PayPal moving toward independence, expect the M&A rumor mill to crank up. Google remains the favorite would-be acquirer amongst speculators. However, I’m not certain that Google, with its powerful presence online, its world-leading Android platform, and lessons learned from its determined attempts to push its Wallet service, sees the need to pick up the PayPal brand for a premium. In fact, Google might be more interested in eBay Enterprise, with its logistics expertise and growing merchandizing outsourcing business, than in PayPal. Amazon, which is outgrowing eBay in its 3rd party merchant business, probably wouldn’t see the point of a PayPal acquisition. I suppose Alibaba could be ambitious enough to see it (or even eBay in toto) as a beachhead to attack Amazon in its home market, but it seems a bit farfetched to me. Others have touted card issuing banks – Capital One, JP Morgan Chase, Bank of America, etc. – as possible buyers. I think Apple Pay, which completely consumes the payments brands that these banks have worked so hard to build, will push other players to follow its lead. Conceivably, PayPal could be an asset to any of these banks in combating the burial of their consumer brands, but I’m not enthusiastic that any of them have reached this conclusion. If they had, they may not have been so quick to sign up with Apple.

As for eBay itself, if it is to present a credible alternative to Amazon for independent retail merchants, it needs to get bigger. It has assembled a roster of merchandizing services that it can provide for retailers – warehousing, inventory management, IT hosting, website development/management, in-store technology, and the eponymous online marketplace. Without PayPal in house, it may still have a privileged position in pushing payments innovations from the former subsidiary through those arm’s length agreements, but could also be free to explore partnerships with other payments providers as well.

I believe that enthusiastic adoption of mobile payments solutions by consumers will only happen as those solutions are embedded into real improvements in the shopping experience itself. Think of the benefit of exiting an Uber car without having to settle up with the driver. eBay is looking to provide these sorts of transformative shopping experiences for its merchant customers. It may well be that they have realized that actually owning the payments processor is not necessary to achieving that vision.

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