Carl Icahn and Elon Musk Are Wrong: Here's Why eBay Keeping PayPal Makes Sense

The decision to leave eBay and PayPal tied together was the right one. PayPal is not likely to face intense competitive pressure from Apple's upcoming mobile payment platform since it has already built a comprehensive risk model to compete with the challenges of facilitating the sale of physical goods online, while Apple must start from scratch.

Apr 15, 2014 at 11:30AM

It's quite refreshing that all the hullabaloo about separating PayPal from its parent company, eBay (NASDAQ:EBAY),has finally ended. Activist investors Carl Icahn and Elon Musk tried hard to get eBay to divest its high-growth unit, arguing that an independent PayPal would be more valuable than its current $40 billion valuation. Musk went on to say that PayPal would ''simply be cut to pieces'' by rivals such as Amazon Payments, Google Wallet, or even Apple's (NASDAQ:AAPL) upcoming mobile payment platform if it remains a part of eBay.

On the surface, it appears as if eBay has been piggybacking on PayPal's success. PayPal's $6.6 billion revenue in 2013 is equivalent to 41% of eBay's overall revenue, and 36% of its profit. eBay's top-line growth of 20% in fiscal 2013 was 1.5 times better than its overall growth of 14%, and 1.8 times higher than the 11.1% growth of its other business segments. Additionally, 30% of PayPal's $180 billion in online transactions in 2013 took place on the eBay website.

Many studies have also shown that corporate spinoffs tend to create massive shareholder value for investors. A good case in point is TripAdvisor's spinoff from Expedia about two years ago. TripAdvisor now boasts a market cap 31% bigger than Expedia's. Maybe the same case would apply here.

It also appears as if eBay has been dragging PayPal down in terms of market performance, since eBay shares have been lagging those of companies with popular payment platforms for the last five years. eBay shares have gained just 80% since March 2008, when chief executive John Donahue took over at the helm. Comparatively, Visa and MasterCard shares have gained 245% over that period, and Amazon shares have climbed 400%.

But, appearances can sometimes be deceiving. eBay bought PayPal in 2002 to help bolster its billing service, Billpoint, to which PayPal was showing a clean pair of heels. Back then, about 40% of PayPal's transactions were being consummated online, and it was imperative for eBay to make online payments easier, faster, and more secure. PayPal was already very strong on these fronts, and an acquisition seemed like the perfect answer for eBay.

During the last ten years, the two companies have been tied together. eBay's payment revenue has grown at a CAGR, or compounded annual growth rate, of 31%, up from $438 million to $6.63 billion. During the same period, marketplace revenue has grown at a CAGR of 18.5%, up from $1.73 billion to $9.42 billion. This shows that the combined entity has benefited PayPal, rather than subdued its growth.

Will PayPal survive the Apple mobile payments threat?
At this point, it is still unclear whether Apple's mobile payment service will only cover transactions that take place in physical stores, or will also extend to cover mobile e-commerce transactions. The latter option would be a much bigger threat to PayPal, since that's its main forte. Although PayPal processed a huge number of mobile transactions worth $27 billion in 2013, it has a much smaller presence in offline payment processing. Most of its mobile transactions are e-commerce related.

The good news for eBay shareholders, however, is that given Apple's history, an Apple mobile payment service would be highly unlikely to support Google's Android OS. This would severely limit merchant interest in Android strongholds where the mobile OS holds the dominant market share such as in Latin America, the EU, China, and parts of mainland Asia.

How is eBay going to cope?
Supposing Apple goes the whole hog and actually launches a mobile payment service sometime in the near future, it would hardly spell doom for PayPal or eBay. Investors should not forget that eBay recently acquired Braintree, a global payments processing company with robust relationships with mobile-only companies such as OpenTable, LevelUp, TaskRabbit, GitHub, LivingSocial, Uber, Rovio and Airbnb.

Braintree is a big business already wildly popular with consumers. The payment processing company processed transactions worth about $12 billion in 2013 alone, $4 billion being mobile payments. Better still, Braintree will be directly incorporated into PayPal, and will therefore acquire many PayPal customers at zero cost. 

Apple will, of course, to leverage its 575 million iTunes accounts, iBeacon, and fingerprint sensors. But, it is difficult to see Apple's new mobile payment platform doing any serious damage to a service as popular as PayPal -- at least not in the near future. PayPal offers its users simple-to-use and fairly priced payment processing programs.

The online payments platform has also forged numerous partnerships with many retail establishments, and lets them accept payments directly through their own networks, instead of via merchant processing systems such as Global Payments. This cuts costs for merchants and makes the platform very popular with many businesses.

Foolish bottom line
The decision to keep eBay and PayPal together is the best since the two companies enjoy a symbiotic relationship. PayPal is also likely to remain the dominant payment processing platform, and even Apple's upcoming mobile platform will have a hard time matching its capabilities, wide adoption, and popularity.

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Joseph Gacinga has no position in any stocks mentioned. The Motley Fool recommends Apple and eBay. The Motley Fool owns shares of Apple and eBay. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

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Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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