PayPal: Paying It Forward

Federal Reserve Chair Janet Yellen delivered an upbeat assessment of the U.S. economy in her prepared testimony to the House Financial Services Committee this morning, indicating that on their current trajectory "economic conditions likely would make it appropriate at some point this year to raise the federal funds rate target." Equity traders appear to be indifferent, however, as both the Dow Jones Industrial Average (^DJI 0.67%) and the broader S&P 500 (^GSPC 0.87%) are up 0.04% and 0.07%, respectively, at 12:40 p.m. EDT. The technology-heavy Nasdaq Composite was up 0.16%.

PayPal: Paying it forward
No one will accuse the folks at S&P Dow Jones Indices of being behind the curve in this instance. eBay Inc. (EBAY 1.09%)has yet to complete the spinoff of its PayPal digital/mobile payments division -- the transaction is expected to be completed on Friday -- but the index provider announced after Tuesday's market close that PayPal Holding Inc. (NASDAQ: PYPLV) will be included in its benchmark S&P 500 index, effective after the close of trading this Friday. 

The shares begin "regular way" trading on the Nasdaq next Monday under the ticker PYPL, but are already trading on a when-issued basis. 

For reference, shares of Facebook (META 0.14%) had been publicly traded for a year and a half before they were added to the index; Google (GOOG 1.43%) (GOOGL 1.42%) had to wait 19 months. On the date of their inclusion, Facebook and Google had market capitalizations of $135 billion and $116 billion, respectively. Based on yesterday's $36.93 when-issued closing price, PayPal is now valued at $45 billion, which exceeds eBay's stand-alone market value. The child has outgrown its parent (in fact, PayPal will also replace eBay in the S&P 100 Index). 

That's not surprising. Although the payments unit contributed 44% of eBay's 2014 revenues to marketplaces' 46%, the difference in growth rates is significant: 

Source: Company documents.

PayPal is very well positioned to take advantage of an important trend in the rise of digital payments and remittances, particularly via mobile devices. One of the key objectives of this spinoff is to get the market to properly value PayPal's growth opportunity. On that criterion, the spinoff already looks like a success. 

Indeed, PayPal is now valued at 8.0 times this year's expected revenues (per PayPal's guidance) and 43.8 times expected free cash flow (by comparison, eBay trades on 4.1 times this year's consensus revenue forecast). Those numbers look pretty rich, but businesses that are riding a long-term secular growth trend and have a competitive advantage -- which PayPal does thanks to the network effect -- have a habit of growing into their valuations quickly.