PayPal Officially Splits From eBay -- Which Standalone Company Is Right for Your Portfolio?

Thirteen years after being acquired by eBay (EBAY 0.31%), PayPal (PYPL -1.14%) is once again sprouting its wings as a public company. The online payments system has enjoyed healthy growth and established the dominant position in a highly competitive industry. As a separate entity, PayPal has also surpassed its former parent with a market capitalization of nearly $50 billion.

eBay, on the other hand, has less to celebrate. In less than a year, the company has gone from three business segments to one, leaving it with the original marketplace business that made eBay a household name -- one that has also seen several quarters of declining sales. How will a slimmer eBay fare as analysts turn their bullish attention to PayPal?

A full transcript follows the video.

Sean O'Reilly: We're accepting payments via PayPal, on this consumer goods edition of Industry Focus.

Greetings, Fools! I am Sean O'Reilly joined today by the one and only Vincent Shen. How are you today, sir?

Vincent Shen: Hey, Sean. How's it going?

O'Reilly: Good. Today we're talking about the long awaited spin-off of PayPal from eBay.

Shen: That's right.

O'Reilly: It's been a long time coming, Carl Icahn obviously forced them to do it. How did all this come about, first and foremost? For our listeners that may or may not be aware.

Shen: You mentioned Carl Icahn who was definitely a big catalyst for this spin-off happening. He first took a stake early last year in January. It came out that he had purchased less than 1% stake in the company, but he's an active investor. Once he picks up any of your shares, if he doesn't like the way you're doing business, or he thinks that you can extract value in some way -- be it a spin-off, a sale, some assets, or picking up something -- then he will tell you very vocally.

There was a pretty vocal, public debate between the company and Icahn over the next three months or so. It kind of died off in April where management maintained the view that they were better of keeping eBay intact as it is. Then they did an about face later that year, and around September they came out and announced "We looked at it. The changing environment for the payments industry for our industry, the e-commerce; we think week can do a better job having the ability to focus on each business separately." That's when they announced they were going to spin-off the company around this time this year?

O'Reilly: Do you think they would have come up with the idea on their own?

Shen: Actually, that wasn't exactly a new idea for eBay. They have assessed the possibility of spinning off PayPal every year since 2008 -- management does internally. It's not a new idea for them. I think it was a big push when they had somebody from the outside like Icahn driving them toward that.

O'Reilly: It's an interesting twist. On the one hand, PayPal benefited from being a part of eBay, because every person -- in my mind I first got to buy something on eBay like an action figure when I was 11, and you either send the guy a cashier's check in the mail, or you used PayPal. It's obviously benefited from that.

Shen: Yeah. eBay purchased PayPal early 2001, or 2002 for $1.5 billion, not long after they went public, actually. There was no denying the fact that eBay and its popularity at the time and growing popularity since then was a major avenue for PayPal's parallel growth.

O'Reilly: PayPal has obviously benefited from being a partner, too. It's being valued at $49 billion right now, and they bought it for $1.5. I would argue that PayPal probably wouldn't be worth $50 billion had it not gotten the boost from being a part of eBay.

Shen: eBay, with its popularity; that's a natural springboard for a payments processing company like PayPal. That was a great deal for eBay. Look at how much it's gone up; 15x in the past 15 years. That was definitely important for both companies in that intervening time when they were one entity.

O'Reilly: In the second half of this show we'll talk more about the competitive position of these companies and their financial valuations. What do we know about the leaders of these two companies? Who's been chosen?

Shen: Something else I thought was interesting that was another potential catalyst for why eBay finally made this decision; even after fighting for months publicly against Icahn and this whole idea was the president of the PayPal division stepping down to join Facebook. All of a sudden they had this...

O'Reilly: I wonder; if that hadn't happened would they have done this?

Shen: A big question the company had was, they wanted to make sure they could attract top level talent to lead PayPal as a separate company. With the president stepping down, they had what they could offer as a CEO position now.

O'Reilly: Of a company that can take over the world of online payments.

Shen: A multi-billion dollar company that is for online payments; that's the big gorilla. The largest, dominant position. That's going to attract some pretty strong candidates.

O'Reilly: Right.

Shen: That was another catalyst for them basically agreeing to this arrangement.

O'Reilly: How did these companies trade right after the IPO the other day?

Shen: This was something I thought was really interesting and kind of proves that Carl Icahn was right in seeing the value being unlocked by these companies splitting up. A way I like to look at it is, before eBay announced this deal last year, in September, their market cap was about $65 billion.

Now, right before the spin-off -- which I think has already priced in some of the synergies and benefits of having these two companies be separate entities -- it was worth $75 billion market cap. Now that the companies are separate, their combined separate market caps is about $84 billion.

O'Reilly: That's a 30% return.

Shen: Depending on how you look at it, if you look at it based on the pre-announcement, September 2014, this split essentially created almost $20 billion for shareholders.

O'Reilly: Wow. Darn you, Carl Icahn.

Shen: Since PayPal started officially trading on Monday when they rang the bell, there was a smaller issue basis since July 6^th. Stock has already traded up 10% since then as well. I think earnings last week being very positive, especially for PayPal, it's definitely going to help the stock in its near-term trajectory.

Then people are going to be spending a lot of time trying to figure out what the prospects for eBay by itself are, when it's lost the star of its three segments, and it's selling its enterprise. It's going to be left with one segment, marketplaces, which is the original one most people think of when they think of eBay.

O'Reilly: Right. It's a mature business.

Shen: Yeah. Where are the areas of growth going to come from for them? What opportunities do they have? We can talk about this later, in the next part of the show as well, but are either of these companies' acquisition targets now? Are both of them? There's definitely certain companies that would love to get a very well-established e-commerce platform and brand name like eBay.

There's also a lot of companies that would love to have a payments company that's as well-established as PayPal as well.

O'Reilly: Yeah. I can't think of any other payments processing companies that are as well established.

Shen: It's a composition coming up from start-ups like Square, Stripe, and then Apple. They released Apple Pay last year. It's interesting that PayPal is in the dominant position, but it's not completely without competition.

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Getting into the meat of things here; how were the earnings a couple weeks ago?

Shen: On the PayPal side; very bright. I have to say, before the official first trading day on July 20^th, having that earnings release on the 16^th...

O'Reilly: Almost makes me think they planned it.

Shen: Just a few days before, being so positive; that is a really nice start to the official trading for this company. They grew everything from revenue, earnings, payments volume, number of active users; across the board their metrics were up. eBay, on the other hand, were down including currency fluctuations. Without those they saw mild growth on the topline, but overall it's definitely been lagging. Especially when the e-commerce industry overall saw a 20% growth last year.

O'Reilly: I never thought I'd see it, but it looks like e-commerce is mature, with respect to eBay. eBay was kind enough to do some pro forma estimates with all their filings of the spin-off and I was really interested to see the last three years, what each division had done respectively. Fiscal year 2012 eBay made $1.79 billion; PayPal made $818 million. Fiscal year 2013 eBay bumped up a little bit to $1.93 billion net income; PayPal made $926 million.

Then last year, PayPal crossed the billion dollar mark; they made $1.02 billion. Then eBay was a little funky with regards to net income. They had a tax loss because of the spin-off and all this stuff. Recently the earnings came in and eBay is on pace. S&P Capital IQ has 12, or 13 analysts covering it. They think eBay will make about $2.14 billion this year. They had a pretty good first quarter at $398 million.

I was interested in PayPal as they're getting a lot higher valuation. You're talking about how they've already crossed the billion dollar mark, they're going to keep growing at 18% to 20%, and it's worth $50 billion in terms of market cap.

Shen: It's already eclipsed eBay.

O'Reilly: Who spun off who here?

Shen: It's true. Right now PayPal is sitting around a $49 billion market cap. eBay's stand-alone is about $35 billion. It's already eclipses its former parent. That's off the first quarter of this year, which was also the first quarter ever where PayPal was the biggest segment. It exceeded marketplaces at eBay when they were still one entity.

Just another sign of how it was picked up in early 2000s, that growth has actually allowed it to surpass the business that originally scooped it up.

O'Reilly: PayPal's fees are not low. If you send money to someone you can do it for free a lot of times, but if you're a company sending money it gets kind of pricey.

Shen: Yeah. Between the merchant services and if you're paying for goods. Based on my experience, sending more personal payments, they take about 2.9% for the person who's receiving it. The net payment volume rose 20% for the second quarter, year over year, to $66 billion. When you're processing those kind of volumes, that percentage could be very lucrative.

O'Reilly: Obviously, mobile payments is part of the ration of spinning of PayPal so they can focus on this. They have a huge leg up. Everybody in the United States knows what PayPal is and use it to send money.

Shen: It is very dominant in the U.S. I think we'll get to this with the Xoom (XOOM.DL) acquisition. They're hoping to pivot that into more international exposures. Not that PayPal doesn't have an international presence, but in the U.S. it's definitely dominant.

O'Reilly: Do they address the problem of getting any bigger and capturing a big chunk of mobile payments globally, the fees will come down? Have they talked about that at all?

Shen: Right now mobile payments make up over 30% of all transactions at PayPal. They're focused on it. It's not a small piece. It's a high growth area for them. PayPal's acquisition portfolio in the past few years has been pretty solid when they picked up Braintree which owned Venmo.

If you're a younger user -- a lot of my friends use Venmo-- that's actually part of PayPal as well. They're definitely focusing on these upstarts and other smaller, more popular areas. Venmo incorporates the social media experience to these payments. The mobile payments is really big for them. The Xoom acquisition...

O'Reilly: I was going to ask; why did they do that? What is Xoom?

Shen: It's a remittance and transfer payment processor. The main use of it is for people in the U.S., especially immigrants, sending money back to their home countries; to their families. A lot of the recipients' big markets are in India, Brazil, Mexico, China, the Philippines, and they processed about $7 billion in payments last year for 1.3 million active customers.

Generated revenue of about $160 million. Xoom charges about $5 to $10 per transaction. This is also another instance where PayPal has taken over Xoom and is part of the competing field for payments with Western Union.

O'Reilly: I was going to ask how its fees compare with Western Union.

Shen: I'm not quite sure.

O'Reilly: It sounded pretty comparable; $5 to $10.

Shen: Usually it's dependent on how much you're sending. Within the U.S. it's got a pretty good base for these people sending money back to their families. Xoom sees this as a perfect opportunity for them because PayPal has very well-established partnerships and relationships with regulators abroad, banks, and much larger international presence.

That's an opportunity for the two of them to leverage PayPal's size, scale, and experience and for PayPal to be able to accelerate its entry into the remittance and transfers market. The World Bank valued it at $600 billion this year. Very significant.

O'Reilly: Okay. eBay and PayPal are split up. What do you think of the valuations of these guys? Which company are you more interested in? Which one has the brighter future?

Shen: I think their share prices reflect the general sentiment of the stocks. eBay has slower growth, uncertainty over how it will do with only its marketplaces.

O'Reilly: It's forward P/E was 16. That's not outlandish. That's actually less than the S&P 500 right now.

Shen: The thing to keep in mind is, for an e-commerce company its growth is lagging in the industry significantly. The fact of the matter is, there's been a lot of changes to this company. They went from three major segments this time last year and now they only have one after selling off the enterprise, too.

That was announced that they were going to sell off their enterprise position as well for $925 million. They paid quite a bit more than that for it originally four years ago. Not a great deal for them.

O'Reilly: Right.

Shen: That uncertainty is going to hang over the stock price. I think earnings growth and everything has not been impressive the past few years. It's lagging, like we said. Whereas PayPal; the growth is there, analysts consensus is about 18% earnings growth in the medium term, over the next five years. The fact that it's trading at about 32 times 2015 expected earnings is not surprising.

 I think PayPal is in a really interesting position because a lot of online e-commerce platforms were hesitant to partner with PayPal because of its ties to eBay -- a competitor for a lot of them. Now that it's its own entity, those partnerships can be forged. It's growth trajectory and its acquisition portfolio like this recent Xoom deal has a very clear vision for its potential and how it can get into this really big industry.

It's a $600 billion transfer and remittance industry, like we talked about. That growth, you're paying for it. It's definitely a premium valuation, 32x, but I think I'd rather pay a little bit more for a strong company with growth prospects like that. Not to completely disparage eBay because everyone knows eBay as well. It's one of the original dotcom companies. I don't think that's going away anytime soon. Its revenues put it easily in the Fortune 500 as well.

O'Reilly: Awesome. Well thank you for your thoughts, Vince.

Shen: Thank you, Sean.

O'Reilly: We'll see you later. If you are a loyal listener and have questions or comments we would love to hear from you. Just email us at [email protected]. Again, that email is [email protected]. As always, people on this program may have interests in the stocks that they talk about, and the Motley Fool may have formal recommendations for or against those stocks. So, don't buy or sell anything based solely on what you hear on this program. For Vincent Shen, I'm Sean O'Reilly. Thanks for listening, and Fool on!