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Icahn Is Wrong About Ebay

By Daniel Segundo - Feb 12, 2014 at 2:00PM

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Ebay is a wonderful business, and splitting the company up is not the best decision for creating shareholder value.

Billionaire investor Carl Icahn recently proposed that eBay (NASDAQ: eBay) be split up into two parts, spinning off its PayPal business

At first glance, eBay shares were up more than 7% in after market trading, but as people considered to weigh the merits of breaking eBay apart, the stock quickly retraced its large gain. Icahn generally takes an activist role in companies, as he tries to manipulate their businesses in a way to increase shareholder value. Icahn currently owns around 2% of the company, and is fighting to gain two seats on the company's board of directors. eBay CEO John Donahoe stated that "[Management] believes that [eBay's] collection of assets drives more growth and success together, than apart." In response to this, Icahn is threatening with a proxy fight in order to get his way.

Why is eBay better as a whole?
I think that eBay is worth more as a whole than the sum of its parts. Both PayPal and eBay's online selling platform work together to create a harmonious blend of growth, as eBay's marketplace business provides retention, while PayPal offers growth potential for shareholders. Especially when looking at eBay as a company down the road in terms of growth and market dominance, PayPal looks quite attractive to eBay's overall competitive position.

eBay is a classic example of the network effect, as the more people that use eBay's service, the more valuable it becomes. More sellers attract more buyers, and vice versa. This competitive advantage has not only allowed eBay to develop a wide economic moat, but lets the firm continue to widen its moat. Therefore, I believe that not only will eBay continue to pump out high returns on invested capital for years to come, but that these returns will likely gradually increase as the firm continues to steadily gain market share.

PayPal fits into this network effect in a similar way that credit card issuers obtain their network effects. The more people that use PayPal as a means of an online payment service, the more likely merchants are to accept PayPal as a form of payment. Altogether, the synergy of PayPal and eBay's marketplace has allowed for gross margins over 65% for the last 10 years, and returns on invested capital over 10% for the last five years, however it is worth noting that returns on invested capital have bounced around in light of consumer weakness during the recession. 

Let's take a moment to hypothetically picture an eBay that has found itself in a PayPal spinoff scenario, thanks to Mr. Icahn. If PayPal is taken away from eBay, a large part of the growth that investors benefit from in eBay's stock would likely be susceptible to a decline. PayPal provides most of eBay's actual growth, and contributes to the firm's expanding competitive position. It is the network economics of eBay's core marketplace business, however, that both maintains and increases the company's market share.

PayPal fuels growth as it has strong momentum in capturing a larger share of the online, mobile, and offline payment markets. With already 143 million active users around the globe, PayPal is quickly becoming a payment standard for online payment transactions. Without the core business of eBay, PayPal probably wouldn't have a hard time gaining traction as a means of payment, but I strongly believe that the relationship between eBay's core business and PayPal is the best choice for creating shareholder value over the long term. The separation between the two would be almost certain to turn eBay into a sluggard in terms of growth, and this obviously wouldn't bode well with shareholders. 

The Foolish line
At the firm's current valuation, eBay shares definitely dont look cheap at the pricey multiple of 25 times earnings. At the right price though, eBay would certainly appear to be a very lucrative investment. Nonetheless, it is highly unlikely that Icahn's proposal will come through, as the board of directors, founder, and CEO of eBay are all against the PayPal spinoff. This may, however, create an ample amount of volatility for the stock in the near term. Needless to say, after taking into account the benefit that both eBay and PayPal share as a team, it is apparent that the two work together in order to create a union that will likely continue to drive overall growth and enrich shareholder value for many years to come.

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