Ahead of its IPO, PayPal is the king of online payments. So why does it still control less than 1% of its market?
In 2002, eBay gobbled up PayPal.
To show you how much the playing field has changed since then, this Friday PayPal will be spitting out eBay.
The legal documents required to make a corporate disunion real tell us that eBay, the parent company, will be spinning off PayPal, its subsidiary. And within that perspective it's absolutely true. Insofar as the markets have something to say about it, though, PayPal is the one ditching its lamer relative.
Typically, when one company spins off another, the shares of the new company will begin trading on a "when issued" basis, which means some shares will be available through select brokers for a couple of weeks in advance. All PayPal shares will be distributed to eBay shareholders after the close of trading this Friday. Those “when-issued” shares began trading on July 6 - the idea being to help ensure a smooth listing with the minimum of volatility. It's the spinoff equivalent of that delicate pre-IPO pricing ritual.
Very quickly, however, it became clear that the spinoff of PayPal from eBay was not going to be a 50-50 split. Investors valued PayPal at $44 billion, or three-fifths of eBay's total market cap. And this even though PayPal's revenue is only 44 percent of eBay's total.
The reason for this discrepancy is pretty clear. Investors value a stock not just on current revenue and profits, but also on the prospects of future growth. PayPal's revenue grew 14 percent last quarter, while the revenue over at eBay's marketplace fell by 4 percent. If you invest in tech, the choice is simple.
But of course, investing in tech is never simple.
PayPal's "when-traded" value has stayed flat this week, while the value of the post-PayPal eBay stock has edged up around 7 percent, likely on recent reports that eBay's plans to sell off the enterprise portion of its business could yield a price tag of $1 billion. Following on the sale of its longtime (and controversial) 28 percent stake in Craigslist, that could leave eBay with a tidy pile of cash to cushion its lifestyle once PayPal finally moves out of the house.
But for eBay, all is not well in its enterprise business. EBay bought GSI Commerce in 2011 for $2.4 billion dollars. At the time GSI was handling the e-commerce operations of retail giants such as Toys "R" Us and Kenneth Cole. But recently, the Wall Street Journal reported that Toys "R" Us is taking its e-commerce operations in house, a blow to the planned sale and one that could lower its value to $800 million.
Left on its own, without PayPal or the enterprise business, eBay's outlook is not so bad. Its marketplace remains an active venue where small, reliable sellers can find a sizable market of shoppers who are looking for value and variety – and in particular, have grown tired of the de-evolution of free-shipping policies over at Amazon.
This is the eBay that was built in the late 90s, erupted into a huge fad in the following decade, and has since matured into the digital equivalent of a shopping mall – a place where you could wander for hours and end up coming home with some good bargains if you knew where to look. This is the eBay that was always the heart of corporate eBay. When PayPal starts trading, that bigger, corporate eBay is going to go by the wayside. But the smaller, older eBay is going to continue doing its thing.
And in the end, it might be better for this older, smaller eBay to be rid of its long history of regrettable acquisitions. PayPal is often remembered as one of the most successful acquisitions in Silicon Valley history. PayPal was bought at $1.5 billion – if it lists at $44 billion, that's an inflation-adjusted 13-year return of 2833 percent, or a CAGR of 25 percent.
But as Peter Thiel pointed out in an interview last fall, the acquisition took several rounds of talks, which were fraught with the turmoil in company valuations following the dot-com bust. Then there's the acquisition of Skype in 2005. And the GSI deal, seen as a potentially smart one at the time (if Ebay had succeeded in integrating enterprise operations into its consumer business) is close to being sold off at a loss. It's just a question of how big a loss.
All of this is leaving the impression that, in the split up of eBay and PayPal, eBay is the sad parent left alone in its empty nest, while PayPal is the bright bird about to alight into something great. But there are also some questions about PayPal's ability to execute on its vision. In the documents submitted during its spinoff roadshow, PayPal drew attention to a few numbers that sound pretty impressive on their own, but put together raise other questions.
PayPal says that there is a $25 trillion addressable market in digital and in-store commerce. This sounds fine, but it’s the kind of blue-sky scenario that is the bread-and-butter boilerplate for technology companies approaching investors. The US GDP is around $16.8 trillion and the economy for the global economy is estimated around $75 trillion. Any company – even Amazon – that cites that figure and expects to be more than a fingernail clipping cast off the body of that beast is just trying to get you excited.
In reality, PayPal handled $235 billion in total payment volumes last year. That is 0.94 percent of the addressable market which PayPal claims it is serving. Think about this: How is it that a company founded 17 years ago to handle global e-commerce payments still able to control less than 1 percent of its market? Look at what Google has achieved toward its stated goal of organizing information. Look at what Facebook did in rearranging the way the world communicates. Yes, PayPal is the largest and most trusted company in digital payments. Yes, financial services have been slow to disrupt relative to media. But alongside PayPal's vaunted list of accomplishments has always been a sense that it's also underwhelming.
The conventional wisdom on eBay's marketplace is that it's lagging behind PayPal. And that's true in terms of pure growth. But in terms of business model, eBay executed on what it could achieve early on and has actually done a decent job of holding onto its market. (Amazon has seen the same slowdown in growth in its core marketplace, but has done a better job of distracting investors with growth in other areas like Web Services.)
The thing about PayPal is that it is growing faster today, but it has been much slower to achieve its potential then eBay ever was. If you are an investor addicted to growth above all, none of this matters. If you are an investor concerned with how well a company has been able to execute on its stated vision, PayPal has been kind of disappointing. Let's say the whole FinTech thing takes off, as its proponents argue, over the next few years. What is to say that PayPal will remain the leader in this disruption when it hasn't been able to capitalize on the opportunity before it so far?
In the longer term, the deep experience and understanding eBay has of global financial rules may well serve it as it grows market share. But it's also just as easy to imagine a future where PayPal, long the potential disruptor, becomes the incumbent to be overturned by newer technologies. Seventeen years is a long time in the digital world. If after that time you find yourself boasting to investors that you have less than a one percent share of the market you have committed to disrupting, you might find someone asking you what went wrong.