EBay Bets PayPal In-House Beats Icahn’s Plan: Real M&A

EBay Inc. is willing to forgo a possible 26 percent stock pop by rejecting Carl Icahn’s proposal to split off PayPal, banking instead on the promise of longer-term rewards by keeping its online payment unit in-house.

Shareholders including Sterling Capital Management LLC and Kornitzer Capital Management Inc. are, so far, backing the stance of Chief Executive Officer John Donahoe, who says that a unified EBay helps fund PayPal’s expansion. Activist investor Icahn called a separation of PayPal, one of EBay’s fastest-growing businesses, a “no-brainer” that would improve value.

While EBay’s breakup value is pegged by analysts and investors at about $69 a share, compared with $54.94 yesterday, investor Condor Asset Management Inc. said the stock will rise as it expands PayPal to more vendors. Sharing risk management and transaction data helps the $71 billion company’s online marketplace and payment units better compete against rivals such as Amazon.com Inc. and payment processor Square Inc., said Susquehanna International Group LLP.

“We can all come up with a higher number than $55 for EBay shares, but that’s why we own it,” George Shipp, a fund manager at Sterling Capital, which oversees more than $45 billion, said in phone interview from Virginia Beach, Virginia. “I don’t know that it’s such a significantly higher number that it means the EBay team is doing a lousy job, or that I have a burning desire to light a fire under the board for some sort of short-term pop. This is not a broken company.”

Icahn Stake

EBay, whose online marketplace sells everything from motorcycles to golf clubs via auctions and at fixed prices, acquired PayPal in 2002 to add online-payment services. The unit almost tripled sales in the five years ended in 2012 and now accounts for about 40 percent of revenue at the San Jose, California-based company.

Icahn, who took a 0.82 percent stake in EBay and is also seeking two board seats for his employees Jonathan Christodoro and Daniel Ninivaggi, said this week that the company “hasn’t done as well as it should have” and spinning off PayPal would unlock value for investors. Icahn didn’t respond yesterday to a request for further comment.

“We have been successful exactly because PayPal and EBay are together,” Donahoe said during an earnings call with analysts this week. “No other payments competitor has achieved PayPal’s success, because no other competitor has a commerce platform like EBay.”

Amanda Miller, a spokeswoman for EBay, declined to comment yesterday.

Better Together?

Sum-of-the-parts estimates from six EBay analysts and shareholders ranged from $60 to $75 a share. That tops EBay’s record high of $58.89 in December 2004, and it implies the company should be valued as much as 37 percent more than its closing price yesterday.

Since EBay disclosed Icahn’s stake and also reported holiday quarter sales that missed analysts’ estimates, the company’s shares have gained less than 1 percent.

Today, EBay fell 1 percent to $54.37.

Even though a split may deliver returns for shareholders, PayPal is in a better position to grow as part of the combined company, said Stephen Kahn, a Toronto-based fund manager at Condor Asset Management.

As EBay seeks to increase PayPal’s use by other vendors, both online and in stores, “staying together is not a bad thing,” Kahn said in a phone interview. “Until PayPal payments broaden significantly beyond EBay e-commerce, I think it makes sense.”

Funding Expansion

EBay can use the free cash flow from its marketplaces business to fund the expansion and innovation, Matt Nemer, a San Francisco-based analyst at Wells Fargo & Co., wrote in a report yesterday. Having PayPal integrated with EBay’s marketplace also helps build the payment service’s customer base, said Josh West, an analyst for Kornitzer in Shawnee Mission, Kansas.

EBay’s marketplace makes up about one-third of PayPal’s revenue and more than half of its profits, according to CEO Donahoe. EBay also contributes more than 30 percent of PayPal’s new customers.

“PayPal definitely benefits from being a part of EBay, and the distractions around trying to spin off part of it or the whole thing could certainly hinder its long-term growth prospects” said West, whose firm advises the Buffalo Funds, which oversee about $8 billion including EBay shares.

Sharing data between the services makes both the e-commerce and online-payment businesses more competitive, Susquehanna analysts Brian Nowak and James Friedman wrote in a report yesterday.

Nothing New

Icahn isn’t telling shareholders anything new by highlighting the potential benefit of a PayPal split, said Shipp of Sterling Capital. Even so, Shipp said he prefers the long-term rewards of keeping the company together to the short-term boost that a breakup might bring.

“PayPal could trade at a higher multiple -- we know this,” Shipp said. “There may come a day when it makes sense, but I don’t know that we’re close to that day. It looks to me like the integrated company is doing well.”

While there are some advantages to keeping EBay and PayPal together, the manager of shareholder Jacob Internet Fund said the case for splitting up is stronger. Retailers that may be hesitant to use PayPal because it’s owned by their competitor could choose to adopt the service if PayPal were independent, Ryan Jacob said in a phone interview.

Win Faster

Investors will eventually give EBay credit for the value of PayPal, though a breakup would accelerate that, said Daniel Johnson, a Louisville, Kentucky-based money manager at River Road Asset Management LLC, which oversees about $10.3 billion, including EBay shares.

“We think we can win if it stays together, but we can win a little faster if it gets split up,” Johnson said in a phone interview.

Even if Icahn fails to spur a transaction, the added pressure on EBay’s leadership benefits shareholders, according to Sean Sun, an analyst at Santa Fe, New Mexico-based Thornburg Investment Management Inc., which oversees $94 billion including EBay shares.

“Having this activism is good because it probably gets management more focused and brings to light the fact that the company is undervalued,” Sun said in a phone interview. “I don’t think the spin is going to happen without management’s support, but just having Icahn in there can get them thinking.”

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