Better apart.

Why EBay Is Freeing PayPal

Katie Benner is a Bloomberg View columnist who writes about technology, innovation, and the cult and culture of Silicon Valley. She lives in San Francisco.
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"We strongly believe that PayPal is more competitive, more agile and more successful when combined with eBay. We are better together. Everyone at PayPal is committed to remaining focused on driving innovation and creating the future of commerce."

That's what the online auction and retailing giant, eBay, had to say back in January about its relationship with its online payments subsidiary, PayPal, when Carl Icahn began rattling its corporate cage, arguing that the faster-growing PayPal should be liberated from its parent.

That was then, this is now.

Today, eBay said that it plans to spin off PayPal so that the payments company -- once a pioneer in its field -- can compete more effectively with other online titans such as Apple and Google.

EBay may still believe that PayPal is better off in its corporate fold, given how lucrative PayPal has been for its parent. But it's fully divesting the unit and analysts note that eBay really didn't have much of a choice to do anything else.

Icahn, as is his wont, was the loudest activist investor targeting eBay. But other shareholders have been pressuring the company's board and its executive team to spin off PayPal ever since the idea was publicly floated several months ago. (Reuters reports that fellow activist Dan Loeb is a significant holder of eBay and is still agitating for more change.) Once Icahn got a board seat and was able to apply pressure from the inside, it was only a matter of time before eBay and its chief executive, John Donahue, had to do something with PayPal.

"Other shareholders have been very frustrated with the performance of the shares over the last year and a half," says Wedbush analyst Gil Luria, noting that eBay's stock has hovered for a long time in the low $50s. "They decided it was time to get the full value of what they own."

Over the next few days you'll read a lot of stories about what this means for eBay and what this means for PayPal. (You'll read even more about how Icahn was right. He'll be happy to read those stories.) Will eBay be able to survive without its growth engine? Will PayPal recover from years of moldering under the eBay umbrella? What about talent? What about innovation? What about... what about... what about?

Most of the questions are worthy. EBay's online store was put through a turnaround after its revenue growth stagnated from 2006 to 2010. But online retailing has changed dramatically over the last decade and eBay's makeover is far from complete. For its part, PayPal is a global leader in digital payments, but like any fast growth company it requires constant reinvestment and smart acquisitions to expand. That isn't an easy process for any team to manage.

In the end, eBay and PayPal should benefit because a split allows them to become better, because they can function more effectively apart from one another.

While eBay may be growing more slowly than PayPal -- Luria estimates that PayPal's business is growing at about 20 percent, versus 10 percent for eBay's marketplace -- it still delivers profit margins of 35 percent. Freed from PayPal and the responsibility for investing all of the capital PayPal needs to thrive, eBay should be able to undertake investor-friendly things like issuing dividends and continuing to buy back stock when appropriate.

At the same time, PayPal will have the freedom to be a fast growth company that, ideally, winds up with a stock price that reflects its promise and its importance. Despite a slew of competition, it's in a relatively strong position and remains a leader in online payments despite competition from credit-card companies, Google, Amazon and Apple. It's growing fast in mobile payments and it's starting to see acquisitions of companies such as the mobile-payments provider, Braintree, deliver worthy financial results (despite the fact that eBay pushed PayPal to overpay for many of its acquisitions, including Braintree and BillMeLater.)

As we all know, mobile (think your smartphone) and digital payments and virtual currencies (think bitcoins) are hot markets right now. They're also markets rife with speculation, some of it ill-informed, about which companies are best positioned to take advantage of shifts in retail and online payments. PayPal is a mobile and digital payments specialist with a real track record and if it chooses to pursue deals with other big digital retailers (something its relationship with EBay prevented) or even companies trying to rationalize the bitcoin arena, such as Coinbase, you might see it flourish.

The market already blessed the PayPal spinoff, with eBay's shares jumping more than 8 percent halfway through the trading day.

When Icahn first agitated for change at eBay, he only wanted it to spin off 20 percent of PayPal. Under pressure, eBay took that suggestion to its logical extreme and set PayPal free. Now let's see what happens.

Corrects final paragraph to indicate that Icahn initially wanted eBay to spin off 20 percent of PayPal.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the editor on this story:
Timothy L O'Brien at tobrien46@bloomberg.net