We established a significant position in eBay (EBAY) during the Third Quarter. While eBay’s challenges were well”mapped – including multiple years of minimal value growth, a weak execution track record, and high employee turnover – we sensed it had arrived at a critical inflection point and gained new focus. A meeting with CEO John Donahoe this summer left us impressed by his process”driven approach to optimizing the business.
We were pleased when Mr. Donahoe announced in September that eBay would split into two by spinning off its PayPal unit. Our work on Alibaba (BABA) since 2011 had persuaded us of the power of the marketplace model in e”commerce and our work on AliPay convinced us that PayPal was an incredibly well”positioned global brand with the potential to become a leading player in mobile payments. Following the spinoff, eBay/PayPal will offer two appealing growth, relative value, and capital return profiles for investors.
eBay/Marketplaces
eBay is one of the world’s ten largest retailers, with strong margins, limited capex, global reach, and consistent high”single to low”double”digit growth. While eBay’s sales growth may appear underwhelming when compared to Alibaba (BABA) or Amazon (AMZN), the company is growing sales 2”3x faster than the Home Shopping Network (HSNI) (which trades at 10x 2015E EBITDA) and Wal”Mart (WMT) (which trades at 8x 2015E EBITDA), and enjoys a much more attractive margin and free cash flow profile.
While eBay will invest in branding efforts during the balance of this year, we anticipate favorable comparisons to drive renewed momentum in 2015. We are also intrigued by efforts to emphasize structured data in ways that will benefit consumer engagement and merchant visibility. Finally, eBay is highly cash”generative and has relatively limited capital needs. It has shown an interest in buying back its stock and a willingness to take on debt to do so. With the split of eBay and PayPal, we believe eBay’s capital return strategy will be more pronounced and structurally, new eBay would be positioned to buy back roughly a third of its float within two and a half years (and almost half its float within 4 to 5 years). We believe core eBay could be worth more than double its implied pre”split value, assuming high single”digit topline growth, modest margin improvement, and a consistent buyback policy.
PayPal
PayPal is a high”growth business with significant opportunities to expand its existing market and margins while pursuing new paths in financial services for consumers and merchants. With significant scale and an attractive funding mix, PayPal generates high incremental margins on payment volume increases which it can use to fund sustained growth.
Apple (AAPL)’s entry into the payments space dampened investors’ enthusiasm for PayPal, creating an interesting entry point. We think the market is missing the fact that ApplePay is primarily an offline mobile solution focused on the Point of Sale (POS) opportunity which represents a small fraction of PayPal’s current business. When we break down the applicability of ApplePay to PayPal’s business mix, we find that ApplyPay will compete directly with only 1.5”2% of PayPal’s total payment volume (TPV).
We believe that Apple’s entry into the mobile payments space could ironically be a net positive for PayPal. Mobile payments have been “the next big thing” for almost five years but have failed to ramp. In part, this is because one needs buy”in from financial institutions, merchants, and consumers in order for a payment technology to gain acceptance. With no pressure to catalyze a decision, the different incentives of these groups have not proven to be sufficiently aligned to overcome their inertia and come to an agreement. MCX, Google, and PayPal now need partners to compete with Apple and we think multiple win/win deals exist. PayPal’s current POS business is de minimis, allowing the company to price disruptively while creating substantial value.
Finally, PayPal’s value will be better reflected in a smaller, more nimble entity. PayPal has the option to go”it”alone, sell to one of many potentially interested parties, or to open itself up to partnerships with other key online players (e.g. Google (GOOGL), Facebook (FB), Amazon (AMZN), Alibaba (BABA), Apple (AAPL)) and become a neutral, online payments network (essentially becoming “the Visa of the Internet”). The market is currently valuing PayPal at approximately 11.5x”14.5x x 2015 EPS (assuming an 8”9x EBITDA multiple for eBay) which seems too cheap for a company growing sales 20% with significant strategic optionality and a strong chance to shape the future of payments.
From Daniel Loeb (Trades, Portfolio)’s Third Point Q3 2014 Investor Letter.
