Research Report by: Ross O’Toole, CFA Email: rsotoole@gmail.com Date: December 15, 2014 Long: EBAY – Positive optionality around operational, strategic and/or financial execution – Stock is worth between $44 - $100 per share with likely value in $65+ range Company Name eBay Inc. TTM Revenues $17,511
Ticker
Price
EBAY TTM EBITDA $5,682 11.0x
$55.82 2015 EPS $3.25 17.2x
Shares Outstanding 1,251 TTM FCF $4,566 13.7x
Market Capitalization $69,831 FCF Yield
Net Cash $7,504 2013 ROIC
7.3%
23%
Enterprise Value $62,327
Quick Thesis: Investors underappreciate the franchise qualities of both eBay marketplaces and PayPal, which have strong network effects and large economic moats. The spinoff of PayPal will remove a very real dis-synergy; the company may very well accelerate its growth across retailers (Amazon, Wal-Mart, others?) who so far have been reluctant to integrate PayPal due to eBay’s ownership. PayPal has positive optionality–the market is not assigning much value to the company’s move into the $10 trillion dollar off-line payment market or its ability to monetize its consumer data. o “PayPal was yesterday’s winner in payments” is a gross exaggeration. The consensus on eBay marketplaces is the brand has been marginalized due to under investment and weaker-than-expected results over the past few quarters (recency bias). o There are numerous opportunities for eBay marketplaces to reignite its growth engine as ecommerce only represents a tiny 2% of total commerce o The consensus is too pessimistic–marketplaces fixed price sales continue to grow at doubledigit rates The two companies have significant strategic value (although tax laws will make a sale unlikely within the first couple of years post-split). Activist investors tend to have limited patience and the two companies will have new CEO’s. It seems likely, especially at eBay marketplaces, that smart capital allocation and cost cutting will play a larger role in creating shareholder value moving forward. In a way, eBay Inc. (EBAY) is an unlikely candidate for being a meaningful mispriced security. First, it is well covered by the financial press. Second, the company has announced the spinoff of its payments business, PayPal (typically acts as an immediate catalyst). Third, its two primarily businesses, eBay marketplaces and PayPal, are widely recognized “franchises” with solid top-line growth prospects in large addressable markets, healthy margins, strong cash flow and high returns on invested capital. And fourth, activists (Carl Icahn, Dan Loeb, Jana Partners) and respected value managers (Baupost Group, Dodge & Cox, Tiger Global) have large and growing stakes in the company. Nevertheless, eBay Inc. is mispriced with 30%+ upside. The stock has largely been overlooked for two years. Since the end of 2012, EBAY has returned ~8% versus the S&P 500 return of ~44%. The company has grown its revenues and EBIT at a 4-year CAGR of +16% and +23%, respectively. eBay Inc. is a cash
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cow having generated FCF (CFFO – CapEx) of $11.8 billion since the beginning of 2011 or nearly $1 billion per quarter on average. There is $2.2 billion remaining on its current buyback program to purchase its undervalued shares. For example, if eBay Inc. uses the ~$12 billion in FCF it will generate over the next three years to buy back stock at an average price of $70 per share and the company generates between $4.5 – 5.0 billion in 2017 FCF, then based on a 20x FCF multiple, the company would be worth $77 - 86 per share or +40-56% upside (assumes ½ of buybacks offset dilution from SBC). As the chart below illustrates, eBay Inc. has a value range above $65 per share and there are reasonable scenarios that suggest the price could easily reach the $70 + range.
Margins
12.0x 18.0x PayPal 18.5% 19.5% 20.5% 21.5% 22.5%
eBay 38.0% 39.0% 40.0% 41.0% 42.0%
2016 Revenue Growth 6.0% 17.0% $59.77 $62.36 $64.95 $67.54 $70.13
7.0% 18.0% $60.38 $62.99 $65.60 $68.21 $70.83
8.0% 19.0% $60.99 $63.62 $66.26 $68.89 $71.53
9.0% 20.0% $61.60 $64.25 $66.91 $69.57 $72.22
10.0% 21.0% $62.20 $64.88 $67.56 $70.24 $72.92
11.0% 22.0% $62.81 $65.51 $68.22 $70.92 $73.62
12.0% 23.0% $63.42 $66.14 $68.87 $71.60 $74.32
*This valuation analysis is fully-loaded EV / EBITDA, including corporate overhead
The impending separation of eBay Inc.’s marketplaces and payments businesses provides a concrete catalyst to realizing significant upside in the next 12-18 months. As Elon Musk said, “It doesn’t make sense that a global payment system is a subsidiary of an auction website. It’s as if Target owned Visa or something.” And former PayPal COO, David Sacks: “If you allowed PayPal to pursue its destiny there are moves it could make to become the largest financial company in the world.” As this report will illustrate, there are more value creating opportunities for eBay marketplaces and PayPal as independent corporate entities than as a combined company. At its current price, the market is under-estimating the company’s operational, financial and strategic potential. And since the company operates with a leadership position in large and growing markets and generates significant cash without needing to spend much capital, there is also a satisfactory margin of safety. To be sure, there are several near and longer-term concerns that are clouding investors’ view of the positive optionality in both businesses. These clouds are likely to evaporate as communication about capital allocation intentions, investments/growth, longer-term margins and results demonstrate the inherent advantages the company has. There are operational, financial and strategic outcomes that suggest the stock is worth between $70 and $100 per share (see valuation sections). There are a few unknowns when it comes to the separation of eBay marketplaces and PayPal. The two companies will need to sign a commercial agreement since PayPal has benefited from being the preferred payment method on eBay. PayPal has had a de facto monopoly at checkout and receives rich data on customers to support its fraud management and other
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activities. On the other hand, PayPal has provided dispute resolution, some product development and data on its customers to eBay. These “similarities” are far outweighed by the benefits of being independent, whereby each company can make better capital allocation decisions, properly incentivize employees, and pursue their own self-interest more efficiently. In addition, until Form 10 is filed in the 1H 2015, how the corporate overhead, D&A and CapEx will be allocated is unknown. In short, the sum-of-the-parts are worth more than the current eBay stock price reflects. The pending separation will allow each company to pursue growth opportunities, improve their cost structures/margins, and better allocate capital. The rest of this report will look at eBay Inc.’s two primary businesses–eBay marketplaces and PayPal–and their valuation from several different perspectives.
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eBay marketplaces Business Description: eBay marketplaces is one of the ten largest retailers in the world with an extensive inventory of products (800m listings as of Q3’2014, +45% since year-end 2013) offered in auction or fixed price formats. The company also owns a collection of local classifieds websites, tickets (StubHub), comparison shopping site Shopping.com and Half.com. eBay is without a doubt a smashing success financially. As a facilitator for small, medium and increasingly large sellers, the company does not compete, but rather partners with sellers, retailers and brands of all sizes. As such, eBay does not take inventory or price risk–it simply generates a fee on each final sale. The platform’s scale (152m active buyers growing at a doubledigit rate and 25m sellers globally) gives rise to a durable and wide economic moat. To illustrate the difficulty in dislodging a competitor with the size and scale of eBay, look no further than the company’s inability to displace Yahoo! Japan in 2001. Further, there are high switching costs, especially for powersellers, who would face the tough task of re-establishing their reputations on another platform.
Revenue Model: eBay marketplaces primarily generates revenues by charging sellers 10% of the final value (includes shipping since 2010) up to a maximum of $750 on both auction and fixed price items. eBay may also charge a small insertion fee and/or advanced listing fees. Lastly, the company also generates advertising revenues.
The company has historically enjoyed strong sales and profit growth as well as relatively stable and high margins. In short, eBay has “franchise” qualities that produces high returns on capital invested (eBay Inc. ROIC 20%+).
eBay marketplaces 9,000 8,000
45.0%
43.7%
7,000
8,284 44.0% 7,398
43.4%
43.0%
6,642
6,000 5,364
5,000
42.4% 5,647 5,311
5,721
42.0% Revenues 41.0%
4,000 3,000 2,000
40.5%
40.3% 39.6% 2,346
2,451
2,252
2,305
2009
2010
2,631
39.8%
2,943
40.0% 3,351
Segment Profits Margins
39.0% 38.0%
1,000 -
37.0%
2007
2008
2011
2012
2013
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**2010 – 2013 Revenue and Segment Profit CAGR of 13.3% and 13.1%, respectively with an average margin of 40%.
eBay marketplaces is on pace to report an impressive $3.5 billion in EBITDA in 2014, despite facing a number of near-term and long-term challenges. eBay has an image problem, however, or what marketplaces president, Devin Wenig, calls a “consumer perception gap.” For many, eBay is the world’s largest garage sale. This perception is due to eBay’s legacy as an auction house, but with fixed price sales accounting for 79% of Q3 2014’s volume (up from 40% in 2008), eBay marketplaces is more accurately one of the world’s largest general purpose shopping malls. eBay is more of a platform for top-sellers (50% of volume and Q3 2014 growth of +14%) and increasingly major brands and retailers (as of Q2 2014 there were 80 major brands/designers with “store fronts” on the platform). In fact, as an independent company, eBay will have the focus to further extend the power of its platform with additional partnerships. For example, eBay marketplaces recently deputed its “innovators’ collective,” a tech-focused section featuring new lifestyle products, electronics and more. The pilot program currently offers 20 products from emerging entrepreneurs with ~80% of the products from small companies and the rest from authorized resellers (think: Nest thermostats). The company has “a strong commitment to helping small businesses think about channel sales and e-commerce,” says eBay’s David Ramadge. This is one example of the company’s ongoing strategy to partner, promote and help merchandise the products of small businesses. …But Current Trends have been Disappointing: eBay marketplaces growth decelerated for the fifth straight quarter in Q3 2014. The gross merchandise volume (GMV) grew at a rather pedestrian +5% excurrency in Q3 2014, a marked slowdown from the +11% growth in Q1 2014. As a result, there is a debate on whether the causes of the slowdown are temporary or structural. In aggregate, eBay’s growth rate is slowing, but it is not all doom and gloom. Auction sales have been declining in the MSD-HSD range for the past several quarters (-7% in Q3 2014), whereas fixed prices sales increased +19% in Q1, +19% in Q2 and +15% in Q3 2014. In comparison, Amazon reported revenue growth of 20% in Q3, but Amazon still struggles to report consistent profits. There is no denying that eBay has missed expectations since late 2013. The causes for the slowdown are less clear. On the one hand, the bulls believe the Google policy changes and the security breach (password reset) are the culprits and will prove temporary. On the other, the bears view these issues as convenient cover for papering over a more structural concerns–increased competition and changing consumer preferences. There is a feeling that eBay has under-invested in its business, i.e. the company has been overearning. Debate: Do the current declining margins and sales growth have temporary or structural causes?
First, Google made changes to its Pando 4.0 algorithm that has hurt the effectiveness of eBay’s search engine optimization (SEO) efforts. Searchmetrics estimates the changes hurt eBay’s organic SEO by as much as 33%. Management has not disclosed how much of their traffic is generated via SEO efforts, but it is believed to be well below 15%. eBay has the largest collection of unstructured data (8m listings with an average turnover of 14 days), which is not as suitable for SEO as structured data. The company has a project underway to re-format its data to mirror structured data and therefore improve its SEO efforts.
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Second, eBay proactively asked all 152m active buyers to voluntarily change their passwords in Q2 2014. eBay was the target of a cyberattack, and although there was no evidence of a data breach, the company asked its users to voluntarily change their passwords. A large majority of users–8085% of the volume–had reset their passwords by the end of the quarter, yet not all had returned to pre-attack activity levels as of a quarter later. The company has been stepped up promotional efforts to reengage with its customer base.
Third, eBay is facing more intense competition across its core eBay platform and leading tickets website, StubHub. Management acknowledged on the Q4 2013 call that marketplaces exited the year at a lower run rate than anticipated: competition was increasing leading consumers to raise their expectations from on-line retailers (the Amazon effect: friendly shipping/return policies).
What I Don’t Like: To be sure, eBay marketplaces is struggling to compete against Amazon, especially Amazon Prime customers who enjoy free shipping, no hassle returns and in some cases same-day delivery service. Amazon has raised consumer expectations by creating a great shopping experience: products always in stock, one-click checkout, free 2-day shipping and returns. This proposition is very difficult for eBay to recreate since it does not have the physical assets to replicate Amazon’s platform. eBay Inc. CEO, John Donahoe, is surprisingly on record stating he doesn’t believe same-day delivery is essential to the eBay customer (Donahoe will not have a place in either eBay or PayPal post-split). It will be interesting whether eBay marketplaces president (CEO post-split), Devin Wenig will have a different point of view. Thus far, eBay has introduced eBay NOW in cities like New York, San Francisco and Chicago, but it has yet to resonate with consumers. eBay launched the initiative, which lets shoppers place orders that couriers/drivers fill by buying at local chains (Target, Macy’s, Staples, Walgreens) and then deliver same day, to compete with Amazon. In Britain, eBay has partnered with UK retailer Argos to expand its click and collect to ~650 stores putting most of the UK population within 10 miles of a distribution point. eBay will likely need more partnerships like this one to effectively compete against Amazon’s and others’ physical asset bases. Luckily, there are emerging companies attacking the delivery market such as Shyp and Deliv. It would be a mistake to write-off eBay’s ability to find ways to better compete with Amazon, Zulily, Wayfair, Google Shopping, etc. Further, Amazon has made its website more user friendly for third-party retailers and is effectively competing for eBay sellers. eBay vs. Amazon: The advantages to selling on eBay include control over your eBay may indeed be looking brand (customize store front), direct contact with buyers, better community at a future where it will need feedback, superior for auction items (rare finds), a true global marketplace. The to spend more to better disadvantages include: a more involved process with sellers required to write compete against Amazon their own descriptions, shoot their own photos, and arrange for their own and others. However, if fulfillment. The advantages of selling on Amazon include rotation of sellers, the money is reinvested which supports small upstarts, fulfillment by Amazon, and a less involved in support of the seller and process. The disadvantages include: no direct customer relationship, fees can buyer experience, it is be higher, payments made twice/month instead of next day on eBay. reasonable to assume growth rates could re-accelerate and cost savings (leverage) can be found in non-core areas like G&A. Volume and take rates are under heavy pressure at ticket reseller, StubHub, which also happens to be eBay’s highest margin business. This has led to lower overall take rates at eBay YTD 2014. eBay has had to lower rates to defend its market share against more aggressive competition, but the company’s poorly executed price changes in Q1 2014 also have not helped.
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eBay Marketplaces Revenues (in millions) ASP Daily Searches (in millions) Days in Period Revenue per Day (in millions) Orders per Day Conversion rate Improvement in Conversion Rate New Conversion Rate New Revenues Incremental Revenues % Increase Incremental Profit @ 40% Margins Run-rate Profits w/ 30% Tax Rate Incremental Value per Share @ 15x Multiple
Q3'14 $ 2,156 $ 37.51 250 90 $ 24 638,670 0.26% 0.05% 0.31% $ 2,578 $ 422 19.6% $ 169 $ 473
This is not the first time eBay has experienced trouble with its core platform. In the mid-2000s, eBay’s traditional auction model came under heavy pressure as consumers’ preference changed. The novelty of the auction had worn off–consumers were becoming increasingly better informed on prices, demanding trusted sellers, and looking for free shipping. eBay’s management responded to the changing competitive landscape by lowering fees (eliminating up-front listing fees, providing rebates to sellers offering free shipping), building better trust with consumers (buyers protection) and overhauling its technology stack to better use the immense about of data it was collecting (improving conversion). By the latter part of the decade, growth had indeed accelerated.
eBay’s Response to the Current Challenges: First, management has initiated its first global ad campaign (across 4 countries) since 2008/09. Clearly, the company needs to “get the word out” that eBay is much more than the world’s largest auction site. In the nearterm, the confluence of temporary issues (Google, Heartbleed) and possibly more structural issues (competition, marketing spend) are hurting margins. The Street has moved to a mostly neutral position (Barclay’s, JPM, RBC, JMP) regarding eBay’s stock. The sense is 2015 guidance will be reset and margins moving forward will be 200-300 basis points lower. Although this outcome is certainly possible, so too is the possibility that a more-focused, independent eBay finds way to reaccelerate growth and improve margins. Moreover, an independent eBay is likely to become much more aggressive with its capital allocation strategy, which is not be properly valued currently. $ 5.67
eBay has a significant opportunity to improve conversion by exploiting its data. For example, the company can create personal feeds, add more channels (collections), improve search results, reduce friction points (encourage more free shipping, improve trust), build recommendation engines, improve local search (Milo and Redlaser acquisitions), and better penetrate international markets either directly, through partnerships or acquisitions. The chart (above) highlights how a small positive change in eBay’s conversion ratio would improve sales and profits. Industry Statistics: Broad e-commerce trends will continue to act as a tailwind. According to eMarketer’s latest forecast, worldwide e-commerce sales will increase +21% in 2014, reaching $1.5 trillion. On-line and mobile users in emerging markets are the key drivers. The New York Times reported in December 2013 that on-line commerce only accounts for 6% for all commerce in the US. This is likely to grow for the foreseeable future at a much faster rate than in-store commerce. E-commerce trends in the US are also a positive for eBay. According to eMarketer’s latest forecast, US retail e-commerce and m-commerce sales will reach $262.3 billion in sales, +16.4% in 2014. By 2017, eMarketer estimates sales will reach $440 billion for a CAGR of +13.8% What I Like: eBay is truly a global business with 50-60m active buyers outside the United States as of Q4 2013. The company continues to improve its global shipping program, now offered in 53 countries as of
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Q1 2014. Importantly, 58% of final sales provide free shipping across the company’s key markets of the US, UK and Germany. Although this is still below where it ultimately needs to be, eBay is making progress. The company began testing free cross-border returns in 4 European countries in Q3 2014. A company like Alibaba could see significant strategic value in eBay. Not only would a partnership or acquisition jump-start Alibaba’s US plans, but eBay also has the largest China outbound sales (Chinese sellers with buyers outside of China). The (Smart) Dressing Room of the Future: eBay technology is being brought to bear as physical store retailers look to merge the benefits of online and offline commerce. eBay worked with Kate Spade to build interactive store fronts at four Manhattan stores last year that allowed customers standing on the street to pick out merchandise and place an order. Nordstrom will be testing eBay’s dressing room technologies at store locations in Seattle and San Jose. Rebecca Minkoff, too, is experimenting with eBay technologies to create a truly connected store–“to marry Amazon-like e-commerce with leads generated by every click and a highly personalized shopping experience” with the benefits that only a physical store can offer. The technology has sophisticated tracking system, which identifies the customer and remembers what she brings into the dressing room and, importantly, what she doesn’t purchase. The goal is nothing short of an attempt to change the retail experience. eBay hopes it can become a vendor to retailers and thus create a new, meaningful revenue stream for the company. Mobile: eBay continues to be ahead of the curve in its mobile strategy. In 2013, the company achieved $20 billion in mobile commerce (+54%) across 190 countries. In Q3 2014, mobile volume reached $7 billion, +41% YoY. In fact, 48% of total GMV involves a mobile touch point and 59% of buyers cross-shop (desktop, tablet, smartphone). There have 282 million downloads of eBay apps, 824 million listing have been created from mobile devices to date, and 7.4 million listings are added from mobile devices per week. To provide one example, eBay sells 13,000 cars/week on its mobile app at fixed prices. In comparison, AutoNation ($6 bn market cap) sold 9,567 cars/week in 2013. Lastly, mobile is becoming an increasingly important customer acquisition channel with management noting mobile attracts both a younger customer (a knock against the company) and more women. Active Buyers: Although recent GMV and revenue trends have disappointed, eBay continues to grow its member base at double-digit rates (see chart below). This user base conducted 250 million daily searches in Q3 2014 and continues to support 25 million sellers on the eBay platform. The business is truly global with 61% of GMV occurring outside the United States. The continued growth in eBay’s user base is probably the best metric for assessing the company’s longer-term growth potential.
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Active Buyers (in millions)
eBay marketplaces 160.0
30.0%
140.0
152.3 25.0%
120.0 20.0%
100.0 80.0
87.7
60.0
15.0%
Active Buyers
10.0%
% Growth - YoY
40.0 20.0 -
5.0% 0.0%
Investors should be careful not to underestimate the scale of eBay’s marketplaces or its purchase velocity:
US Marketplaces: a pair of shoes are sold every 2 seconds; a woman’s dress is sold every 1 second; a cell phone is sold every 4 seconds; an iPad is sold every 13 seconds; patio and garden furniture every 45 seconds…
Mobile Sales: a car/truck is sold in the US every 5 minutes; a woman’s handbag is sold every 11 seconds; in the UK, a car/truck is sold every 2 minutes; a woman’s handbag is sold every 18 seconds…
eBay Motors: a motorcycle is sold every 7 minutes; a RV or camper is sold every 38 minutes; a boat is sold every 23 minutes; parts & accessories are sold every 0.4 seconds; an engine/component is sold every 9 seconds. In Q3 2014, more than 77% of vehicle sold were interstate transactions.
eBay marketplaces is truly an e-commerce behemoth and the naysayers are cautioned not to take its many competitive advantages (network effects, scale, growth and margin opportunities) for granted. Although there are some legitimate concerns, I contend that the current valuation under appreciates the company’s sales/profit consistency. Moreover, the market is discounting an independent eBay’s future operational, strategic and/or financial opportunities. Valuation Scenarios: eBay marketplaces has reported TTM revenues of $8.784 billion (+9%) and operating profits of $3.364 billion (38.3% margin). The data table below illustrates the base case scenario for our first look at valuing eBay’s marketplaces.
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10.0x
Mult.
Segment Margins (includes its share of corp. Overhead)
$34 38.0% 39.0% 40.0% 41.0% 42.0%
6.0% $29 $30 $31 $32 $33
7.0% $30 $30 $31 $32 $33
eBay marketplaces 2016 Revenue Growth 8.0% 9.0% 10.0% $30 $30 $30 $31 $31 $31 $31 $32 $32 $32 $33 $33 $33 $33 $34
11.0% $31 $32 $32 $33 $34
12.0% $31 $32 $33 $34 $34
Here are the key assumptions behind the above analysis: A. 2016 revenues of $10.7 billion in revenues B. 2016 segment margins of 40% and segment profits of $4.3 billion C. eBay marketplaces retains all the debt ($7.685 billion) and 87% or $13.1 billion of the total cash ($15.1 billion) as of Q3 2014 D. eBay marketplaces is responsible for its share of 2016’s corporate overhead (47%), which in total is 10% of sales @ 8x E. Shares Outstanding: 1.251 billion as of Q3 2014 Based on a range of multiples (8-15x), the possible values for eBay marketplaces is between $23 – $53 per share. eBay marketplaces has consistently grown at 2x competitors like HSNI, WMT and LYV with much better margins and cash flows. These companies trade between 8-11x EBITDA. As such, a 10x base case is a conservative approach with an adequate margin of safety. eBay’s operational advantages are being mispriced by the market; in other words, although there is always a wide range of outcomes, it is more probable that eBay finds success and its valuation nears the higher-end of its range. In a strategic transaction, eBay marketplaces could fetch as much as 15x (Heinz was acquired at 14x in a financial transaction) or closer to the $53 upper end or nearly the entire value of eBay Inc. Comp Table
Ticker HSNI
MELI
Price $ 74.55
S/O 53
Market Cap. 3,951
Net Cash/ (Debt) (137)
Enterprise Value 3,814
$ 128.50
44
5,674
567
6,240
2014 334 11.4x
EBITDA 2015 365 10.4x
2016 394 9.7x
160 39.0x
197 31.8x
241 25.9x
Another approach to eBay marketplaces value is to look at its share of eBay Inc.’s earnings. eBay marketplaces share of eBay inc.’s 2016 earnings of $3.59 is $2.12 (+10% YoY). By applying a reasonable 15x multiple, eBay marketplaces would be worth $32 per share with a range of possible outcomes between $25 - $38 based on 12-18x 2016 earnings. Capital allocation is likely to become an increasingly important component of value creation at eBay marketplaces post-split. The company will generate significant free cash flow and it is a maturing business with limited capital needs. Further, activist are likely to push for buybacks and/or a shareholder friendly dividend policy. Dan Loeb’s recent letter to his investors indicates he believes the company could acquire one-third of its float in 2 ½ years and possibly one-half in the next 4-5 years. eBay Inc. is expected to generate $12 billion in FCF over the next three years.
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eBay marketplaces could lever-up and buy back stock in a tender offer and thus quickly reduce a significant amount of its public float (assumes the company is not so generous about issuing stock options). eBay could easily take on at least $8 billion in additional debt and use half its cash ($6.5 billion) to purchase shares at the mid-point of our valuation range of $32 per share and retire ~450m shares or ~36% of its outstanding shares. Recent Trends Update (+): ChannelAdvisor has reported results for on-line sales for the long holiday weekend: Channel Total: YoY Amazon eBay
Thanksgiving Day 20.1% 25.9% 3.0%
Black Friday 22.0% 24.2% 26.9%
Cyber Saturday 27.0% 45.9% 14.9%
Cyber Sunday 18.2% 23.8% 16.3%
Cyber Monday 16.7% 13.7% 32.3%
Five Day Total 20.6% 23.8% 20.5%
ChannelAdvisors updated their same-store sales estimates for the first week of December and eBay reported gains of +14.0%, which was behind Amazon at +20.8%, but in-line with total e-commerce gains of +14.8%. These are solid results considering coming into holiday, eBay was lagging e-com growth. Incidentally, Google Shopping has had a very difficult beginning to the holiday shopping period with growth lagging over the Cyber 5-day shopping period (+5.8% only) and turning negative in the first week of December (-0.2%). The Wall Street Journal reported last week that eBay Inc. management is considering laying-off 10% of eBay marketplaces workforce ahead of the PayPal spin-off. This confirms that eBay marketplaces has the opportunity to shedding unproductive assets in favor of reinvesting in growth drivers–seller support, marketing and sales efforts.
PayPal The Business of PayPal: From its beginning in June 1998, PayPal has had a grandiose goal–to be at the center of every transaction, everywhere—reflective of its founders’ (PayPal Mafia: Elon Musk, Peter Thiel, Max Levchin and Reid Hoffman) ambitions. In 2013, PayPal processed $180 billion worth of transactions (+24% YoY; 5-Year CAGR +24.5%) in 26 currencies across 193 countries and in turn generated $6.6 billion in sales (+19%; 5-Year +22.5%) and $1.6 billion in operating profits (5-Year CAGR +27%).
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PayPal Revenues
Segment Profits
7,000
6,000 5,000
20.3%
21.0%
20.0%
22.2%
16.6%
4,000
Margins 30.0% 6,628 24.4% 24.0% 25.0% 5,574 20.0%
4,412
15.0%
3,436
3,000 2,000
2,796
2,404
1,927
10.0%
1,000 481
392
2007
2008
722
463 2009
1,588 5.0%
1,359
978
0.0% 2010
2011
2012
2013
**5-Year Revenue and Profit CAGR of +22.5% and +27%, respectively
The founders’ goal of upending the payment processing industry has yet to take hold according to their original ambitions; however, PayPal is one of the few companies to establish a sizeable beachhead in the massive industry of processing payments. How a typical payment flows through the The Addressable Market: The payment industry is system: a consumer pays $100 for an item by huge, and growing: just the e-commerce portion swiping her credit card. The merchant acquirer (essentially where PayPal plays today) is a $1 (First Data, Chase Paymentech) receives $0.35 for trillion dollar market. The commerce market in enabling the merchant to accept to accept the card. total (on-line and off-line) is estimated at least $10 The payment network (V, MC, AmEx, Discover) trillion market. A recent Forbes article stated that receives $0.15 for facilitating the transaction over in 2013 there were $15 trillion in worldwide retail their network. The bank/card issuer receives $1.50 transactions. for handling fraud and extending credit. The merchant receives ~$98 out of the $100 Gartner estimates that mobile payments will top transaction. $720 billion by 2017, up from $235 billion in mobile payments recorded in 2013 (CAGRE +32%). PayPal is processing ~one out of every six dollars spent on-line. As the company pushes into physical store commerce, it increases its addressable market by 20x. To put this in perspective, management stated in 2012 that for every 1% of the off-line market share captured, it would double PayPal’s overall total payment volume (TPV). Mobile-enabled commerce is estimated to be a $4 trillion long-term opportunity. The industry has three main constituencies–financial institutions, merchants and consumers. The merchants, in particular, would love to have the incumbent processors disrupted. The problem is the system works really well: there are few inconvenient friction points to remove. However, the sheer size of the opportunity has not stopped hundreds of companies from trying to insert/disrupt the status quo (a recent search on AngelList reveals there are now at least 1,475 digital-payment-related start-ups). PayPal happens to be one of the few successful companies to gain meaningful share–and its grow rate is actually increasing.
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How does PayPal Make Money? Paypal’s revenue model is, in fact, similar to other payment processing companies. PayPal charges a merchant 2.9% + a $0.30 fixed fee for transactions under $3,000. For merchants with volume between 10,000 - 100,000, the fee drops to 2.2% and for > 100,000 in volume, the fee is 1.9% (For international customers, PayPal charges 3.9% + a fixed fee based on the currency received). PayPal has introduced a square-like card reader for small merchants and the company has been expanding its PayPal Credit (formerly Bill Me Later) offering, but revenues are still dominated by traditional transaction fee collected on the dollar volume on its network. The average transaction for PayPal is $65 Management has said the company should be able to sustain a with users making an average of 5.5 transaction margins of 60%+, which PayPal has comfortably transactions/quarter or 22 per year achieved historically. The three primarily factors that impact (includes PayPal Credit). transaction margin are. 1) Take rate, which is the blended rate PayPal earns on processing transactions. Take rates are a function of the type of transaction (crossborder, PayPal Credit, off-line, on-line, mobile) and competition. 2) Interchange fees or the fees PayPal has to pay credit card networks and financial institutions whenever a PayPal user funds their account using credit. PayPal has benefited from an early decision to encourage members to fund their accounts via their bank accounts (ACH), which gives PayPal a very low cost funding source (avoids hefty credit card fees). 3) Fraud rates, which have been historically very low. To reach operating income, direct operating costs must be subtracted from the transaction margin. These costs include customer support, sales and marketing, R&D, G&A and customer acquisition costs. Operating margins have historically been in the upper 20-25% range. Debate #1 – Take Rate, Transaction Margins and Operating Margins are Under Long-term Pressure Payment processing is a commodity business dominated by a small group of scaled incumbents. PayPal’s take rate over the past few quarters has been declining at an accelerating rate raising concerns about the business’s long-term profit potential. However, there are legitimate reasons the take rate should decline as PayPal grows (the company’s off-eBay TPV growth has been accelerating). First, as PayPal adds larger merchant customers and gains share within these merchants, the take rate will naturally decline. Second, as PayPal grows its presence off-line (in-store) and through mobile (Venmo) the take rate will naturally decline (more competitive market). Third, hedging activity also can negatively impact the take rate. On the other hand, cross-border transactions generally improve take rates. PayPal Credit will also improve transaction margins (interest earned on customers outstanding credit balances) as well as increase customer engagement, i.e. increase volume. PayPal Credit: It’s in the early stages of growth (2013: high 20% growth rate | Q3 2014: +29%) and as of Q2 2014 accounted for There is a general concern that PayPal will only 4.9% share of PayPal’s US addressable market TPV. need to increase investment spending in order to maintain its market position. The Street never favors companies that are undergoing margin pressure, even when that investment spend is absolutely the right thing to do for the long-term success of the company. Make no mistake: this is a once-in-a-lifetime opportunity to create the premier payments ecosystem and when the war is over, the switching costs will be very high.
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PayPal Take Rate
Transaction Margins
3.90%
65.5%
3.80%
65.0%
3.70%
64.5% 64.0%
3.60%
63.5%
3.50%
63.0%
3.40%
62.5%
3.30%
62.0%
3.20%
61.5% Q4'12
Q1'13
Q2'13
Q3'13
Q4'13
Q1'14
Q2'14
Q3'14
The concerns about declining take rates are overblown in the context of the sheer size of the market opportunity ($10 trillion in commerce transaction volume). If take rates are coming down for the “right” reasons, then PayPal is finding success (accelerating its growth rate) in a considerably larger addressable market. What I like #1 – Active Registered Users Continues to Grow Double-Digits | Merchant Services Growth is Accelerating PayPal’s active member base has increase over 125% since 2008 reaching 156.9 million members as of Q3 2014.
PayPal 180.0
156.9
160.0
20.0%
140.0 120.0
15.0%
100.0 80.0
25.0%
68.6
60.0
40.0
10.0%
Active registered accounts
% Growth - YoY
5.0%
20.0 0.0% 2008 2009 2010 2011 2012 Q1'13 Q2'13 Q3'13 Q4'13 2013 Q1'14 Q2'14 Q3'14
-
Active registered accounts continues to grow in the low double-digits, which is very healthy for a service that has been around for over fifteen years. The industry remains in the early innings of its growth curve; as new products/features are released, it is probable growth rates could actually accelerate further.
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PayPal’s net total payment volume (TPV) has been steadily growing north of 20% for the past six fiscal years. In fact, PayPal’s TPV is larger than all its direct competitors except for Alipay. PayPal’s 2013 TPV of $180 billion (> $200 billion on 2014) compares quite favorably to Square, which is expected to report ~ $30 billion in 2014 or Stripe, which reported $1.5 billion in 2013.
PayPal 200,000 180,000
160,000
35.0% 28.4% 26.7%
140,000
23.9%
25.0%
22.1%
120,000 100,000
30.0%
29.1%
19.1%
80,000 60,000
20.0% 15.0%
Net Total Payment Volume (TPV) % Growth - YoY
10.0%
40,000 20,000 -
5.0% 0.0%
Even more importantly, PayPal’s merchant services TPV (non-eBay) is near the beginning of a long, steep growth curve. Merchant services growth has accelerated for the past six quarters (see box). The drivers behind the growth are: a) increased consumer adoption, b) expanded merchant coverage, c) market share gain at existing merchant accounts, and d) overall transaction growth in e-commerce, other on-line payments (travel, tickets, services) and off-line growth.
Merchant Services TPV Growth: 2012: +28% 2013: +31% (particular strength from large merchants) Q1 2014: +32% Q2 2014: +33% Q3 2014: +37%
These drivers have a long runway before reaching maturity. And it is perhaps not unreasonable to assume and independent PayPal will find ways to accelerate its growth since it is widely-known other retailers have been reluctant to incorporate PayPal into their transaction engines due to eBay’s ownership. In the future, it’s possible PayPal will be offered on websites like Amazon and Alibaba. An independent PayPal should be able to more readily establish new partnerships, strategic alliances and new channels of growth (mobile, in-store retailing). What I Like #2: PayPal counts 70% of the US Internet Retailer 100 and 63% of EU Internet Retailer 100 has customers as of year-end 2013. PayPal customers made 895 million transactions in Q3 2014 or more than 9.7 million payments per day. The founder of Stripe recently commented that the market for
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payments is in its infancy. E-commerce is 2% of commerce. The room for growth is enormous and the line between what consumers do on-line will continue to blur more and more with what consumers do in the physical world opening up new channels of growth for PayPal. Debate #2 – PayPal’s Innovation Engine is Broken There is clearly a perception that PayPal has had problems with innovation. In fact, Carl Icahn said recently, the company has been “riding a really good wave,” inferring that the company has not kept pace with industry trends (Square would be a good example). Moreover, there is plenty of chatter about employee turnover within the PayPal ranks, which also makes it difficult to sustain an innovation engine. While not without merit, the perception is outdated–it may be more of reflection that PayPal is most famous for pioneering the online payments industry fifteen years ago. David Marcus and James Barrese Reinvigorate PayPal: When Marcus (now at Facebook) became president of PayPal a couple years ago, he reinvigorated innovation by implementing what he called an “invisible turnaround.” Marcus recognized that Square’s eloquent solution to allow small merchants to accept credit/debit cards right from their smartphone/tablet was winning many new customers. So, he set out to create a Square-killer called PayPal Here. This initiative took seven months. In 2013, PayPal introduced 28 new products (the company delivered 0 new products in 2012). A PayPal Here card reader works with When Chief Technology Officer James Barrese took over in more payment options than Square and is 2012, he shifted the company’s 3,500 strong tech team slightly less expense for the merchant–it from an outdated waterfall structure to an agile development charges 2.7% per swipe vs. Square, which structure. Marcus collapsed the cumbersome nine-silo system charges 2.75%. There were > 300,000 of development into a single, more adaptable set of software users of PayPal Here as of late 2012. tools that dramatically improved product development and decision making. He recruited new talent from Google, Netflix, Amazon and Box and in the process laidoff one-third of PayPal’s engineering team. In perhaps his shrewdest move as PayPal President, Marcus acquired Braintree (85.7 million cards on file for single click/repeat purchase in Q3 2014) for $800 million in December 2013 to jump-start PayPal’s push into m-commerce. Braintree’s one-click payment software is hugely popular with services such as Uber, AirBnB, Hotel Tonight, OpenTable, TaskRabbit and Fab.com. The Braintree acquisition was brilliant for another reason; Braintree had acquired Venmo, a rapidly growing, popular peer-to-peer money transfer company gaining traction with millennials for its ease-of-use, but also because it’s social: “It’s like Facebook and PayPal combined–only a beter version of both of these things. Just download it.” –Journalist. Although Venmo does not currently generate significant revenues because most of its volume is low-risk ISO, the company has plans to become a more full-service ISO over time and capture significant revenue and profits in the future. Venmo plans generate revenues through its API platform that will allow developers to send/share messages with money. It’s hoping to lead a new form of advertising by providing social interactions with purchases that brands are so desperate to leverage. Marcus may have not been a good long-term fit for PayPal, an organization with a reported work force of over
“Just Venmo me,” has become a popular phrase among millennials. The company has the potential to disrupt retail banking. Venmo said it processed $700 million in payments during Q3 2014 (+50% QoQ and up from $141 million a year earlier (+396%).
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13,000 employees. Marcus is an entrepreneur at heart. He would leave to take the reins at Facebook Messenger earlier this year. There is an industry rumor that Apple was in discussions with PayPal to partner on its mobile initiative, Apple Pay. The deal, however, fell apart when Apple got wind that PayPal would partner with Samsung to offer finger-print protected mobile payments on the Galaxy S5. Bank Innovation reported that Marcus was irate with the decision (apparently forced on him by eBay Inc. CEO John Donahoe). This may have been the straw that broke the camel’s back. Incidentally, Donahoe was reported to want the top job at PayPal post-split, but the board had other ideas. Dan Schulman, an American Express executive, will become PayPal’s CEO when the company separates from parent, eBay Inc. He is a relative unknown; therefore it’s difficult to handicap what impact (+/-) he will have on the company post-split. Nevertheless, there a few options he is likely to consider, such as aggressively pursuing deals with Amazon,, Alibaba and even Apple Pay. Moreover, PayPal is in a unique position to “white label” its platform since unlike Apple, Google or Facebook is truly platform agnostic. Schulman is likely to accelerate the growth of PayPal Credit, which improves the company’s overall economics and possibly even consider acquiring a bank charter to disrupt the traditional banking system and increase consumers’ use of PayPal as an alternative to checking/savings accounts. It would also allow PayPal to move into providing personal/small business loans. Lastly, PayPal will be in a position to use its currency to accelerate acquisitions among the thousands of start-ups to protect its rear and push forward on the offensive much like Braintree and Venmo have done. Recent Innovations: In August 2014, PayPal introduced “one touch” PayPal allowing consumers to simplify the payment process. In 2014, PayPal is experimenting with Beacon, a cheap matchbook-sized Bluetooth transmitter that connects a consumer’s smartphone to a store’s payment system. If a consumer uses PayPal’s digital wallet, she can pay via a credit card or debit card, use coupons, collect loyalty points, all without removing her phone from her pocket/purse. comScore report recently that PayPal has 72% share of digital wallet transactions, a market that is expected to reach $1 trillion by 2017. PayPal’s digital wallet has some cool features, including: o Accepts many forms of payment, including installments o Allows for a 5-7 day grace period o The flexibility to change the method of payment after the transaction is complete o Apply gift cards and coupons o Record loyalty points o Platform agnostic–works with merchants–allows them to choose how to increase sales with its customers PayPal wants to build the operating system for mobile payments and let merchants decide what features/functions to add on top to entice consumers to basically spend more. Debate #3 – PayPal won’t be Successful in Off-line Commerce and the Transition to M-commerce PayPal is often accused of missing the opportunity to extend its leadership position off-line and through m-commerce. This accusation rings a little false for several reasons. First, no company has succeeded offline or m-commerce–yet. Google has tried with its Google Wallet, but mostly failed, for example. Amazon payments is not exactly killing it either. Facebook has yet to launch a product. Second, as mentioned previously, the current system works really well in the physical store environment. Merchants, and more importantly, consumers need a reason to change. So far, consumers have not been incentivized to shift from existing payment options/choices to alternative solutions like a digital wallet. This may be on the cusp of changing.
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PayPal and its competitors need to a) create a better consumer experience, b) increase a merchant’s volume and/or lower a merchant’s costs; otherwise, there is little incentive for consumers and merchants to adopt new technologies and methods of payment. The ugly truth is paying with a physical credit card is a relatively frictionless activity today. As mentioned above (recent innovations), PayPal’s digital wallet has some cool features, but the messaging has been poor (PayPal is embarking on its first serious media campaign in 2014). PayPal’s mobile metrics are actually quite good. In 2013, mobile TPV reached $27 billion (+99% YoY) up from only $600 million in 2010 or an incredible 4,400% in three years. In Q3 2014, mobile TPV hit $12 billion, +72% YoY and accounted for 20% of PayPal’s total TPV. The company is on-track to process 1 billion mobile transactions in 2014. Mobile is the fastest growing part of the payments industry. Mobile is expected to record $250 billion in 2014 payments (reaching $700 billion in a few years). In-store transactions made via a mobile device will reach a measly $3.5 billion in 2014, but industry experts expect that to approach $118 billion by 2018 (+114% 4-Year CAGR). Venmo’s founder is willing to bet consumers will not be swiping plastic in five years–they will be using mobile devices. There are certainly signs (including Apply introducing Apply Pay) to suggest the combination of smartphones and social networks leading to a shift in the payments industry’s winners over the next decade. And this is not simply about processing payments (commodity), but more importantly about collecting massive amounts of consumer data, which offers even larger rewards for targeting marketing (not contemplated in current valuation). The Threat of Apple Pay: Apple’s foray into mobile payments with its Apple Pay service is certainly a concern. At launch, Apple had ~220,000 merchants (for context, there are 9 million merchants in the US) on board and the company is rumored to receive PayPal’s Braintree supports Apple Pay via its v.zero a $0.15 fee per transaction from the credit card SDK, which allows merchants to accept not only Apple issuing banks. Thus, it’s not trying to disrupt the Pay, but also credit/debt cards, PayPal (one touch like current payment networks or encroach on PayPal’s Apple) and Venmo in as little as 15 minutes of set-up core revenue stream; in fact, it needs a PayPal to time. Moreover, Apply Pay is not a payment process the payments. As a point of reference, processor and therefore needs to partner with one (or PayPal already licenses its cloud-based software more) so merchants can complete customer for use with existing POS equipment covering 1 transactions using Apple Pay. million retailers, including Home Depot, Foot Locker, and Dollar General. PayPal ended 2012 with 23 major retailers as customers. In addition, PayPal in August 2012 signed a partnership with Discover to reach its 7 million merchant locations in the US. Apple’s tight control over hardware, software and services is a key reason it captures a disproportionate share of the profits in smartphone sales. However, this “walled-garden” may not work so well in payments, which needs to work across devices, networks and operating systems. PayPal is uniquely positioned to create an ecosystem that supports transactions anywhere, anytime, on any device. Apple does some unique advantages, including 500 million + iTunes accounts with stored credit cards and more importantly an unmatched ability to capture consumers attention with easy-to-use designs. One could argue that the market is big enough for more than one winner and Apple’s entrance will help accelerate adoption of its service as well as bring much needed attention to other services like PayPal’s digital wallet solution.
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In any event, the Apple threat may be over-estimated. Apple Pay is aimed at off-line retailers where the market remains underdeveloped as no company has demonstrated an ability to convert users through greater convenience or ease-of-use. According to Citi analyst, Mark May, less than ½ of 1% of PayPal’s revenues are at risk from Apple Pay (based on iOS market share and PayPal’s average take rate). And PayPal does offer merchants a potentially cheaper solution since its funding source in many cases is tied to a consumer’s bank account, which incurs much lower fees as opposed to Apple Pay, which ties directly into the status quo credit card interchange system and does not fundamentally improve merchants’ position. Not only do merchants not save on issuer transaction fees, but they run the risk of losing valuable customer data. On the other hand, consumers can make purchases literally with the simple press of a button (this technology is not unique to Apple). Both Apple and PayPal offer consumers an additional layer of security. Neither service transfers a consumer’s credit card information across the cellular network, but instead issues a one-time token that authenticates the transaction at the point-of-sale. Apple does have the advantage of seamless integration into the Apple ecosystem (hardware, software, services), but Apple will struggle to figure out a way to work on non-Apple devices. PayPal–as an independent company–should be to exploit the opportunity to work across iOS, Android, Blackberry and Microsoft products. Clearly, Apple will not be the only competitor to PayPal in m-commerce. Google has Google What I Like #3: PayPal has not missed its wallet and millions of gmail users. Facebook has opportunity to extend its leadership position in millions of messenger users. Snapchat recently m-commerce and within physical store retailers. In fact, PayPal enjoys several advantages: its easy-to-use, announced SnapPay. It’s difficult to handicap the impact these and other competitors will trusted, widely-accepted, particularly useful with have on the development of m-commerce and cross-border/multi-currency transactions and works its eventual winners. to forge new partnerships, with existing POS equipment. Moreover, PayPal will have an opportunity including Apple and Alibaba. Alibaba recently commented that it can see itself working with PayPal in the future. PayPal has already partnered with the three largest POS vendors, including industry leader Verifone. And many retailers are on board, including Abercrombie & Fitch, Aeropostale, American Eagle, Barnes & Noble, JC Penny and Guitar Center. Retailers that integrate PayPal can reduce their dependence on Mastercard and Visa. It’s reasonable to assume PayPal’s pending independence will help increase partnerships and other opportunities to exploit its platform to accelerate its growth. Digital Wallets – The Holy Grail in the Transformation to M-commerce For mobile commerce to really take-off, the digital wallet will have to be widely adopted by consumers. The problem is consumers have had very little reason to adopt them. There is simply very little demand for the product today (PayPal’s wallet has really cool features, but no one cares yet). Hill Ferguson, PayPal’s Chief Product Officer, said in December 2013, “the digital wallet is the lynchpin for everything we do, but it’s interesting, because consumers aren’t asking for them.” Sucharita Mulpuru, a VP at Forrester Research and an expert in on-line commerce and consumer behavior says: “Digital wallets, at this point in time, are solutions looking for problems. We don’t fundamentally have friction in payments in the US. People who want to use cash are using cash for a reason; they prefer to or they don’t want to be traced. As for credit cards, there is not something fundamentally inconvenient about them. They are fast, they’re reliable, our networks are good.”
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PayPal has recognized the transition, like most transitions, will start slow and then reach a tipping point when adoption will accelerate quickly. This is why it partnered with Discover to issue a PayPal branded credit card. It builds its brand and inches consumers toward an eventual plastic-less future. Another catch is the personalization touted may not benefit the consumer as much as it benefits the retailers. And it raises consumer privacy concerns. Marcus and others see new technologies like biometric fingerprint sensors as assuaging these concerns over time. As PayPal CTO James Barrese has said: “What we have is the opportunity to converge and simplify payments and commerce. Through mobile technologies and devices, consumers will have new ways of paying. Looking back through history, first we had barter system, then currencies, and then we developed broader forms of credit. We’re in the middle of another historic shift in the way people pay. Our challenge is in making something relevant, simple, and global. In the end, PayPal is incredibly well-position either as an independent company, through strategic partnerships or an out-right sale to the likes of Google, Alibaba, Facebook, Mastercard or Visa. For example, a recent report suggested Apple leapt three years ahead of Google in payments, but still only solves the last part of the purchase funnel. SurveyMonkey polled over 1,300 adults between 18 – 64 who have used an online payment website/app between October 10 – 19. Their findings support the strong brand recognition PayPal enjoys:
20
21
20.0x
Mult.
Margins (includes its share of overhead)
Valuation Scenarios: The data table below illustrates the base case scenario for our first look at valuing PayPal.
18.5% 19.5% 20.5% 21.5% 22.5%
17.0% $28 $29 $31 $33 $35
18.0% $28 $30 $31 $33 $35
Payments (PayPal) 2016 Revenue Growth 19.0% 20.0% $28 $28 $30 $30 $32 $32 $34 $34 $35 $36
21.0% $29 $31 $32 $34 $36
22.0% $29 $31 $33 $35 $36
23.0% $29 $31 $33 $35 $37
Here are the key assumptions behind the analysis: F. 2016 revenues of $11.4 billion in revenues G. 2016 segment margins of 20% and segment profits of $2..3 billion H. PayPal retains zero debt and 13% of total cash or $2 billion as of Q3 2014 I. PayPal is responsible for its share of 2016’s corporate overhead (47%), which in total is 10% of eBay Inc. sales @ 8x J. Shares Outstanding: 1.251 billion as of Q3 2014 Based on a range of multiple (15-25x), the possible value for PayPal is between $19 - $47 per share. PayPal has been growing its key metrics at a very high rate. The company’s 5-Year revenue CAGR is +22.5%, whereas similar companies such as V and MA are growing at a 5-Year CAGR of +13%. V and MA trade at 16.6x and 13.7x 2015 EBITDA and 15x and 12x 2016 EBITDA, respectively. PayPal has a greater potential to disrupt the payments industry than V and MA, which are the incumbents. Further, the company key merchants services TPV growth is accelerating. As the company enters off-line commerce in a more significant way, there is an additional $10 trillion market opportunity to pursue. Comp Table
Market Ticker V
MA
Price $ 257.70
$ 85.03
S/O 765
1,169
Net Cash/ Cap.
197,141
99,400
Enterprise
(Debt) 4,856
1,384
Value 201,997
100,784
2014
EBITDA
09 - '14
2015
2016 Rev. CAGR
8,548
9,597
10,737
23.6x
21.0x
18.8x
5,514
6,268
7,175
18.3x
16.1x
14.0x
13.2%
13.0%
Another approach to PayPal’s value is to look at its share of eBay Inc.’s earnings. PayPal share of eBay Inc.’s 2016 earnings of $3.59 is $1.46 (+19% YoY). By applying a reasonable 25x multiple, PayPal would be
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worth $37 per share with a range of possible outcomes between $29 - $44 based on 20-30x 2015 earnings. The chart below illustrates the additional value created for PayPal if it is successful at penetrating more than on-line commerce. PayPal’s Commerce Opportunity @ Different Market Share Levels
Year Commerce Market PayPal's TPV Revenues Operating Profits Future Value Present Value S/O Per Share Value
2034 18,061,112 1,806,111 58,699 12,327 147,921 15,334 1,251 $ 12
2034 18,061,112 2,709,167 88,048 18,490 221,881 23,002 1,251 $ 18
2034 18,061,112 3,612,222 117,397 24,653 295,841 30,669 1,251 $ 25
Key Statistics: Market Share Take Rate Operating Margins Multiple Discount Rate Years
10.0% 3.25% 21.0% 12.0x 12.0% 20
15.0% 3.25% 21.0% 12.0x 12.0% 20
20.0% 3.25% 21.0% 12.0x 12.0% 20
(in millions, except per share values) Assumes the commerce market is $10 trillion today, growing at 3% per year.
Importantly, the above example does not account for PayPal’s opportunity to monetize the vast amount of customer data likely to be collected if it achieves success in in-store/mobile commerce. There is clearly significant strategic value as PayPal creates a platform agnostic ecosystem that not only collects a cut of every transaction, but makes intelligent use of the consumer data it will collect–location, preferences, loyalty, and tendencies–to drive higher retail sales. Square reportedly will generate $900m in 2014 revenues and has been valued at $6 billion or ~6.7x sales. If this multiple is applied to PayPal’s $7.6 billion in TTM revenues, then PayPal would be worth $41 per share. Recent Trends Update: PayPal reported global mobile TPV for Black Friday increased +56% YoY as of 12 PM on Black Friday. Recent reports suggest mobile commerce has shown very good strength over the long holiday weekend accounting for over 40% of traffic/transactions. Here are a few statistics released by Braintree for its activity over Thanksgiving Day, Black Friday and Cyber Monday: o o o o
Total transactions on Thanksgiving 2014 were 3.1x Thanksgiving 2013 Mobile transactions on Thanksgiving 2014 were 4.2x Thanksgiving 2013. Total transactions on Black Friday 2014 were 2.9x Black Friday 2013 Mobile transactions on Black Friday 2014 were 2.3x Black Friday 2013.
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o
Mobile transactions on Cyber Monday 2014 were 2.9x Cyber Monday 2013
eBay Inc.’s other Assets eBay purchased GSI Commerce (since renamed eBay Enterprise) in 2011 for $2.4 billion. eBay Enterprise provides commerce technologies, omni-channel operations and marketing solutions for large, nationally recognized retailers and brands (essentially allows retailers/brands like Aeropostale, Dick’s Sporting Goods, MLB and Mattel to compete on-line by providing fulfillment, inventory management, payment processing and marketing solutions). Enterprise generates most of its revenues from the take rate on merchandise sales that the company enables. The business is undergoing a leadership change due its lack of financial progress since its acquisition. Enterprise reported revenues of $590m, $1,083m and $1,112m and operating profits of $83m, $128m and $91m between 2011-2013. YTD revenue growth has been minimal and operating profits almost nonexistent. eBay has made a few other, small interesting acquisitions in the past few years, including Milo, Redlaser and Shutl: Milo – essentially the site lists real-time in-store product inventory for over 50,000 stores across the country and features over 3m product from the likes of Target, Macy’s, Best Buy, Crate & Barrel and more. The market of online research to offline buying was estimated at $917 billion in 2010. Redlaser – compare prices from the brands and merchants online or around the corner. It’s an app that allows a consumer to scan barcodes and shop for the lowest prices, online or locally. Shutl – a same-day delivery start-up in the UK and expanding into US that is a web platform and marketplace for point-to-point delivery. Minority Interests: eBay owns a 28% stake in Craigslist (Craigslist is valued at $1 billion +) and a 17% stake in MercadoLibre (eBay’s stake is worth ~ $1 billion at current prices) Conclusion There are multiple ways to “win” by being long EBAY at these prices. As independent companies, both eBay marketplaces and PayPal can pursue value enhancing operational, financial and potentially strategic opportunities. A thorough review of different valuation approaches suggest the stock is worth at least $65-70 per share with an adequate margin of safety.
The consensus under estimates both PayPal’s dominant position in the payment ecosystem, its ability to innovate and the sheer size of the opportunity. It remains in the early innings of an industry transformation. The consensus also under estimates eBay marketplaces’ platform. Marketplaces is a top 10 retailer by volume with significant advantages like a large and growing user base (best indicator of future sales potential).
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