Evaluating the Paypal Spinoff

• Paypal holds more growth potential than marketplace side of E-bay  
• Paypal could see major growth if it gets access to upward trends in mobile payments and other emerging markets 
• Paypal will be challenged by Apple Pay and Google Wallet in mobile and other regulatory and legal barriers
• Paypal should be fairly valuated at around $40-45 billion when it spins off  

     As I've suggested in another article technology has systematically disrupted information based industries and potentially the next industry that's in line is the more entrenched world of finance. One company that is uniquely poised in that disruption is Paypal. According to Paypal's next CEO Dan Schulman "There is no question that change is going to sweep through the financial industry. The financial industry is no different from other industries where technology has touched down."

Background: In late 1998 at Stanford, Peter Thiel introduced the idea of a digital wallet to Max Levchin and Luke Nosek. The three began working on the concept which later turned into the company they founded Confinity.  That service (after a brief stint with Elon Musk as CEO) evolved into PayPal in 1999 and was acquired by E-bay back in 2002. Although integrated with E-bay at this point it was still an unsustainable jumble of ideas kept alive by future Silicon Valley influentials. Its payment volumes mostly came from the E-Bay which made it a natural acquisition target for the E-bay. Paypal survived mainly because most of E-bay users were individuals or small businesses that were unable to accept credit cards. After struggling to find place within E-bay's growing user-base, in the second half of 2004, PayPal Merchant Services began to enroll other online merchants outside eBay as well as reducing fees for online purchases and launching PayPal mobile.

     Since then Paypal's contribution to E-bay's earnings has continued to outpace the growth of its parent company and E-bay may have even slowed Paypal's ability to expand its reach, specifically in hindering the launch of PayPal App. Along the Paypal has been able to acquire other related startups like Braintree, Venmo, card.io, fig, bill safe, and Bill me Later that have roughly fit into its lofty although vague mission statement being the "Web’s most convenient, secure, cost-effective payment solution," in some cases doing it better than Paypal itself.  Still after the spin off, will Paypal still thrive without Ebay's backing? At this point Paypal seems to have more potential and more opportunity for growth than its parent and with its spin-off coming in early 2015 it's worth taking a look where its potential lies, what lurking obstacles might hinder that potential and what a good price for the company would be when it does break away.

http://www.businessinsider.com/the-mobile-payments-industry-update-2014-10

Upside-The biggest immediate challenge and opportunity for PayPal is racing against tech giants like Google and Apple in the sphere of mobile in store payments. Mobile payments alone are predicted to have a 90 billion market by 2017.  Along with these grandiose tech companies, major credit card companies will also vying for this space. Paypal has already preemptively produced an app although it has still fallen short of anything that is as efficient and easy to use as traditional credit cards. Google wallet and Apple pay have the huge advantages in this area because they are backed by large established databases and services customers already trust. At the same time the size and scope that these companies work under could slow down their ability and motivation to profit from this area of tranformative growth.

In Paypal's favor, its future CEO Dan Schulman seems to be suited almost specifically for this task. His experience came from telecom starting out as an AT&T executive then in 2001 growing Virgin mobile USA to be acquired by Sprint in 2009. Most recently he has been trying to expand the reach of American Express to people without access to traditional banking by using digital alternatives like mobile. While in this endeavor, he caught the vision of a tech driven sea change in how banking can be done.  Driven by a desire to give banking access to under-served populations, and undo the convention that "its expensive to be poor" he says: "I believe that we are entering into the era of the non bank. An era where consumers have all the power of a bank branch in the palm of their hand. Its not hard to imagine that technology is going to redefine the world of consumer retail banking.  Digital wallets are morphing into tools that can serve as a real alternative to bank branches." And while I don't think we will see traditional banks disappear altogether I do think he is on the right track for growth and how to reach youth and lower income segments.  It also suggests that Schulman will do whatever is necessary to cut costs to the user while working to make the Paypal app more intuitive user-friendly. I also think he may also try to make other relevant banking services accessible to Paypal users through the Paypal app. While he has the right direction and motivation I could see him struggling to adapt to a more startup, innovative minded environment and pulling together the right team and working to get the technology right as his background is more from an executive and finance mindset.

In addition to a CEO who will pursue his vision of bank alternatives, Paypal has already established agreements with retailers that it will could try to expand into in store purchases. Most likely Apple, Google and Paypal grow with this trend with Paypal getting the most movement if it is able to make a compelling app and partner effectively with banks or credit card companies in the process.
 
   In addition to replacing credit cards there is also a  growing market of peer to peer digital payments, Mobile peer to peer and Paypal at this point is by far the most recognized and trusted service positioned for growth in this field.  Along with direct peer to peer payments using Venmo, growth could come in this segment as services like Uber, Lyft, AirBNB, and other mobile transactions rely on its service to make their businesses work.

http://www.cardfellow.com/blog/paypal-here-vs-square/

     In a related application Square has enabled transactions for small business and opened up a new market which can work with Paypal and which  Paypal has countered with its own mobile transaction device to compete with square.
As other small businesses and store fronts convert to using a computer checkout they often favor this convenient device for credit card transactions. Although insert will  become obsolete with implementation of mobile payments, it will likely continue to fill a necessary niche for a long while before payments go completely to smart phones.

Risks-Some obstacles that Paypal will continue to face are similar to ones that it has faced since it began:
-Continuing to gain the trust willingness of customers to use Paypal without direct support from E-bay
- Still being unproven method of handling money and continuing to get access to more retailers and users to give it a chance despite many drawbacks
-Pressure from Visa and Mastercard older, established systems that have huge experience and databases that are not going to give up their position willingly. For Paypal to compete with the credit card system they would need instant transactions rather than waiting for days for orders to process as they currently do with E-Bay
- Paypal has many of the safety issues of a bank, hackers and fraud that have used its open nature to take advantage of Paypal users. As Paypal grows it will continue to have to deal with regulation and how to interface with purchases in other countries etc.
    Along these lines my own experience has been that when selling larger priced items on E-bay there are offers from scammers in questionable locations like Nigeria offering to buy the item. I can only guess, but I imagine once they see the item being shipped they cancel the payment and take advantage of the time lapse in payment to take the merchandise and run. Luckily I'm not naive enough to send a $500 camera to Nigeria but this is just one anecdotal sample of likely countless other instances where users have hacked accounts and found other fraud angles to take advantage of the weaknesses in this new type of transaction. As with many types of new technology and the sharing economy, it assumes a certain level of intelligence and self reliance in its customers which is wonderful but only works if people actually live up to these ideals. If customers act like users in the old banking system and care more about fraud than getting things done better the system will not move forward.

Conclusion- While about a third of Paypal's payment volume still comes from E-Bay, there seems to be little doubt that the more profitable of the two companies will ultimately be PayPal. Current E-bay CEO John Donahoe has indicated that "While eBay’s marketplace, the company’s core business, accounts for over 30% of PayPal’s annual revenues, that figure will dwindle to just 15% within three years. And while the Ebay's $9.9 billion in revenues last year eclipsed PayPal’s $7.2 billion, PayPal’s 19% annual revenue growth outpaced Marketplaces’ 10%."  As seen in the chart below Paypal has grown consistently along with E-Bay since 2002 and went from making up 18% of its revenue to 38% in 2011.

http://vator.tv/news/2012-07-08-now-10-years-after-being-acquired-paypal-going-strong 

         So there's a lot of  room to grow and a lot of potential, but what it actually worth? Both E-bay and Paypal have about 150 Million users. In E-bay's 2012 Revenues was about $16 Billion in 2013 and  probably around $19 Billion in 2014. As Donahoe points out 40% of that is coming from Paypal so simply taking 40% of E-bay's current would give a rough valuation of  $40-45 Billion not factoring in Paypal's more optimistic future. For me anything below $40 Billion divided by the proposed number of shares would be enough margin of safety to get a stake in Paypal growth. The growth will likely be a very bumpy ride but if you stick it out, there will quite possibly be solid upside that will continue to compound as it plays an integral part in financial transactions for a long time to come.