Baird Equity Research Analysts Colin Sebastian and Rohit Kulkarni break down the hypothetical but compelling idea of Google acquiring eBay/PayPal.

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A possible “best of both worlds” opportunity. With activist investors recommending the split of PayPal from eBay Inc (NASDAQ:EBAY), we believe a potentially more attractive option is missing from the discussion: Google Inc (NASDAQ:GOOG) acquiring eBay/PayPal would serve not only to “unlock” the value of the two segments, but also help solve two of Google’s competitive shortcomings. WIth a significant arms race unfolding in payments, we review the strategic and financial rationale for this combination, including respective benefits and risks.

Commerce and Payments are on the Internet center stage, currently benefiting from significant innovation, massive disruption and extraordinary opportunities for growth. While e-commerce is consolidating among a fewer number of large-scale marketplaces, we still see the payments market as more of a “jump ball,” partly due to the inevitable collision course of online, local and mobile commerce.

Addressing Google’s Achilles heel

Google Inc (NASDAQ:GOOG) has unmatched strength in Search and engineering; however, struggles with Wallet and Checkout are well documented, and the company is lacking scale with two key pieces of the platform puzzle: Payments (including credit card and transaction data) and E-commerce (marketplace). We believe acquiring eBay/PayPal would be one way for Google to secure quickly a strong leadership position in commerce and payments, and likewise, could represent a better strategic option than alternatives proposed for eBay.

Creating a Balance of Power in E-commerce

Together with eBay Inc (NASDAQ:EBAY)/PayPal, Google Inc (NASDAQ:GOOG) would be in a much stronger position to fend off well-capitalized competitors. Specifically, we note that Larry Page has shown that he is open to large deals, and both companies would likely be stronger together in the significant technology and user arms race unfolding with Amazon.com, Inc. (NASDAQ:AMZN), Apple Inc. (NASDAQ:AAPL) and Facebook Inc (NASDAQ:FB).

Unlocking the value of PayPal

In prior research notes, we have argued that the sum of parts valuation for eBay Inc (NASDAQ:EBAY) is greater than the combined company market value. While we see potential benefits for PayPal operating independently, this scenario could prove very challenging for eBay Inc (NASDAQ:EBAY), and as an alternative, a combination with Google could be a “best of both worlds” opportunity.

Potential accretion up to 50% premium over eBay’s 3/14 closing price

Assuming Google Inc (NASDAQ:GOOG) takes on no leverage and maintains a cash cushion of $10 billion or more, we estimate an acquisition would be accretive up to a 40-50% premium over Friday’s closing price ($57).