Spinoff of PayPal from eBay: It’s Too Early

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Stifel Equity Trading Desk analysts Christopher C. Brendler and John Davis suggest that PayPal’s strategic positioning does not look favorable for a separation, in their report dated March 17, 2014.

Although market conditions are ripe for a spin, our analysis of PayPal’s strategic positioning does not suggest material benefits from a separation from eBay Inc (NASDAQ:EBAY). On the contrary, we believe eBay mgmt is laser focused on PayPal and its unique capability to lead next-gen retailing. While recent execution has been choppy, PayPal continues to grow rapidly through both online and offline wallets and dominates both channels today. Despite this early lead, however, competition is set to heat up dramatically and we still believe PayPal is vulnerable to new threats. With Icahn helping the stock to ignore these risks and “omni-channel” still just a concept, we expect PayPal to struggle to meet increasing expectations.

Carl Icahn’s moves to spinoff PayPal

Carl Icahn‘s bold moves to force eBay to spin-off PayPal has shifted our attention to mobile payments and the growing potential for transformational changes in brick-and-mortar retailing. In our view, PayPal is in a unique leadership position with a dominant online wallet, trusted global brand, and growing base of both consumers and merchants. Although PayPal has struggled so far to gain significant traction offline, it remains early and we believe the company’s strategic positioning has improved recently with strong partnerships, smart acquisitions, and keen strategic decisions.

Moreover, despite powerful potential competitors, PayPal not only continues to dominate online, it is the far and away leader offline as well with nearly 4x the acceptance of its nearest competitor, Google. With deep retailing experience and the only scaled mobile wallet in the world, we view PayPal as the leading contender to drive next-generation mobile-powered commerce.

PayPal’s mobile payment benefits eBay

We believe this shift to mobile plays to eBay’s strengths. Although expensive, the Braintree acquisition was well-timed as we see mobile as the answer to the question of why PayPal offline. Moreover, mobile ubiquity has broken down the traditional barriers between B&M and ecommerce, and we expect a growing push from B&M after the latest security breaches.

This could create opportunities for PayPal, but recent execution has not fueled confidence. Although its lead is still expanding both online and offline, it is still so early and the industry is evolving too rapidly to predict even leading contenders at this point. Although competition has struggled, no one’s giving up and we still see a significant and growing threat to PayPal, both online and offline. Not only are there hundreds of potential competitors, major threats like Apple Inc. (NASDAQ:AAPL) and Amazon.com, Inc. (NASDAQ:AMZN) are now close while Google Inc (NASDAQ:GOOG) and Visa Inc (NYSE:V) remain as committed as ever.

Finally, we still struggle to find a compelling case for PayPal offline. Consumers to date have shown little interest in offline digital wallets and it remains to be seen if there is a “killer app” to revolutionize B&M payments. While Starbucks Corporation (NASDAQ:SBUX), Uber, and OpenTable Inc (NASDAQ:OPEN) showcase the potential, all three represent unique time-saving opportunities that are hard to apply to mainstream B&M retail. PayPal’s offline dreams are powered by mobile not payments, and we question how well PayPal can leverage its online success to successfully compete on POS technology/software at the B&M retailer.

Still, given the extraordinary pace of change and incredible potential in mobile-driven commerce, we give PayPal a shot so we do not think PayPal should be spun-off today. In addition to all the reasons laid out by our colleague Jordan Rohan (“Activist Interest Creates Tricky Situation, Risks For Investors” also out today), we’re not sure it is worth the distraction at this critical juncture. In our view, eBay mgmt is squarely focused on its unique “omni-channel” opportunity and investing heavily so we see no major strategic benefits from a near-term spin-off.

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