Long-time activist investor Carl Icahn made headlines in early March by stating that in his long career of challenging companies’ managements and boards of directors, he has never seen worse corporate governance than that of eBay (EBAY). The strong words came in the midst of his ongoing efforts to convince the company’s management to spin off its market-leading online payment platform, PayPal, from its namesake internet auction business. Elon Musk, PayPal’s co-founder who is currently best known for his successful leadership of Tesla (TSLA), has chimed in with his agreement, pointing out that with many competitors emerging in the field, it is hard to see how the battle to maintain PayPal’s primacy in online payments is helped by it remaining a subsidiary of an online auctioneer.
PayPal was acquired by eBay in 2002, in what was an apparently wise move in retrospect, as PayPal now has 143 million active registered accounts, providing merchants with a large base of potential customers. It is available in about 193 countries and 26 currencies, and thus reduces some of the risk and complexity involved in international trade. It also gives U.S. merchants the ability to offer consumer credit to American consumers through its “Bill Me Later” service. Part of the platform’s edge has been that it enables consumers to pay merchants without sharing sensitive financial information, such as credit card and debit card numbers, while still being able to minimize fraud and manage risk for both buyers and sellers.
While eBay’s Marketplaces segment still beats its Payments segment in revenues and operating income, many believe that due to its competitive strength and the vast possibilities that are likely to arise from being a leader in online payments, PayPal is destined to become the crown jewel of the company over the long term. As Mr. Icahn is eager to point out, the company has a questionable record of monetizing its strongest assets to maximize shareholder benefit. In particular, he points to the example of Skype, a leading voice-over-IP company of which eBay sold a 70% stake in 2009 to a group of investors, which then in turn sold its stake for over three times as much to Microsoft (MSFT - Free Microsoft Stock Report) less than two years later. Icahn believes that appreciation should have been foreseeable to management and thus should have ended up in shareholders’ pockets.
eBay responded forcefully in a letter titled “The Truth About Skype”, in which it laid out the timeline of events leading to its sale of Skype, including CEO Jack Donahoe’s admission in 2007 that the 2005 acquisition hadn’t performed as expected. It also highlighted the exhaustive process of exploring possibilities for an IPO or sale of Skype, in which it contacted numerous financial and strategic buyers. The letter pointed out that many business journalists at the time had expressed surprise at how high the sale price was, particularly as the divestiture came in the midst of a deep recession. The company also retained a 30% stake in Skype, and thus realized a net gain of $1.4 billion on the sale to Microsoft. Furthermore, Skype had gone through a dramatic overhaul after the sale, which was at least partly responsible for the increase in value.
With management and the board of directors standing their ground, and the war of words possibly getting too hot even for the outspoken Mr. Icahn, the billionaire activist is now aiming for the company to conduct an initial public offering of 20% of PayPal, rather than a full spinoff. In this more-modest proposal, he seemed to concede that management had a point in defending the synergies between eBay and PayPal, which could be preserved in the sale of a minority stake. However, Mr. Icahn still believes that a partial spinoff could help to prove his point, as it would demonstrate the market value of PayPal and provide capital for the company’s other needs.
The company quickly shot down the toned-down suggestion, saying that such a move would not make PayPal more competitive and would create a distraction for the company.
While the board seems to have the upper hand at the moment, Mr. Icahn has likely tapped into an important point for eBay shareholders, namely that PayPal may ultimately prove to be worth more than the company as a whole is currently selling for on the market based on its recent trading range. Sooner or later, the company may again face pressure from shareholders to realize that value.
With a strong balance sheet, steady profit margins, and multiple growing segments, the company’s shares offer investors both safety and solid appreciation potential going forward, whether Mr. Icahn gets his way or not. In the meantime, buyers should be prepared for some very interesting shareholder meetings.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.