2 Are Better Than 1

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

It's no secret that eBay (NASDAQ: EBAY) has done an amazing job not only growing their traditional business, but also expanding their PayPal division as well. When it comes to online sales, the two most recognized names are Amazon.com (NASDAQ: AMZN) and eBay. eBay's results speak for themselves, but there is a problem--there is value in PayPal that is likely not reflected as a part of eBay. The bottom line is that eBay and PayPal need to split.

Online Shopping Is Continually Changing
While Amazon and eBay have already survived the deluge of online shops that sprang up during the dot.com bubble, they face a new breed of competition today. Some are companies they know, others are new entrants. A good example of a competitor they have dealt with for a while is Target (NYSE: TGT)

Target continually updates their selection and offers exclusive deals to compete with online merchants. One way the company is attempting to differentiate themselves is through their REDcard. The REDcard comes in both credit and debit flavors, and carries three big benefits that eBay and Amazon can't match. First, customers get 5% off their purchases both in store and online. Second, you get an extra 30 days for returns. Third, and maybe most important, Target.com purchases ship for free.

A newer entrant into the online shopping arena is Facebook (NASDAQ: FB). Though the company is still seen as primarily a social site, Facebook Gifts has the potential to be a major disruptive force in online shopping. Many people use Facebook to remember their family and friend's birthdays. If users can order them a gift from the same site, the option might be too easy to ignore. With gifts available from candy, to wine, to toys, the selection is appealing. The fact that your friend is notified instantly makes last minute gift giving no problem. With over 1 billion users, there are millions of birthday wishes being posted, which means that if Facebook only captures a small portion of sales through Facebook Gifts, every other retailer better be aware of this new threat.

What Makes eBay Different?
Part of what makes eBay different is that the site is a bargain hunter's dream. Small businesses can sell their wares to an audience of millions, and individuals can sell unwanted items. In that situation, retailers of all stripes have no chance of competing on price. eBay Marketplace is still growing at a good clip, with active accounts up 12%, and gross merchandise sales up 19% in the current quarter. 

The other big difference between eBay and other sites is PayPal. The service is so integrated into the website that many people have never completed an eBay transaction without PayPal. This division now has 123 million registered users, and payment volume jumped 24% in the current quarter.

Here's The Problem
As great as these two businesses are, it seems they would be worth more as two separate entities. eBay trades for about 20.8 times projected earnings, with a 14.6% expected growth rate in EPS over the next few years. In the last five quarters, eBay's Marketplace division has grown revenue by between 10% and 16%, and active users have grown by 6% to 12% in the same timeframe. 

PayPal is on a different growth trajectory. This division is growing revenue by 22% to 29% over the last few quarters. In addition, PayPal's user growth is faster, with rates of 12% to 15% in the last year or so.

Faster Growth = Higher Multiple
In the stock market, companies that are expected to grow earnings at a faster clip are routinely awarded a higher multiple. The standout example is Amazon, which is expected to post better than 40% EPS growth in the next few years, and sells for over 180 times projected earnings. Facebook is also growing fast, with analysts calling for 29% earnings growth from the social network. In response, the stock sells for nearly 50 times projected earnings. Even Target sells for a PEG of 1.2, with an expected 11.7% growth rate, and shares are trading at 14 times projected earnings. 

Though PayPal might never match Amazon's multiple, Facebook sells for 1.72 times its growth rate. Considering that PayPal has been growing revenue by 25% on average, and Facebook is expected to see 29% EPS growth, it's not a stretch to assume that PayPal's earnings might grow by the same amount over time. This comparison means PayPal might sell for a PEG of 1.7 or more. eBay would likely be marked down to a multiple slightly above Target because of its slower growth. However, the company's high margin business should command a premium PEG ratio of at least 1.3 or 1.4 times its growth rate.

A 28% Premium At Least
The eBay division (with GSI thrown in) makes up 58.34% of revenue. This proposed company's average revenue growth rate has been 12.4% in the last five quarters. With a multiple of 1.3 to 1.4 times growth, the shares would probably carry a P/E ratio between 16 and 17. 

PayPal makes up 41.66% of revenue, and has grown revenue at an average rate of 25%. If PayPal carried a PEG of 1.7, the shares would trade for a P/E of 42. If you add these figures together, the combined company should have a weighted P/E ratio of 17.50 for PayPal, and at least 9.33 for eBay Marketplace and GSI.

This combined multiple of 26.83 is a roughly 28% premium to what the stock currently sells for. The bottom line is at over 40% of revenue, PayPal is all grown up. This division needs to be separated from eBay so the market can value its growth more appropriately. In this case, 2 companies are clearly better than 1.


MHenage has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, eBay, and Facebook. The Motley Fool owns shares of Amazon.com, eBay, and Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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