The ideal situation for a spinoff is when you have a small, fast growing division lodged within a large, slower-growing company. The new, fast-growing company commands a high P/E ratio while the large company is mostly unaffected by the loss of the division. This creates value for shareholders because the sum of the market values of the two companies is now greater than the original company.
But sometimes, the benefits of a spinoff aren’t as clear. It’s been long rumored that eBay Inc (NASDAQ:EBAY), the online marketplace, would eventually spin off PayPal, the payment processor. But would this actually create shareholder value?
PayPal has grown to the point where it makes up a significant portion of eBay Inc (NASDAQ:EBAY)’s total revenue. In 2012, the company recorded $14 billion in revenue, of which about 40% was from the PayPal unit. The bulk, 53%, came from the marketplace business, and the rest came from the enterprise business. Revenue growth for PayPal was 26% for the year, much faster than the 11% revenue growth for the marketplace business.
A spinoff would result in eBay Inc (NASDAQ:EBAY), a company with $8.5 billion in annual revenue and 11% revenue growth, and PayPal, a company with $5.6 billion in revenue and 26% revenue growth.
eBay Inc (NASDAQ:EBAY) doesn’t disclose the net profit attributable to each business, but in total, the company had $2.6 billion of net income in 2012. eBay Inc (NASDAQ:EBAY) currently trades at 26.7 times earnings, and the average analyst estimate for annual earnings growth over the next five years is about 15%.
This high multiple is likely due to the prospects of PayPal becoming a much larger force in the payment processing business. The company is expanding into in-store payments, trying to break into a business dominated by the credit card companies. This will not be an easy task, and the margins associated with this expansion will be far lower than online payment processing.
PayPal is not a fast growing business trapped in a low-multiple company. A couple of years ago, when eBay Inc (NASDAQ:EBAY) shares were floundering, an argument could have been made for a PayPal spinoff. But today, the valuation seems to be fully recognizing PayPal’s long-term potential already, leaving no real reason to pursue a spinoff.