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.
Nearly equals
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.
Little benefit
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.
An example of a recent successful spin-off is when drug giant Pfizer Inc. (NYSE:PFE) spun off animal health business Zoetis. Pfizer Inc. (NYSE:PFE) is such a big company, with about $60 billion in revenue in 2012, that having a small fast-growing business like Zoetis within it didn’t have any effect on Pfizer Inc. (NYSE:PFE)’s results. With Pfizer trading with a P/E ratio in the low-to-mid single-digits, it made sense to separate Zoetis from the company.
Today, Zoetis trades at 36 times earnings now that it’s no longer buried inside of Pfizer Inc. (NYSE:PFE), and the spin-off essentially created a $15 billion company without any noticeable effect to Pfizer Inc. (NYSE:PFE)’s fundamentals. This type of situation is an ideal spinoff.
Pfizer Inc. (NYSE:PFE) was able to use the proceeds of the spin-off to fund a massive share buyback program, creating significant value for shareholders. It was a smart move for Pfizer to focus on its core business and shed its animal health business, and shareholders benefited from that decision.
PayPal, however, is not like Zoetis. eBay is transforming from an e-commerce company into a payment processing company, and I doubt that we’ll see a spin-off in the foreseeable future. With eBay at its current levels, there’s just no benefit for shareholders.
The bottom line
eBay has two distinct businesses, but with the stock trading at lofty valuations, there seems to be no reason for a PayPal spinoff. If the stock ever reaches the types of levels seen a few years ago, then a PayPal spinoff might make sense, but I don’t think we’ll be seeing one any time soon.
The article Does a PayPal Spinoff Make Sense? originally appeared on Fool.com and is written by Timothy Green.
Timothy Green has no position in any stocks mentioned. The Motley Fool recommends eBay. The Motley Fool owns shares of eBay. Timothy is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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