Of course eBay has to spin off PayPal. Here's why it hasn't done so.... yet

By Sarah Lacy , written on August 21, 2014

From The News Desk

Headlines today say that eBay is still considering a spin off of PayPal. The reports manage to be, at the same time, both thrilling and “duh.”

If it happens, a PayPal spin-off would be one of the most exciting tech spin-offs ever, with big ramifications for most of the global Internet. While most people acknowledge that PayPal has greatly stagnated under eBay, its network effects have been so powerful that not even a total lack of innovation has been able to dent it.

Under former President David Marcus’ short tenure, the brand gained new energy, talent and focus. Product wise, there aren’t yet a ton of exciting new PayPal innovations in the market – this week’s launch of One Touch was a good start – but even still, the company accelerated the growth rate of its non-eBay business every quarter under Marcus.

PayPal isn’t just a unicorn. It’s a magical unicorn with a forcefield of protection around it. Even the unicorn stupidly stabbing that forcefield with its own horn hasn’t been able to do damage.

Braintree, Square, and Stripe were the company’s three greatest threats in the startup world. Braintree has since been acquired by PayPal, Square is still mighty but struggling to find a business model beyond slim margin transactions, and Stripe is valued at a whopping $1.75 billion, but is hardly a real threat at this point, because most of its customers are small companies and it has little offline presence to speak of.

More surprising: None of the usual tech giants are anywhere to be found on payments. Amazon and Google are still flailing with their half-hearted attempts, and -- despite many rumors to the contrary and the hiring of Marcus to run messaging -- it seems highly unlikely we’ll see a payments play from Facebook any time soon.

The possible exception is Apple, given how much media we buy via our smart phones. But still, that’s just through iTunes and the App Store, and the bulk of the mobile app world has embraced free. Most online payments -- mobile or desktop Web -- still flow outside of Apple.

The thinking by many of the incumbents is that payments can be a great business but only if that’s all you do. Payments are hard and focus is key. It is one of the most indisputable winner-take-all markets on the Internet. And PayPal is astoundingly still the undisputed winner. You have to look at paid search and Google to see any Web 1.0 generation company that has so dominated its core market, even as that market has continued to grow larger and more lucrative. It’s a stranglehold of boa constrictor proportions.

All this considered, it starts to look obvious that PayPal will one day be a public company. It deserves to be. It is too valuable an asset to continue to be inside a slow moving auctions marketplace that far fewer people -- whether consumers, developers, or investors-- care about anymore. PayPal already represents the bulk of eBay’s market cap.

David Marcus not-so-subtly agitated for it in his Forbes Cover when he said:

[PayPal is] a 13,000-person company where we’re changing everything and rewiring the whole culture. It’s really brutal. … At large companies you always find someone with reasons not to do something–the self-preservation thing is highly frustrating. ...

If you allowed PayPal to pursue its destiny there are moves it could make to become the largest financial company in the world. In the same profile, PayPal co-founder, and everyday Ironman, Elon Musk offered a similar assessment, saying:

It doesn’t make sense that a global payment system is a subsidiary of an auction website. It’s as if Target owned Visa or something. [It] will get cut to pieces by Amazon Payments, or by others like Apple and by startups if it continues to be part of eBay.
We’ve heard that article caused a bit of a dust up inside the company. It didn’t lead to Marcus’ departure directly, but his frustrations at being part of a larger company seemingly did. Marcus stated as much, saying he left because he wanted to do something more “entrepreneurial” -- nevermind his eventual actions – joining a company with more than 6,000 employees – which showed otherwise.

Everyone has been closely watching and waiting to see who Marcus’s replacement might be. If it’s someone internal, like Braintree’s Bill Ready for instance, it’s probably a sign the company won’t be spun off anytime soon. And that person may well leave with the same frustrations in another few years, starting the cycle a new. If it’s an elite public market CEO like Jamie Dimon, it’s a sign the company is heading out on its own.

So far, eBay CEO John Donahoe has hedged by staying in charge himself, allowing the team that was assembled under Marcus to execute his existing playbook for the foreseeable future -- at least as publicly communicated to the world and to the PayPal team.

Again: Almost everyone believes this will spin-off happen one day, just as it was obvious that Yahoo would one day unlock the value of its Alibaba assets, despite several CEOs worth of fits and starts. But there are two reasons eBay has hesitated to spin PayPal off thus far. One is a good reason if you are an eBay shareholder, and one isn’t so good, but is nevertheless a real factor in the decision nonetheless.

First the good reason eBay is scared to let PayPal go:

Remember the point about how no other big US Internet incumbent had come close to competing with PayPal? The second this thing is spun out Amazon, Google, Facebook and probably some big Chinese players are going to make massive, massive offers to buy it.

Why wouldn’t they? It’s a classic case where having failed to build it themselves, they each need to buy an established platform it if they wanted to be serious about payments. There’s no one anywhere close to being as established or attractive as PayPal. And payments would be a huge, core advantage for any of these companies in achieving their ambitions of global internet dominance. As we’ve seen recently in Valley M&A, offers will balloon for defensive as well as offensive reasons, as even companies like Facebook, that don’t currently have ambitions to enter payments, simply look to keep a platform this powerful out of rivals’ hands.

It is the worst possible time in the M&A cycle for this to go down, from eBay’s point of view. Given the crazy acquisition math that’s been swirling among the big boys in Silicon Valley -- and that Wall Street has been more or less supporting -- the market caps these companies have, and the cash positions they’ve amassed, someone would no doubt put up a number big enough that management and investors would have to say yes.

This itself is no doubt driving some of the investor frenzy to spin PayPal out sooner than later.

And now the less good reason: All the personal, political bullshit.

Spinning off PayPal is an ego and cultural landmine for eBay. CEO John Donahoe has done yeoman’s work rebuilding one of the classic Web 1.0 brands into something Wall Street was once again interested in. On a financial basis, eBay has been one of the only successful Web 1.0 turnarounds in history. A huge part of that is the PayPal safety net, but Donahoe also deserves a ton of credit for his execution and leadership.

Donahoe isn’t ready to retire. So what does his job look like if he spins out PayPal? EBay is far less interesting without it. I’ve heard some insiders speculate that Donahoe may even pick PayPal as the company he’d run -- that’s how boring eBay is for a CEO of his skills and ambition.

Beyond that, there are tricky economics for the PayPal management team. Anyone working on PayPal is likely to get far more valuable options and upside than former colleagues staying at eBay. These aren’t reasons not to spin off PayPal, but they are reasons that it could continue to be put off. Ebay would be one dysfunctional and depressing workplace the day after such a deal goes down.

The company knows this is coming. The market knows it is coming. Every employee of PayPal assumes it’s coming, at some point. The world believes it is inevitable, eventually. The only multi-billion-dollar questions are whether it is happening now and whether it should happen now.

Someone who is leaking all of this to the press certainly thinks so. With so much to gain from a potential spin off -- even in the rumors and the immediate impact they have on the stock -- it’s impossible for outsiders to judge if this is actually happening now, or someone is simply stoking the fire for other reasons. I’ve had conversations about this consistently since Marcus’ departure, and I still don’t know if it’s in the immediate offing. There’s a lot of informed speculation, but the handful of people who would know for sure aren’t talking. The stakes are simply too great.

But you can bet the CEOs of the other major Internet giants are watching closely, checkbooks in hand.

[Image via Kārlis Dambrāns, Flickr]