Spinout needed: eBay slammed after missed earnings and reduced Q4 holiday forecasts (despite PayPal growth)
EBay, which is already under a microscope after announcing two weeks ago its plans to spin out PayPal, reported earnings today. Marking the end of an all around rocky summer, the payments and commerce company missed revenue expectations and delivered future guidance that fell short of forecasts.
At $0.68 per share, the company exceeded earnings estimates by a penny, but it wasn’t enough to buoy the stock. Q4 earnings estimates of between earnings of between $0.88 and $0.91 per share and revenue between $4.85 billion and $4.95 billion, each of which missed forecasts for the crucial holiday period, didn’t help matters. Shares fell nearly 4 percent in after-hours trading, before recovering most of the losses, this after slumping nearly 1 percent during market hours amid an all around rough day on Wall Street.
At the forefront of all investors’ minds is the recently announced, which will see eBay’s payments and marketplaces businesses operating independently by the end of 2015. EBay CEO John Donahoe and CFO Bob Swan spent a considerable portion of today’s earnings call addressing the planned separation, while also explaining the reasons for this quarter’s disappointing performance.
As expected, PayPal unit continues to perform well, growing payments volume by 29 percent and revenue by 21 percent year-over-year, reaching a top line of $1.95 billion for the quarter. According to the company, PayPal now has 157 million registered accounts and facilitates one in every six dollars spent online, processing $203 billion in total payments volume over the last 12 months.
EBay’s marketplace unit, however, saw only 5 percent year over year revenue growth, topping out at $2.156 billion for the quarter. That said, the marketplace business continues to deliver attractive margins and has grown to support 152 million registered buyers – how engage many of those buyers are is another question – and averages 800 million concurrent active listings.
Operating margins, at 20.9 percent for payments and 35.9 percent for marketplace, are down nearly 8 percent within both eBay’s payment and marketplaces units, due primarily to increased brand advertising and marketing spending. The eBay brand, in particular, faced strong headwinds during the year, including a massive security breach that saw the login credentials of the company’s then-145 million users compromised. The resulting password reset, combined with changes to Google’s algorithms that devastated eBay’s search rankings, have necessitated more spending to (re)acquire and engage users, according to Swan. He also pointed to pricing changes at StubHub that resulted in lower take rates on the company’s ticket sales that further depressed eBay marketplace margins.
“EBay is clearly facing some near-term challenges,” he said during today’s call today. “Growth is not what we wanted or expected. Slowing traffic growth has delayed the modest recovery we expected during the second half.”
Donahoe and Swan mostly stuck to the existing script when discussing the planned business separation, hammering on the idea that it was done “at the right time, and for the right reasons” – in other words, not because Carl Icahn demanded it and not because Apple and Alibaba each recently entered their two primary markets in a major way.
“Each business will focus and flexibility to capitalize on unique opportunities, and capitalize on competitive advantages,” Donahoe said. In a statement earlier in the day, he said, “Rapidly changing competitive environments in commerce and payments underscore the opportunities for eBay and PayPal, and highlight how each business will benefit from the focus and agility of being an independent company.”
Swan later added the process of separating the companies will occur in three parts. First, eBay and PayPal will create operating agreements that will govern their future arms-length relationship, meant “to preserve relationships between businesses while minimizing dis-synergies,” according to Swan.
The next step will be to determine the appropriate levels of capitalization for each independent business. The future eBay marketplace entity will retain all existing debt, while both companies will get a portion of the company’s cash holding to fund future growth. Swan hinted here that there could be some stock buybacks prior to the spinoff, meaning just how much cash will be available mid-next year is currently unclear.
Finally, eBay will file its Form 10 with the SEC formally outlining the proposed transaction in the first half of 2015, and plans to complete the separation during the second half of the year.
When asked by a Goldman Sachs analyst about the decision making authority of future eBay and PayPal CEOs Devin Wenig and Dan Schulman will have in the interim, Donahoe deadpanned, “None.” Joking aside, he reminded listeners that he and Swan remain “on the hook” for the combined company’s financial performance pre-separation and that while they will do everything possible to set each company up for mid- to long-term success, it won’t be at the expense of eBay’s near-term performance.
As mature businesses in two highly competitive categories, both eBay (marketplace) and PayPal face real challenges ahead as standalone companies. But today’s earnings report, and the dramatic contrast in the performance of each business, underscores just how necessary a split is. Assuming they can maintain most of the existing synergies through arms-length relationships, the transaction should be positive for both companies when it comes to flexibility and the ability act strategically.
Expect to see PayPal emerge as the stronger, and likely more valuable of the two companies post-split. The payments company has been far more innovative (both organically and through acquisition) and remains atop one of the most valuable and strategic of categories. Ebay, on the other hand, seems like an aging brand and business model that, while we shouldn’t expect it to go away anytime soon, faces serious headwinds and shows limited signs of life in its ability to reinvent itself.
This said, it could be as much as a year until we get to see an independent PayPal and eBay. A year is a relatively short time in the lives of these two-decade-plus old giants, but in technology (and on Wall Street) it’s a small eternity. Place your bets accordingly.