Pando

Congrats on your independence, PayPal! (I give it two years)

An asset so nice, I bet it's acquired twice.

By Sarah Lacy , written on July 24, 2015

From The Money Desk

Finally! The Internet and Wall Street Gods have heard our cries.

For years, people have argued that PayPal “deserves” to be an independent company.

The rumbling started with the original PayPal mafia. As PayPal’s value grew beyond that of its corporate parent eBay, many wondered how dominant the company could have become, had it not sold. No matter how ineffective PayPal’s management was at times, no matter how bureaucratic the company became, it was still the dominant payment company on the Web. What could it do on its own?

Those thought experiments hit a fever pitch in recent years with everyone from internal PayPal execs to Carl Icahn shouting the same pleas for independence. Finally, this week, it happened: PayPal was spun out. It’s now a publicly traded company worth some $45 billion.

And yet, I’ve asked this before and I’ll ask it again: Does anyone actually think this independence will last? PayPal is just too good of an asset for someone not to want to own it. I can’t imagine it’ll be more than two years before another Internet giant buys them again.

One of the strange things about PayPal is how dominant it is-- particularly since acquiring Braintree-- and yet what a small sliver of the market it has. As Kevin Kelleher wrote last week:

PayPal says that there is a $25 trillion addressable market in digital and in-store commerce. This sounds fine, but it’s the kind of blue-sky scenario that is the bread-and-butter boilerplate for technology companies approaching investors. The US GDP is around $16.8 trillion and the economy for the global economy is estimated around $75 trillion. Any company – even Amazon – that cites that figure and expects to be more than a fingernail clipping cast off the body of that beast is just trying to get you excited.

In reality, PayPal handled $235 billion in total payment volumes last year. That is 0.94 percent of the addressable market which PayPal claims it is serving. Think about this: How is it that a company founded 17 years ago to handle global e-commerce payments still able to control less than 1 percent of its market? Look at what Google has achieved toward its stated goal of organizing information. Look at what Facebook did in rearranging the way the world communicates. Yes, PayPal is the largest and most trusted company in digital payments. Yes, financial services have been slow to disrupt relative to media. But alongside PayPal's vaunted list of accomplishments has always been a sense that it's also underwhelming.

This weird catch-22 harkens back to the original argument for why it should be spun out-- just think of what PayPal could do!-- but which also makes it such an attractive target. You are buying a cornerstone for how money moves around the global Internet, and yet one that is still growing and has so much potential for growth ahead of it.

In addition, Google, Amazon, and so many other Internet giants have tried and failed to build some sort of proprietary payments company. Facebook has toyed with the idea of payments. At Pandoland last month, Stan Chudnovsky-- a key part of the recent PayPal team just before the spin out and now a part of David Marcus’ team building Facebook Messenger-- even hinted at the idea of payments becoming a part of Messenger, comparing what they wanted the service to be to how leading Asian messenger services work. He described bringing so much of the functionality of the Web -- including commerce -- into the messaging app.

If you think more about PayPal as a small business tool, you could see Microsoft being interested.

The list of companies that can buy PayPal is limited, but these Internet giants aren’t the only ones. There are the big financial companies: Visa, MasterCard, American Express.

And what about the Asian giants? PayPal would be an incredibly strategic buy for Tencent or Alibaba, given their dominance of the online payment business in China, and the fits and starts and challenges they’ve had trying to establish a strong business in the West. It might be the only combination that could yield a truly globally-dominant payments giant.

Every time I ask this question to someone in the hedge fund world, they readily agree. Every time I’ve asked this question to PayPal execs they mostly shrug and say they can’t predict the future. But I’ve not yet heard a great argument for why this won’t happen -- and likely in the next few years.

I don’t mean any of this as a knock on PayPal-- rather it’s a compliment to how valuable it is. And I think the management team genuinely wants to run an independent company.

To me, PayPal’s only hope to keep its independence is to execute so well and post enough growth that investors would see enough value to keeping this thing independent. If that happens, at least the purchase price would have to be at a steep premium.

It might be worth a publicly-traded PayPal to do some bigger acquisitions. The conventional wisdom was that once it bought Braintree, Stripe or any other company that had hoped to be acquired by the payments giant was SOL. But now, with a strong public currency, why not gobble up Stripe and Square? Price would be an issue: Both Stripe and Square have inflated valuations in the multiple billions, but both also have huge developer and small business fan bases and a lot of talent. If PayPal is serious about keeping this independence, it may have to get more aggressive about showing that to Wall Street.

Whatever the playbook, what investors need to see is a different PayPal as a public company, not the same juicy asset growing organically quarter over quarter as the digital world’s financial plumbing, just begging to become someone’s crown jewel again.