Fitch: No Change to eBay's Ratings, but Long-Term Credit Overhang Expected from Icahn Proposal

NEW YORK--()--Fitch Ratings does not expect to take any immediate action on eBay, Inc.'s (eBay) ratings following last week's announcement of a proposal to spin-off PayPal. The proposal from Carl Icahn to separate PayPal from the remaining business (eBay MarketPlaces) is predicated on the assumption that both companies should have higher multiples as standalone entities than the current valuation of the combined entity. Fitch believes the proposal ignores the financial flexibility PayPal could require in navigating the ultra-competitive mobile and offline payment markets. Management has also cited product and market overlap as a rationale for keeping the companies together.

While Fitch does not expect any action in regard to PayPal in the near term, a potential spin could be a modest negative event for the company's credit profile. Fitch believes this issue will be an overhang to the credit for the foreseeable future and could eventually force management into some action. Separately, eBay announced a $5 billion share repurchase plan, which Fitch does not view as material to the credit for reasons discussed at the end of this commentary.

Marketplaces Still an A-category Profile with PayPal Spin, but Leverage Could Rise:

If eBay were to spin-off PayPal today, Fitch believes this would be a modest negative credit event for bondholders. While leverage metrics would remain strong under any number of scenarios, the remaining company would make an attractive target for further leverage. A stand-alone Marketplaces business also has longer-term business risk as its future growth is tied increasingly to efforts to bridge the gap between offline and online retail.

Fitch estimates eBay's current leverage at 0.8x with approximately $4.1 billion in debt and $5.4 in EBITDA for the year 2013. PayPal represented approximately $1.6 billion of total EBITDA or 30% of the total. Assuming no change in debt, eBay Marketplaces leverage pro forma for a spin-off of PayPal would rise to 1.1x. Fitch believes this leverage coupled with the strong market position of eBay Marketplaces and solid free cash flow would still be a solid credit, likely in the 'A' category.

Fitch has cautioned of the potential to split PayPal from eBay Marketplaces and the longer-term ramifications for several years. At the current rating, PayPal benefits from access to low-cost capital while Fitch believes that Marketplaces has minimal business need for a strong investment grade rating. Fitch believes that splitting off PayPal could lead management to take a more aggressive approach to the capital structure as a means of boosting shareholder returns. Following the rationale behind the proposed spin, it seems unlikely that the focus on shareholders would simply end there.

PayPal Divestiture Unlikely in the Near-Term:

Fitch does not believe that any significant change in the corporate structure will occur near-term. Management has stated that it opposes any effort to separate PayPal and evaluates such scenarios regularly. The company has cited numerous strategic and economic reasons for keeping the companies together. Both entities are in the early stages of long-term efforts to expand the respective businesses from online-centric to omni-channel platforms with the inclusion of mobile and offline markets. The products are well integrated and leverage different technological capabilities to some degree. PayPal also leverages consumer data from eBay Marketplaces in its risk management process. The principal economic benefits are that PayPal has higher margin business through eBay channels and that cash generated from eBay Marketplaces helps fund PayPal's expansion.

In Fitch's view, the long-term goals of each are neither co-dependent nor mutually exclusive. PayPal's ultimate success in becoming a preferred payment mechanism through mobile and offline, a very long-term goal, is not particularly dependent on the future performance of eBay's Marketplaces. Nor is Marketplace's focus on bridging the divide between offline and online tied to the success or failure of PayPal. There are some modest product and marketing synergies whereby the combination of both PayPal and the remaining eBay businesses are more effective together than apart. The strategic relevance of the combination may just as effectively be addressed in some form of partnership though.

The diversification of risk offered by the combination of the two businesses longer-term may actually be a significant reason to keep the companies together. Both are unquestionable leaders in their respective original markets. Both are attempting major business transformations that will take years to gauge whether they are successful. The upside to each is significant, as is the downside. It is fair to question whether PayPal could retain its position in online payments if it is not successful in mobile payments. The cash generative nature of each business and the diversification of outcomes likely provide management comfort in making these investment decisions. Would Marketplaces as a standalone business have the same long-term strategy it has now? Would PayPal as a standalone business be able to make the investment it will need to change consumer purchasing habits offline and lead the market in mobile payments? Financially speaking, the answer to both is yes, but Fitch believes the strategic rationale is stronger as a combined entity rather than as separate businesses.

The economic benefit to PayPal of being highly integrated in Marketplaces has been enormous but is less compelling going forward. PayPal's unique advantage in the fight for mobile and offline payment adoption is its 100 million-plus user base which was largely enabled by its combination with eBay. However, Fitch believes that the opportunity for PayPal going forward is almost entirely outside of eBay. The higher margin business through the eBay channel likely stems from the source of funding in those transactions. PayPal's margin is severely impacted when a transaction is funded via credit card. PayPal users on eBay are probably more likely to have funds in their PayPal accounts or have it linked to their bank accounts.

Management may see the combination with Marketplaces as being more significant in the transaction funding issue longer-term. This is a key risk to PayPal as it expands; can it replace the usage of credit cards offline and mobile rather than simply be a conduit for credit card transactions, in which case the business model is a lot less attractive. It is not clear to Fitch how a combination with eBay Marketplaces would play a material role in this regard for merchant services (non-eBay) transactions. The ability to grow the consumer lending business, Bill Me Later (BML), as an alternative to credit card funding is a more relevant issue. While the inclusion of eBay Marketplaces today helps fund BML, Fitch believes a standalone PayPal would be able to access reasonable financing for this part of its business.

Resolution of Shareholder Activism Uncertain - Overhang to the Credit Guaranteed:

While the cost / benefit analysis of a separation of PayPal may be unclear, the potential means and timing of a resolution to the shareholder activism is murky. As a result, Fitch expects this issue to be a significant overhang to the credit for the foreseeable future. While Icahn has raised his stake in eBay following the announcement, to date there have been no public announcements of other institutional investors joining his push to separate the companies. That said, Fitch does not expect Icahn to walk away from his proposal anytime soon, and he has indicated a willingness to engage in a proxy fight with the company.

The timing of eBay's soft guidance for 2014 and 2015 is unfortunate for management. Fitch believes that further weakness in earnings or guidance could lead to greater support for Icahn's position from other investors. Given the significant transition the businesses are undergoing and the strong benchmarks management had provided to investors in its three year roadmap just last year, the risk of further disappointments is natural. While this may not be enough to ultimately force the issue with PayPal, it could certainly be enough to keep the issue on the table long-enough to force some activist solution from the company.

Potential Alternatives:

Fitch believes management will ultimately need to make some change to resolve this issue. There are numerous potential courses of action, and the probability of any particular option being chosen will likely change the longer this remains unresolved. In the near term, an outright separation of PayPal is the least likely outcome yet more likely the longer this goes. Icahn has stated it sometimes takes years to accomplish his goals, a timeframe that may be realistic here.

A leveraged share repurchase could be an alternative, particularly if there is no momentum for Icahn's position. Yet it is doubtful that management would be inclined to pursue that approach unless it was really immaterial to the overall capital structure. Still it could be a way out particularly if there is an extended stalemate.

An equity carve-out of PayPal as a publicly traded subsidiary of eBay could be attractive in part to both parties and not necessarily a bad deal for bondholders. Fitch believes this provides management the flexibility to continue the strategic direction of both companies while also giving shareholders the ability to invest in one (PayPal) or a mix of both MarketPlaces and PayPal. It also sets the stage for a longer-term complete separation of the companies, which Fitch believes will likely happen over the long-run, regardless of the Icahn proposal.

A separately traded PayPal has benefits both in terms of a potential acquisition currency but also establishes a market price for the company should a strategic combination come along. If PayPal is ultimately to be successful in mobile and offline payments, it may need to join forces with another partner well established in offline transaction processing.

Fitch believes this also helps bondholders who would likely remain at the eBay Marketplaces entity with any potential transaction. PayPal benefits from a solid balance sheet and high investment grade rating. If it remains a majority owned subsidiary of eBay Marketplaces, it would likely limit the potential to significantly increase leverage at the parent.

Ratings Impact:

At this point in time, there is no impact to the ratings as we believe the outcome is highly uncertain and the timing of any action is beyond the near-term. If momentum for shareholder activism increases or eBay indicates that it is considering a strategic action in response, it is possible the rating outlook could be changed or the ratings placed on Negative Watch. While it is possible the ratings could be negatively impacted by any resolution to the matter, it is equally possible that there is no change at the company and no impact to the ratings over the next several years.

Current Valuation:

The debate as presented by the Icahn proposal is centered on the potential for PayPal to command a higher trading multiple than what is currently represented in the combined entity. Based on the recent stock price of $55, Fitch estimates eBay's enterprise value at roughly $67 billion which is 12.5x LTM EBITDA. PayPal's EBITDA has grown at a CAGR of approximately 30% the past three years, similar to management's guidance through 2015. The eBay Marketplaces business has grown roughly 15% each of the past three years, also in-line with guidance from management through 2015. For arguments sake, if one assumes PayPal would trade in a range of 20x to 30x LTM EBITDA as an independent company, that would imply a 5x to 9.3x multiple for eBay Marketplaces based on the current enterprise value

Share Repurchase Plan Does Not Impact the Ratings:

eBay announced that its board has approved a new $5 billion share repurchase program which the company will use to offset dilution from options and for opportunistic repurchases. There was no timing associated with future repurchase activity but Fitch expects that this could lead to a modest increase in debt at the company. eBay ended the year with $1.7 billion in cash in the US plus $2.8 billion overseas and $8.3 billion in investments. Fitch would expect the company to finance near-term repurchases with debt to avoid depleting its US cash balance but for any increase in leverage to be modest and likely temporary. Fitch does not believe that the share repurchase plan is materially negative to the credit given the company's strong liquidity and nearly $4 billion in annual free cash flow.

Fitch currently rates eBay as follows:

--Long-term IDR 'A';

--$600 million 1.625% senior unsecured notes due 2015 'A';

--$250 million 0.70% senior unsecured notes due 2015 'A';

--$1 billion 1.35% senior unsecured notes due 2017 'A';

--$500 million 3.25% senior unsecured notes due 2020 'A';

--$1 billion 2.6% senior unsecured notes due 2022 'A';

--$750 million 4.0% senior unsecured notes due 2042 'A';

--Short-term IDR 'F1';

--$2 billion 4(2) commercial paper program 'F1'.

The Rating Outlook is Stable.

RATINGS SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action include:

--Further growth and diversification of eBay's business and sources of cash flow. Specifically, if PayPal grows to represent half or more of cash flow generation and debt financing needs of the overall company remain minimal, positive rating action could be warranted.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

--The potential to separate the PayPal business from eBay Marketplaces, although not a likely scenario in the near term, with the potential to add materially greater leverage to the remaining Marketplaces business.

--If normalized free cash flow to total adjusted debt falls close to the 20% level or if the company institutes a share repurchase program in excess of FCF.

Additional information is available at 'www.fitchratings.com'.

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

Contacts

Fitch Ratings
Primary Analyst:
Jason Paraschac, CFA, +1-212-908-0746
Senior Director
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst:
Jamie Rizzo, CFA, +1-212-908-0548
Senior Director
or
Media Relations:
Brian Bertsch, New York, +1 212-908-0549
brian.bertsch@fitchratings.com

Sharing

Contacts

Fitch Ratings
Primary Analyst:
Jason Paraschac, CFA, +1-212-908-0746
Senior Director
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst:
Jamie Rizzo, CFA, +1-212-908-0548
Senior Director
or
Media Relations:
Brian Bertsch, New York, +1 212-908-0549
brian.bertsch@fitchratings.com