When Should Companies Split: An Analysis of Ebay and Paypal Split
Every day, there seems to be a constant stream of companies opening their doors and businesses jumpstarting their operations. This does not come as a surprise, as people are always coming up with business ideas and will go to great lengths to get these ideas implemented and take shape. In the thriving and competitive world of business, it is also common to hear talks about mergers and acquisitions, as well as expansions and bankruptcies. Businesses acquiring other businesses and companies joining forces with other similar companies seem to be the norm, especially for those that are eyeing growth and further development.
Just as you will hear a lot of businesses merging and joining forces, there are also businesses that take the other route: they split. This is often seen in the case of giant corporations and very large companies.
This article provides insights about 1) reasons for company splits, 2) when should a company be split, 3) the eBay and PayPal split.
REASONS FOR COMPANY SPLITS
We can probably enumerate more than a dozen reasons why this or that company should split. However, there are three main reasons why companies decide to break off in half, or in various pieces.
1. To improve organizational focus and strengthen management
Often, in the case of large companies that have complex structures, there is a great possibility of the structure becoming convoluted and messy. A company split is performed in order to clean it up.
Take, for example, the case of the information technology giant Hewlett Packard. Its organizational structure is comprised of several groups or divisions, such as the IPG or the Imaging and Printing Group (for imaging and printing systems, products and technology), the PSG or the Personal Systems Group (for personal computers), the EB or the Enterprise Business (which includes HP Technology Services and various Enterprise Security Services), and the HP Software Division, to name a few.
On October 6, 2014, HP announced its plans of a company split, separating the enterprise or corporate products and services business from the personal computer and printer business. The result would be two companies: HP Inc, which will focus on the consumer-facing hardware, such as printers, personal computers, and the like, and HP Enterprise, which will be devoted to the enterprise-focused products and services. The targeted completion date of the split is October 2015.
Analysts reflect that the organizational mess that spurred HP to decide on a company split can be blamed on the fact that it dipped its fingers on too many pies at once. It already has quite an extensive and diverse product mix, and that is already one cause of confusion, but then it started to go after corporate clients, as well as homeowners and other direct consumers. In short, its attention was now divided and focusing on one thing at a time is going to be difficult.
The company split will then allow HP to remind management about what is truly important for them. The respective management of the two companies will then be able to focus on their businesses, without being affected by the other.
2. To maximize shareholder value
In the case of the upcoming HP split, the stakes of the shareholders of the original single company will be divided equally between HP Inc and HP Enterprise.
Keep in mind that shareholders are more concerned about cash flow and getting a return on their investments in the business. Naturally, the growth of a business will mean higher returns for them. Therefore, they would appreciate seeing a company take aggressive measures in order to achieve that growth, especially if the company is clearly being held back from doing so.
A company split will help accelerate growth, especially if one business manages to separate itself from a company that cannot seem to keep up. In the case of HP, it turned out that the consumer-facing PC and printer segment became so huge, accounting for around half of the revenue of the entire company. The other segments seem to be lagging behind in comparison, so shareholders were likely feeling a bit antsy since the synergy is no longer there. They are no longer benefiting from each other, and so shareholders see that their investments are not being maximized.
By making the split, both of the two separated companies will be more focused. HP Inc can grow freely, and HP Enterprises can also implement its strategies for growth. Each company can now pursue their growth strategies independently and make their investment decisions.
3. To optimize investments
Shared ownership can hamper segments from making investment optimizations decisions. They cannot freely decide on how to allocate investment dollars for their strategies, divisions, and projects without first having to confer with the other segment. In a complex structure such as HP, there tends to be a hierarchy or prioritization, and if the segment is slightly low on the priority list, they will not be able to allocate investments properly and efficiently.
Once the split has been closed, HP Inc and HP Enterprises can now separately channel their respective investment dollars to the right areas of the business.
WHEN SHOULD A COMPANY BE SPLIT?
When it comes to company splits, timing is also very crucial. Just as there is a right time to start a business or to think about merging it with another, there is also a right time to effect a split. Here are the tell-tale signs that a company should consider splitting up.
- When one segment of the business is relying on another segment for its survival. When it is clear that one segment is already suffering because it is used to “feed” the other segment, it is time to think about making a permanent separation. If you do not act accordingly, the non-performing segment may just drag the other performing segment.
- When the business, as a whole, cannot keep up with the growth and advancements in the market and industry it belongs to. This is often seen in the case of tech companies. Technological innovations keep on springing left and right, and it is possible that a segment of the business may be able to keep up while the other segment could not. Split the segments into two businesses instead so the slow-growing business segment can better focus on its own “backyard”.
- When the investors of the business have different preferences. One group may prefer that the business take aggressive steps towards growth and gaining a bigger chunk of the market. On the other hand, another group may be content with the way things are going, provided the business is getting a steady income and growing steadily, albeit slowly. These difference in opinion may be a reason to consider going for a split.
THE EBAY AND PAYPAL SPLIT
The separation of Ebay and Paypal is one of the hottest news to hit the business front in recent years.
Paypal, the worldwide online payments system and currently one of the largest internet payment companies in the world, was established in 1998 but became an eBay subsidiary when the e-commerce giant acquired it in 2002. It was considered to be a match made in heaven, as Paypal became the default payment method used by most eBay users, accounting for over 70% of all eBay auctions.
Paypal has shown an impressive growth rate in the following decade, most notable of which are its acquisition of the VeriSign payment solution, its partnership with MasterCard, the enhancement of its fraud management systems through the purchase of the startup Fraud Sciences, and its acquisition of another online payments company called Bill Me Later. Most recently, Paypal also became partners with Discover Card and also acquired engagement software developer IronPearl and the payment gateway BrainTree. It became even bigger when it decided to move offline, allowing customers to make Paypal payments in stores, and not just online.
In the beginning, Paypal greatly relied on eBay transactions for the volume of payments made through its system. However, as the years passed and Paypal became more proactive, it was able to get payments through and from channels other than eBay. Case in point: almost 50% of payments processed by Paypal were through eBay auctions back in 2009. In 2014, that figure was down to barely 30%. It is also earning huge margins and is even expected to exceed half of the total earnings of eBay in several years. eBay CEO John Donahoe even predicted that, come 2018, only 15% of Paypal’s annual revenues will come from eBay, with the remaining 85% coming from other sources.
These recent developments have certainly placed Paypal in a very good position. In fact, it can be clearly seen that Paypal no longer needs eBay to sustain itself.
Reason for the Ebay & Paypal Split
There were many speculations on why Paypal has decided to go its way now, separate from eBay. Some said several investors were already itching for the online payments company to go independent because it is already “wasted inside eBay”. Others said that the competition with Apple and other online payment startups call for a more aggressive stance in claiming its exclusive market share.
Those are valid points, and perhaps they hold more than a little water. However, the primary reason for the split is clearly the fact that Paypal can already stand solidly on its own two feet, and it will be able to take greater strides on its own, unhindered by management from eBay.
Together, eBay and Paypal have proven to be a strong business. Separately, they will be even stronger. Both companies agree that the synergy – and its benefits – to the two segments are dwindling or declining. By splitting, the two entities will still be able to co-exist via arm’s length transactions, where they will benefit even more than when they were under one umbrella.
In the statement released by Donahoe regarding the impending split, he also acknowledged how the market and industry landscape has been evolving and becoming more challenging. Businesses are presented with more opportunities that they can take advantage of. The split, he says, will unlock shareholder value, seeing as it can be more aggressive in how it attacks the market and further deepens its hold.
The future for both companies
After the split, Paypal will now be a publicly held company, separate from its former parent company, eBay. Dan Schulman, formerly of American Express, was named as President of Paypal while current President of eBay Marketplaces, Devin Wenig, will become the new CEO of eBay.
Whether the split turns out to be a good idea or a bad one is yet to be seen. However, the figures are good for both companies, and they are expected to be even better. Clearly, the split has been thought through, and the efforts made to ensure the transition is as smooth as possible are obvious.
It was a good idea for the two companies to decide to remain friends after the split. They even signed an agreement that prohibits them from competing against each other with respect to their core businesses. Ebay will not establish its payments system while Paypal cannot set up its marketplace to rival eBay. Both parties, however, are not prohibited from working with other external direct competitors. For example, Paypal can provide its payment systems service to other marketplaces for physical goods while eBay can employ other online payment companies for its transactions.
In the event, however, that Paypal will be acquired by another e-commerce company (a rival of eBay), this would give eBay the go-ahead to build its own payments system, but only after giving a 15- to 20-month notice in advance to Paypal.
Analysts say that, in the long term, the split will eventually make the two companies targets for acquisition by larger rivals. In the case of eBay, a possible acquirer is the Chinese e-commerce company Alibaba. Meanwhile, competition in the payments space is becoming even stiffer, especially with the recent entry of Apple Pay into the fray.
The separation, however, could be seen as a good time for Paypal and eBay to focus on their core businesses: eBay on its marketplace business and Paypal on its payments system. While it is true that the spin-off does not, in any way, affect the ever-increasing rate of competitors springing up left and right, it will, however, put them in a better position to face down these threats separately.
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