Like many of its customers, auction giant eBay has decided to use PayPal as its electronic payment system.
On Monday, eBay said it is acquiring online payments company PayPal in a deal valued at $1.5 billion. eBay will also phase out its own competing service, eBay Payments by Billpoint.
PayPal, which went public earlier this year, allows consumers to make and accept payments over the Internet without using a credit card. The bulk of its business comes from eBay auctions.
With the acquisition, eBay gains control of the popular electronic payment service favored by many of its customers. "PayPal is the 'gorilla' in the online payment market, as eBay is the 'gorilla' in the online auction market," Merrill Lynch analyst Justin Baldauf said in a research note.
eBay bought Billpoint in May 1999 but did not fully launch the service until spring 2000. Despite heavy promotion, Billpoint has struggled to win market share from PayPal.
According to PayPal, it handles payment for one in four winning auctions on eBay. Given that eBay is hoping to boost the use of electronic payments for auctions, analysts said it was easier to buy its rival than to beat it.
eBay said it is hoping to increase the number of electronic payments made via eBay. The bulk of transactions on eBay are still conducted via check or money order.
eBay CEO Meg Whitman said the PayPal acquisition will help both customers and the company's bottom line by speeding up the payment process. Buyers and sellers complete transactions days faster using electronic payments, Whitman said.
Whitman, speaking on a conference call, said about 40 percent of eBay transactions are settled with electronic payments, a figure she hopes will "increase dramatically."
"It's very hard to give a specific number--two years ago it was practically zero--but I would think 60 to 70 percent range would be a realistic goal," she said.
Although the PayPal-eBay rivalry was heated at times, the two parties said they had been talking over a deal for a month. Analysts had long expected some sort of deal between the two companies.
"eBay and PayPal have built vibrant user networks on the Internet," PayPal CEO Peter Thiel said in a statement. "The beauty of this deal is that it will allow us to offer our communities new tools and added flexibility to do more business."
One longtime eBay and PayPal user, however, wasn't impressed.
Harrisville, Rhode Island, resident Donna Pelletier said the acquisition of PayPal gives eBay too much control over her business.
Pelletier, who sells books and collectibles on eBay, had avoided using eBay's Billpoint service. She said she may abandon PayPal, even though her customers use the service to pay for about 80 percent of her auctions.
"I don't want to get rid of PayPal, but I may have to down the road because I just don't think it's right," Pelletier said. "My auctions are supposed be my business. I don't want eBay having total control of it."
Changes for PayPal
PayPal will continue to offer its service as an independent brand, but there are some changes ahead.
eBay Chief Financial Officer Rajiv Dutta said eBay will discontinue PayPal's online gaming business, which was expected to account for 10 percent to 15 percent of total revenue in fiscal 2003. Dutta said the move is due to the "uncertain legal situation" around online gaming. Citibank recently said it would stop allowing its credit cards to be used for online gambling, and a bill is currently pending in Congress that would ban online gambling.
PayPal also brings other problems to the table. A few states have begun to question whether the business constitutes illegal banking or money-transmitting services. PayPal also faces several class-action lawsuits from customers who claim the company illegally froze their accounts.
eBay's biggest goal right now should be improving PayPal's somewhat poor reputation for customer service, said Forrester Research retail analyst Carrie Johnson.
"PayPal users have a love-hate relationship with the service mostly because of customer service problems," she said. "PayPal has had so many problems with customer service in terms of being difficult to reach, etc. If eBay can put a little muscle behind the service, PayPal users will be pleased, as opposed to being alienated or frustrated by the change."
PayPal has tried to branch out beyond eBay and launched a bill payment service in February. Thiel said on the conference call that "seamless integration" with eBay should enhance such services.
But Forrester's Johnson said she believes eBay may dump the extra services to focus on auctions.
"There's plenty of room to grow in the auction business," she said. "PayPal had to look for other sources of revenue. eBay doesn't have to do that. I would expect them to make sure they can get the core service down pat."
Extra services aside, a big reason for the PayPal deal is eBay's quest to hit $3 billion in revenue by 2005.
In a research report last year, Pacific Crest Securities estimated that eBay would garner more than $7 million in revenue for each point of market share it took from PayPal in 2002.
The deal is also likely to help eBay's bottom line. "The combination of the two networks should expand both platforms while minimizing shared operational costs," eBay said.
Billpoint was losing around $10 million to $15 million per year, according to eBay's Dutta. One reason the service was not making money is that its customers are more likely to use credit cards to access the service, which costs eBay more money than if they use bank accounts. PayPal has a "better mix," Dutta said, and therefore lower costs.
PayPal reported reaching operating profitability before it went public, and last month the company said it expected to report second quarter revenue of $53 million to $54 million, with pro forma earnings per share of 8 cents to 9 cents.
While eBay generally reports gross margins in the 80 to 83 percent range, executives estimated that PayPal's margins, if they were calculated using the same formula, would be around 45 percent.
Wall Street analysts said eBay paid a fair price. Baldauf said the premium eBay paid for PayPal was "modest."
The deal calls for PayPal shareholders to receive 0.39 shares of eBay for each share of PayPal. That values each PayPal share at about $23.61, based on eBay's Friday closing price. That is a 15 percent premium over PayPal's Friday close.
The purchase price will include around $18 million in acquisition-related costs. eBay expects the deal to be a boost to pro forma earnings. But, because of charges of $13 million per quarter for stock-based compensation and amortization of intangible assets, the deal will cut into net earnings per share.
Separately, eBay on Monday announced preliminary results for its second quarter, posting a profit of $54.3 million, or 19 cents per share, on sales of $266 million. Analysts had been expecting the company to report a profit of 17 cents per share on sales of $264 million, according to First Call. eBay said it was particularly helped by its U.S. auctions business, which grew 48 percent year over year. International sales rose 148 percent year over year. eBay will announce complete second-quarter results July 18.
News.com's Troy Wolverton contributed to this report.