Can PayPal Pull This Off

In an Internet market starved for success stories, PayPal is one of the few
upstarts brimming with potential. Still, the Palo Alto company, which handles
payments for buyers and sellers on the sites of auctioneer eBay and other
e-commerce players, left the high-tech world agape when it filed paperwork on
September 28 for an $80 million IPO. The move came just 17 days after hijacked
jetliners crumbled the WTC towers and knifed into the Pentagon, killing
thousands and pretty much guaranteeing a US recession. Investors are so skittish
that not a single company went public in September, the first month without an
IPO since Gerald Ford was in the Oval Office.

What gives? PayPal can’t offer a public explanation because of the
Securities & Exchange Commission-mandated quiet period for pre-IPO
companies. However, interviews with analysts and investment bankers, and an
examination of the company’s IPO paperwork, shed some light. PayPal isn’t
desperate for cash. The company boasts $135 million in cash and short-term
investments as of June 30–enough to fund the company for two more years.

The likely catalyst for PayPal’s IPO bid: It has taken a hefty, if tenuous,
lead in handling online payments for consumers and small businesses and is
seeking to cement its position before well-heeled rivals can make up ground.
PayPal says it has 65% of the market for electronic payments in online auctions,
vs 25% for Billpoint, which is majority-owned by eBay. Billpoint’s revenues
soared 181% between the first and second quarters of this year, much faster than
PayPal’s 36% growth–although Billpoint started from a much smaller figure.
PayPal, which spent only $45,000 on advertising in this year’s first six
months and relied on word of mouth to build its customer base to over 10 million
accounts, would benefit greatly from the increased visibility and respect that
come with a successful IPO.

Another reason for PayPal’s IPO filing could stem from its efforts to sell
the company. Earlier this year, PayPal executives discussed selling to eBay,
Citibank, and other companies, but no one would approach PayPal’s asking price
of more than $700 million, according to analysts and investment bankers. Filing
to go public may put pressure on would-be buyers to boost their offers.
"They’ve probably got dual (financing) strategies," says a Wall
Street analyst who follows Net-payment companies and insisted his name not be
used to protect his relationship with PayPal.

PayPal could end up outsmarting itself. If public investors won’t meet the
company’s asking price, which analysts believe will value the entire company
at $700 million to $900 million, PayPal could find itself in a tight spot. Does
it drop the price of the IPO and force its private investors to take a haircut?
Or does it withdraw the offering and focus on negotiating with potential buyers–albeit
from a weaker bargaining position?

Although its IPO may be a tough sell, PayPal has quite a bit going for it. By
providing easy-to-use accounts from which buyers and sellers can instantly
exchange money over the Internet, PayPal has become popular among eBay users who
had previously been sending checks in the mail and trusting that sellers would
deliver the goods as promised. In the past six quarters, PayPal’s customer
ranks have jumped more than tenfold, to 10.5 million accounts, generating $750
million in transactions. PayPal’s take: 2% to 4% of each sale, depending on
the amount of monthly business the seller does, as well as 30 cents per
transaction.

Even more impressive is the fact that it far outpaces eBay-owned BillPoint on
the auction giant’s own site. Some 70% of eBay sellers have signed up for
PayPal, vs 30% for BillPoint. PayPal’s popularity feeds on itself, as buyers
and sellers flock to the payment platform where they can transact with the
largest network of people.

PayPal’s financial picture, especially its link to eBay’s thriving
business, has sparked at least lukewarm interest from institutional investors.
This year’s first-half revenues of $34.2 million are up from $3.3 million in
the same period last year. Although PayPal lost a total of $56.9 million in the
past two quarters, $32.8 million of that came from amortization of goodwill, a
charge that doesn’t cost the company cash. A true viral-marketing company,
where word-of-mouth brings in most new users, PayPal spent only 14 cents to add
each new customer account in June, down from $6.30 per account last year.

PayPal’s success has grown out of a number of misfires. The technology was
originally developed by a Silicon Valley startup called Confinity, backed by
mobile-phone giant Nokia. When Confinity introduced the PayPal service in 1999,
its focus was on letting people make payments with their mobile phones. But the
mobile-commerce market was slow to develop, and Confinity sold out in March
2000, to X.com, a Palo Alto company that was developing a finance website.
During 2000, X.com recognized that many larger companies, including E*Trade
Group and Yahoo!, were far ahead in building successful finance sites. So X.com
founder Elon Musk shuttered its online finance operations, renamed the company
PayPal, and concentrated on electronic payments. Today, PayPal’s 33-year-old
CEO, Peter Thiel, and much of its management team–which averages 32 years of
age–are from Confinity.

While the revamped PayPal is generating interest from some investors, it may
not get a valuation that it likes. The company raised $90 million in its last
round of private funding in March, valuing the whole company at $700 million,
according to analysts. But PayPal’s quest to hit that mark in an IPO appears
to be a stretch. PayPal’s publicly traded rivals, including CheckFree Corp,
trade at about 2.5 times next year’s revenues. Assuming PayPal hits the
highest analyst estimates of $100 million in revenues this year and can somehow
double that to $200 million next year, the same multiple would put PayPal’s
valuation at roughly $500 million.

Even that is no sure thing. While the IPO market is rough for any company, it
is even worse for Internet upstarts. Only one Net company, Web-hosting startup
Loudcloud, has been able to go public this year–down from 129 Internet IPOs in
2000, according to market researcher IPO.com. Loudcloud’s stock has plunged
77% since its March offering. Investors are particularly wary of unprofitable
companies, and PayPal is not slated to make money for at least two more
quarters. "The company lost $170 million last year, and its maximum
offering would raise $80 million. Ratios like that always make me a little
uncomfortable," says Marc Baum, CEO of IPO.com.

With the interval between the SEC filing for an IPO and the actual offering
doubling on average (since the start of 2000) to nearly 140 days, PayPal will
likely get at least one more quarter to bolster its numbers before testing
investor appetites. With scores of Internet companies searching for any glimmer
of hope, PayPal executives aren’t the only ones hoping they can pull it off.

By Ben Elgin in BusinessWeek. Copyright 2001 by The McGraw-Hill Companies, Inc