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