Condor in the News - Commentary on EBAY

EBay Bets PayPal In-House Beats Pop From Icahn Plan: Real M&A
2014-01-24 21:26:02.824 GMT
     (For a Real M&A column news alert: SALT REALMNA .)
By Brooke Sutherland, Brian Womack and Tara Lachapelle

Jan. 24 (Bloomberg) -- EBay Inc. is willing to forgo a
possible 26 percent stock pop by rejecting Carl Icahn’s proposal
to split off PayPal, banking instead on the promise of longer-
term rewards by keeping its online payment unit in-house.

Shareholders including Sterling Capital Management LLC and
Kornitzer Capital Management Inc. are, so far, backing the
stance of Chief Executive Officer John Donahoe, who says that a
unified EBay helps fund PayPal’s expansion. Activist investor
Icahn called a separation of PayPal, one of EBay’s fastest-
growing businesses, a “no-brainer” that would improve value.

While EBay’s breakup value is pegged by analysts and
investors at about $69 a share, compared with $54.94 yesterday,
investor Condor Asset Management Inc. said the stock will rise
as it expands PayPal to more vendors. Sharing risk management
and transaction data helps the $71 billion company’s online
marketplace and payment units better compete against rivals such
as Amazon.com Inc. and payment processor Square Inc., said
Susquehanna International Group LLP.

“We can all come up with a higher number than $55 for EBay
shares, but that’s why we own it,” George Shipp, a fund manager
at Sterling Capital, which oversees more than $45 billion, said
in phone interview from Virginia Beach, Virginia. “I don’t know
that it’s such a significantly higher number that it means the
EBay team is doing a lousy job, or that I have a burning desire
to light a fire under the board for some sort of short-term pop.
This is not a broken company.”

Icahn Stake

EBay, whose online marketplace sells everything from
motorcycles to golf clubs via auctions and at fixed prices,
acquired PayPal in 2002 to add online-payment services. The unit
almost tripled sales in the five years ended in 2012 and now
accounts for about 40 percent of revenue at the San Jose,
California-based company.

Icahn, who took a 0.82 percent stake in EBay and is also
seeking two board seats for his employees Jonathan Christodoro
and Daniel Ninivaggi, said this week that the company “hasn’t
done as well as it should have” and spinning off PayPal would
unlock value for investors. Icahn didn’t respond yesterday to a
request for further comment.

“We have been successful exactly because PayPal and EBay
are together,” Donahoe said during an earnings call with
analysts this week. “No other payments competitor has achieved
PayPal’s success, because no other competitor has a commerce
platform like EBay.”

Amanda Miller, a spokeswoman for EBay, declined to comment
yesterday.

Better Together?

Sum-of-the-parts estimates from six EBay analysts and
shareholders ranged from $60 to $75 a share. That tops EBay’s
record high of $58.89 in December 2004, and it implies the
company should be valued as much as 37 percent more than its
closing price yesterday.

Since EBay disclosed Icahn’s stake and also reported
holiday quarter sales that missed analysts’ estimates, the
company’s shares have gained less than 1 percent.

Today, EBay fell 1 percent to $54.37.

Even though a split may deliver returns for shareholders,
PayPal is in a better position to grow as part of the combined
company, said Stephen Kahn, a Toronto-based fund manager at
Condor Asset Management.

As EBay seeks to increase PayPal’s use by other vendors,
both online and in stores, “staying together is not a bad
thing,” Kahn said in a phone interview. “Until PayPal payments
broaden significantly beyond EBay e-commerce, I think it makes
sense.”

Funding Expansion

EBay can use the free cash flow from its marketplaces
business to fund the expansion and innovation, Matt Nemer, a San
Francisco-based analyst at Wells Fargo & Co., wrote in a report
yesterday. Having PayPal integrated with EBay’s marketplace also
helps build the payment service’s customer base, said Josh West,
an analyst for Kornitzer in Shawnee Mission, Kansas.

EBay’s marketplace makes up about one-third of PayPal’s
revenue and more than half of its profits, according to CEO
Donahoe. EBay also contributes more than 30 percent of PayPal’s
new customers.

“PayPal definitely benefits from being a part of EBay, and
the distractions around trying to spin off part of it or the
whole thing could certainly hinder its long-term growth
prospects” said West, whose firm advises the Buffalo Funds,
which oversee about $8 billion including EBay shares.

Sharing data between the services makes both the e-commerce
and online-payment businesses more competitive, Susquehanna
analysts Brian Nowak and James Friedman wrote in a report
yesterday.

Nothing New

Icahn isn’t telling shareholders anything new by
highlighting the potential benefit of a PayPal split, said Shipp
of Sterling Capital. Even so, Shipp said he prefers the long-
term rewards of keeping the company together to the short-term
boost that a breakup might bring.

“PayPal could trade at a higher multiple -- we know
this,” Shipp said. “There may come a day when it makes sense,
but I don’t know that we’re close to that day. It looks to me
like the integrated company is doing well.”

While there are some advantages to keeping EBay and PayPal
together, the manager of shareholder Jacob Internet Fund said
the case for splitting up is stronger. Retailers that may be
hesitant to use PayPal because it’s owned by their competitor
could choose to adopt the service if PayPal were independent,
Ryan Jacob said in a phone interview.

Win Faster

Investors will eventually give EBay credit for the value of
PayPal, though a breakup would accelerate that, said Daniel
Johnson, a Louisville, Kentucky-based money manager at River
Road Asset Management LLC, which oversees about $10.3 billion,
including EBay shares.

“We think we can win if it stays together, but we can win
a little faster if it gets split up,” Johnson said in a phone
interview.

Even if Icahn fails to spur a transaction, the added
pressure on EBay’s leadership benefits shareholders, according
to Sean Sun, an analyst at Santa Fe, New Mexico-based Thornburg
Investment Management Inc., which oversees $94 billion including
EBay shares.

"Having this activism is good because it probably gets
management more focused and brings to light the fact that the
company is undervalued,” Sun said in a phone interview. “I
don’t think the spin is going to happen without management’s
support, but just having Icahn in there can get them thinking.”

For Related News and Information:
Icahn at EBay Shows Boards Learning to Listen to Activists
NSN MZV5B76KLVR6
EBay Says Icahn Proposes PayPal Spinoff After Taking Stake
NSN MZV1QO6KLVSU
PayPal Increases Mobile Investment as Smartphones Replace Cash
NSN MXL7666S972A
EBay deal news: EBAY US TCNI MNA
Real M&A Columns: NI REALMNA
Top deal news: DTOP

--With assistance from Beth Mellor in New York. Editors: Beth
Williams, Sarah Rabil

http://www.bloomberg.com/news/2014-01-24/ebay-bets-paypal-in-house-beats-icahn-s-plan-real-m-a.html

US $ Strength to persist vs. CDN $

The US Dollar gained 7.2% over the Canadian Dollar during 2013. The Canadian Dollar weakness is a function of both a strong US Dollar and a weakening Canadian Dollar.

When the Chinese economy was growing in excess of 10%, it was buying commodities in record quantities. This translated into currency strength in commodity oriented economies such as Canada, Australia and New Zealand. As growth in the Chinese economy slowed, their purchases of resources declined. This resulted in declining Commodity prices, along with the resource based economies currencies.

The US economic recovery is slowly gathering steam. Rates in the US have already moved up and the bias is clearly to the upside. With Canadian economic growth slowing, interest rates in Canada are unlikely to rise as quickly as in the US. Higher yields on US assets make holding or buying the US Dollar a more attractive proposition for investors. Money on the margin migrates to where it can earn the highest risk adjusted return.

The US Dollar has been and remains the world's reserve currency. None of the events over the last six years has changed this. If anything, events have transpired to solidify the US Dollars position as the global reserve currency. This is especially true as it becomes increasingly evident that there is currently no credible alternative. Part of the reserve currency's functions is to provide stability for global investors. Post the financial crisis, governments around the world mandated that their banks invest in safer and more liquid bonds. US government bonds, and the highest grade US corporate debt fit this better than non-investment grade or illiquid foreign bonds. The US bond market is deep, providing ample liquidity for investors to get in and out of at a moment's notice.

Many countries around the world are incentivized to depress their currency to ensure the competitiveness of their export oriented industries. This is accomplished by countries selling the local currency and buying the US Dollar. This results in upward movement of the US Dollar which translates into a lower Canadian Dollar.

Q4 AND 2013 IN REVIEW

Condor Asset Management is celebrating our fourth anniversary. We have consistently matched or outperformed comparable stock indices. Over the last year we also achieved stock returns in excess of 30% while maintaining our commitment to solid conservative investment profiles, as per the request of the majority of our clients. We are proud of our track record and appreciate the trust our clients have placed in us.

Over the last 3 months North American equity markets continued their winning ways. The S&P/TSX index gained 6.5% and the S&P 500 increased 9.9%. The full year was even better with the S&P /TSX gaining 9.4% and the S&P 500 increasing 29.6%. When factoring in the movement of the US Dollar relative to the Canadian Dollar, the US market provided Canadian investors with a gain of 38.9%. Contrary to some predictions, US Dollar strength relative to most major currencies persisted throughout 2013. We see few near term reasons why the Canadian Dollar will recoup these losses (vs. the US $). See our next blog entry.

Positive economic data is a catalyst for the upward movement of the stock market. The final revision to third quarter US GDP growth was +4.1%, partially boosted by an inventory build. Businesses typically build inventory when perceptions regarding the economy are positive. The employment data also highlighted a growing economy. Jobless claims dipped below 300,000 while November non-farm payrolls increased by 202,000. The unemployment rate declined to 7%, which is The Fed’s originally stated target for reducing the quantitative easing program. One of the bright spots was auto sales hitting levels which have not been seen since the financial crisis of 2008. Another highlight was the ISM (Institute of Supply Management) survey which yielded positive results of greater than 50% (which signify expanding demand). The ISM manufacturing survey was 57.0% while the comparable data for services was 53.9%.

This abundance of positive economic data has resulted in rising interest rates. Investor anticipation of a taper announcement pushed US bond rates to 3%. At the conclusion of The Fed's Open Market Committee meeting in December, The Fed announced that they would reduce bond purchases by $10 Billion a month starting in January. They further stated that depending on the data, they would continue reducing purchases throughout 2014.

Canadian bond returns during the past year were -1.2%. This is only the third year of negative bond returns since 1979. Bond returns over the last two years were a miniscule +1.2%. With current rates being as low as they are, rate increases will likely result in bond returns similar to the last two years. We currently prefer short term bonds so our clients are positioned to take advantage of potential reinvestment opportunities presented by higher interest rates.

We do not subscribe to the theory that rising interest rates will be negative for stock markets. An increasing interest rate environment accompanied by a growing economy is typically positive for stock markets. These conditions are currently present in the US and to a lesser degree in Canada. The US economy is forecasted to grow 2.5% - 3.0% in 2014, with Canada facing more modest growth of 2.0% - 2.5%. Both growth forecasts are an acceleration from the 2013 GDP growth rates. The US stock market surged with the Feds announcement of its reduced bond purchases. The Fed also surprised the market by promising to keep interest rates at current low levels for "an extended period of time". While this appears to be positive in the short term for financial markets, an accelerating US economy will probably make this a short lived promise.

There has been a fair amount of discussion concerning the potential of a stock market crash. We believe this is unlikely to occur. The crash argument hinges on the stock market being in an asset bubble created by low interest rates. It is extremely rare that so many pundits correctly call a bubble in a timely manner. When looking at the fundamentals compared to prior bull markets, stocks are not overvalued. Stocks on average trade at 15 times earnings, which is close to the historical average (Chart 1). Stocks are neither historically expensive nor cheap. With 8% earnings growth forecasted for 2014 (and 2015), there is still upside embedded in individual stocks.

Chart 1: S&P Trailing P/E

Source: Deatsche Bank

We did see a minor stock market correction (around 5%) near the end of September. We expect there will be at least one, if not more, corrections in 2014. This does not change our belief that equity markets offer reasonable returns for the foreseeable future.

Our discussion up to this point has been predicated on a reasonable US GDP growth rate. To date, growth has been somewhat tepid. Having said that, all the variables are in place so that 2014 might be the year where growth accelerates above 3%. Contributors to this would be improved employment rates, a better than expected housing recovery, growth in auto sales and the wealth effect.

2013 US GDP growth was depressed by approximately 2% in part due to higher taxes and reduced government spending. This follows two years of fiscal spending dragging down growth by about 1% per year (light blue line in Chart 2). US Government spending has been declining since 2009, while private sector GDP has grown at a 3.3% pace during the same period. Most of this fiscal spending handicap will disappear in 2014. State and local governments are beginning to invest in long delayed infrastructure projects. The Federal government recently passed a two year budget with less severe spending cuts than originally planned. The budget deal also reduces uncertainty by lowering the risk of a government shutdown due to legislative dysfunction. This is positive for the stock market, as investors dislike uncertainty and try to avoid. With government spending not impeding GDP growth, the US economy has potential to grow at something closer to 3.5% in 2014.

Chart 2: Real GDP

Source: BEA, Haver, Deatsche Bank

The wealth effect may also lend some support to accelerating growth in 2014. The consumer has been deleveraging (by increasing their savings rate) over the last few years in order to reduce debt levels. This growth impediment was necessary to repair the damage from the financial crisis. Consumer’s financial balance sheets have significantly improved. Less consumer debt combined with low interest rates have resulted in the household debt servicing ratio (Chart 3) currently being at the lowest level in 30 years. The lower income necessary to service household debt suggests that consumers will have more money available to spend.

Chart 3: Debt Service Ratio

Source: The Federal Reserve, J.P. Morgan

Bull markets typically do not end unless there is a recession. Based on the abundance of positive economic indicators, a recession is not in our near term forecasts. If anything, we see an economy that is slowly gaining momentum. The biggest surprise for 2014 could be an economy that returns to normal. We define a normal economy as one that has a healthy employment market, buoyant housing and auto sectors and no fiscal drag from government spending. This would increase the probability the economy would grow in excess of 3%, which is has not done since before the recession.

Stocks are currently more attractive than bonds. While bonds are an important part of a diversified portfolio, their returns will be below historical levels. We see positive returns for both the US and Canadian stock markets but not to the same degree as 2013. Going forward, stock selection and being in the right sectors will be an increasingly important part of generating above average returns. Condor Asset Management has demonstrated that we can navigate the market risks and provide superior returns. Please contact us at Condor to see how we can aid you in designing a portfolio to help you achieve your financial goals.