Wall Street vs. Silicon Valley


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Michael Haden 09/01/2014

Mix one part iconic activist investor (Carl Icahn), with two parts iconic corporation (eBay, PayPal) and you have the recipe for financial drama. Add a dash of personal animosity, and you have a full-fledged soap opera. Just such a show may be the aim of recent theatrics between Icahn and eBay.

In January, Icahn purchased a block of eBay stock. Almost immediately, he began a push to have the company spin off PayPal , while at the same time nominating two of his employees to join the eBay board. eBay subsequently rejected the nominees, saying that neither was qualified. Icahn quickly responded with an open letter to eBay stockholders. In the letter, Icahn berated eBay CEO John Donohoe for his "inexcusable incompetence," while calling into question his handling of the company's sale of Skype . The letter went on to accuse eBay board members Marc Andreessen and Scott Cook of having "material conflicts of interest."

eBay responded by calling the attacks a "charade." Donohoe has suggested that Icahn's attacks were intended to provide short term pop for eBay stock and drive up Paypal's value ahead of its sale, a strategy he denigrates as "short-term financial engineering."

Beyond the rhetoric lies an argument over PayPal's value to eBay, as opposed to eBay's value to PayPal. The Icahn camp would argue that PayPal is held back by eBay culture. Icahn suggested that PayPal cannot attract top talent while tethered to eBay. Others have pointed to an overlap of functions that leads to repetition of work  PayPal founder Elon Musk has said of eBay owning Paypal, "It's as if Target owned Visa or something."

Most analysts agree with Donohoe that PayPal benefits from synergies within the eBay enterprise. Because of its established eBay business, Paypal is able to keep margins low in areas where it is trying to expand. eBay data is used by PayPal for fraud checking and customer mining. These analysts point to PayPal's expansion into the credit business as an example of the opportunities for growth afforded by the relationship with eBay. "Bill Me Later" provides credit to buyers in the eBay Marketplace while "Working Capital" is providing small business loans for sellers.

Reid Hoffman, one of the founding board members at Paypal, believes that the true question is "What conditions will allow Paypal the best opportunity to grow its customer base?" Hoffman sees the squabble as a classic example of the clash between Wall Street short term profit taking and Silicon Valley long term innovation. In his view, PayPal, and consequently, eBay, will profit most by maintaining their existing relationship.

Chart courtesy of stockcharts.com

Whether Icahn prevails and drives up the stock price while extracting a premium price for PayPal, or Donohoe holds on to PayPal and continues to reap the benefits of their association, eBay stands to emerge as a winner. Either of these outcomes supports pursuing a bull-put credit spread on EBAY. Look at the October 45/50 bull-put credit spread for at least a $0.20 credit. You will need to use limit orders to place this trade. This trade has a target return of 4.2% over 51 days, which is an annualized return of 30.06%, (for comparison purposes only). EBAY stock has to fall 9.7% to cause a problem. Be aware that this is an aggressive trade, best undertaken by investors with diverse portfolios and high tolerance for risk.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Originally published on InvestorsObserver.com

This article appears in: Investing , Options

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