Why Did eBay Change Its Mind on PayPal?

With payments competition mounting, eBay has finally decided to spin off PayPal, and a split looks like a good thing for both the payments and the marketplace businesses.

The Tuesday announcement of the spinoff comes months after activist investor Carl Icahn made a large investment in the company and asked for it to spin off the payments subsidiary. eBay responded back in January that a spinoff didn't make sense, but since then a few noteworthy things have happened.

The spinoff announcement comes just weeks after Apple announced it would enter the digital payments market with Apple Pay in October. Amazon also recently announced a new credit card reader for mobile devices to complement its "sign-in and pay with Amazon" service.

With the growing competition in the digital payments market, PayPal needs freedom from its marketplace parent company in order to compete.

PayPal is ready to go out on its own. Image source: PayPal's YouTube channel

PayPal no longer needs eBay
When eBay purchased PayPal in 2002, the vast majority of PayPal's revenue came from the eBay marketplace. Over the last 10 years, however, the percentage of PayPal transaction volume coming from eBay has declined from over 70% to below 30%.

What's more, PayPal is growing much faster than eBay's core marketplace business. Last quarter, eBay's payments net revenue increased 19.8% year over year, compared to an 8.6% increase in its marketplace business. As a result, payments now account for 44.6% of eBay's total revenue.

Indeed, there are still synergies between PayPal and eBay's marketplace. For example, as part of eBay PayPal didn't need to pay for referrals and services from the marketplace. As part of the separation, the two entities will have to sign an arm's length commercial operating agreement. But with a shrinking share of PayPal's business coming from eBay, the impact should be minimal.

But why now?
Not much has changed within eBay since Icahn called for the spinoff and the company rejected it in January. PayPal was growing just as rapidly in January as it is now, and it was becoming less reliant on eBay in the process.

Over the last nine months, however, we've seen a lot of progress in the digital payments area. Both and Twitter announced buy buttons, but spurned PayPal and chose to work with payments start-up Stripe. Just a few years ago PayPal would have been the de facto choice for the social networks.

Stripe is doing particularly well with mobile app developers, an area PayPal has focused on recently. Last year, eBay acquired BrainTree, which makes the popular Venmo app and facilitates payments for mobile apps.

However, PayPal has had trouble attracting top-notch talent due to its lack of autonomy. Splitting the company from eBay should help attract and retain talent by giving them stakes in the company they work for, not its parent company. Additionally, having a direct say over PayPal's strategy should help attract high-level management like PayPal's new president and CEO-to-be, Dan Schulman, who is coming over from American Express, where he led the company's mobile and online payments strategy. 

In addition to losing out to Stripe, Apple's and Amazon's recent announcements regarding digital payments represent a threat to PayPal. Amazon launched a credit card reader in August, and is offering introductory rates far lower than PayPal is for its own device. Even after the introduction expires, Amazon is offering better rates. Considering both companies are positioned as online retailers, brick-and-mortar stores may be hesitant to use the services of these competitors. Separating itself from eBay gives PayPal an advantage in that regard.

Amazon unveiled Local Register in August. Source: Amazon.com

But Apple Pay may be the biggest threat to PayPal. The service is designed to work both in stores and with apps. Apple partnered with six digital payments back-end companies to help developers integrate Apple Pay into their apps. PayPal and Braintree are not on the list. Unlike PayPal, Apple Pay doesn't require users to download an app or sign up for another account. Apple also carries instant credibility and consumer recognition on par with PayPal, making its button just as clickable.

PayPal seems scared of Apple Pay. Over the last couple of weeks I've seen more television commercials for PayPal's mobile services than I'd ever seen before. Granted, PayPal just launched its first TV ad campaign in May; it's noticably stepped up its airtime since Apple Pay was announced.

Positioning to compete
Separating from eBay will allow PayPal to compete better with the growing number of competitors. E-commerce companies may be more likely to use PayPal now that its revenue won't go directly to funding a huge competitor in eBay. Additionally, the autonomy will allow eBay to attract better talent to improve its products and make them more appealing to developers and merchants. As a result, PayPal will be able to grow faster independently than it would if it stayed under eBay's control.

As for eBay's core business, it's left to focus on its marketplace business, which is competing more closely with Amazon than ever before. Removing PayPal from consideration could open new avenues for eBay to partner with other platforms like Twitter and Facebook, just as Amazon has done.

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The article Why Did eBay Change Its Mind on PayPal? originally appeared on Fool.com.

Adam Levy owns shares of Amazon.com and Apple. The Motley Fool recommends Amazon.com, American Express, Apple, eBay, Facebook, and Twitter. The Motley Fool owns shares of Amazon.com, Apple, eBay, Facebook, and Twitter. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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