Founded in 1999, PayPal Inc. enables people with an email to send and receive cash money over the Internet. Formerly known as X.com Corporation, PayPal has been popular with merchants and buyers who do business Online, including those in popular auction site eBay. As an alternative to wire transfer through commercial banks, PayPal allows anybody to wire and receive funds by setting up accounts with the company's Web site.
Registered users of PayPal are able to link their credit cards or bank accounts, and debit to (or credit from) those accounts in case they receive (or transfer) funds through PayPal.
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PayPal targeted online merchants, individuals, small businesses, and other entities underserved by traditional mechanisms (Thiel).
PayPal has achieved rapid growth since its founding in March 1999. According to its prospectus filed with the Securities and Exchange Commission, PayPal had 10,000,000 registered users in 36 countries, as of the third quarter of 2001. Despite its rapid growth, PayPal saw a significant opportunity to expand. Among other things, it noted, citing the U.S. Census Bureau, that, small businesses generated a total of $1.6 trillion in annual sales, and only over 3 million merchants in the U.S. were able to accept credit card payments. In September 2001, PayPal announced an initial public offering of new shares of stock.
Summary of Events and Circumstances
If you had been in charge, how would you have handled PayPal's IPO process differently? To answer that question, I will study the documents submitted by the company to the Securities and Exchange Commission, and the news reports on the outcome of the sale of stock.
The Goal of the Public Offering of Stock
According to the company's prospectus, the company intends to use the proceeds of the IPO as follows:
- $10 million to $15,000,000 to support collateral requirements in light of increasing transactions with outside merchants;
- $10 million to $15 million for capital expenditures; and
- the remaining amount for international expansion and additional product development.
In February 2002, PayPal launched a public offering of 6,210,000 shares of its common stock at $13 a share. PayPal netted proceeds of $70,600,000, net of underwriting discounts.
Salomon Smith Barney, Bear, Stearns; Co. Inc., Merrill Lynch; Co., William Blair; Company, SunTrust Robinson Humphrey, SoundView Technology Group, and D.A. Davidson; Co. was engaged as underwriters for the transaction.
Company's Financial Condition
According to its annual report submitted to the Securities and Exchange Commission, PayPal had $104,831,000 in revenues and total operating expenses of $216,215,000 as of the year ended December 31, 2001, compared to $14,460,000 in revenues and $187,524,000 in expenses the year before. PayPal incurred operating losses during those two years - $173,064,000 in 2000, and $111,384,000 in 2001. PayPal had $278,577,000 in assets and $198,665,000 in debts as of the year ended December 2001.
At the peak of its preparations and marketing of its IPO, PayPal said that it had been threatened with patent infringement suits, forcing it to pull the deals (Hennessey). According to its annual report, the company said it received a notice from Tumbleweed Communications Corp., a Redwood City, California-based software company specializing in Internet security, that PayPal had violated its Tumbleweed's patented techniques for the delivery of e-documents to Internet users. A month later, PayPal also receive notice from Arizona-based NetMoneyIN, Inc., a privately held company based in Arizona, of 13 patent violations in connection with doing business with vendor web sites to check purchases by credit cards. PayPal disputed the allegations, but still the lawsuits caused concerns among existing shareholders and potential investors.
At the time of its IPO plans, PayPal was also facing complaints with the state of New York that it was engaged in illegal banking. It was also accused of providing a mechanism for money laundering and fraudulent activities because its system was able to escape government regulations. Regulators of Louisiana also refused to allow PayPal to operate in the state.
If I were the one running PayPal, I would have waited for the market to stabilize and the lawsuits to be resolved before pushing with the IPOs. Note that (i) the merits of the lawsuits pointed in favor of PayPal, (ii) the company had opportunities to expand, and the (iii) company's shareholders were expected to reap returns in the future.
Company is Profitable
Some people may think that launching IPOs at a time when the company is facing losses is discouraging to investors because the net profits of the company will add book value to the shareholders' interests, while further losses will reduce the money available to shareholders. However, while the company did not make profits in 2000 and 2001, it does not easily mean that the company will not be profitable in the years to come. Note that from only $14.5 million in 2000, revenues rose more than 600% to more than $100 million a year later. The company was also facing massive growth. In its 2001 annual report, it said that during the year, it added an average of 20,000 new accounts every day.
In the years to come, after it establishes its network and operations and obtains its target customer base, PayPal is expected to reduce expenses. Its business concept -- charging fees to transactions -- allows it to make money.
Wait for Circumstances to Improve
Any bad news, according to Supidta Basu's conservatism principle, and Werner F.M. De Bondt and Richard Thaler's publication on behavioral finance usually discourages people from making investments, and companies to write off their value.
Given that PayPal believes it is innocent of the infringement claims, it should have waited for the potential lawsuits to be resolved so that investor confidence to recover. PayPal asserts it is innocent of the infringement accusations because (i) it does not directly processed credit or debit cards for merchants, and (ii) it engaged business before 2000 when CertCo obtained its patent. Hence, there should have been a rush with the IPOs.
After the IPOs were launched, PayPal won favorable resolutions on the infringement claims. It also was able to obtain a favorable outcome from the New York Banking Department on the illegal-banking accusations, and subsequently obtained licenses to operate in Louisiana, eliminating precedent and fears that other states may also revoke its licenses. These events resulted in a rise in trading prices of PayPal's stock and an increase in market capitalization.
After shares were sold at $13 a share, the stock rose 55% to $20 a share on Feb. 15, 2002 closing. This shows that the initial offering price was greatly undervalued. The company would have obtained more proceeds if they did not under-value their stock given that it should have had rosy projections ahead.
Five months later, on June 27, 2002, PayPal announced it was offering 6,000,000 shares of its common stock, at $19.00 per share. The price is a slight discount to the $19.50 per share trading price at the NASDAQ National Market on June 27. A higher offering price would have translated to more proceeds to the company and thus more money to finance its expansion needs. The $19 per share offering price was 33% higher than its prior IPO's price done only five months before.
eBay had its own Billpoint but clients still preferred PayPal. As of the end of 2001, about 71% of eBay's auctions accepted PayPal compared to only 25% through eBay's Billpoint. Because of its reliance on PayPal, eBay mulled a takeover on PayPal. The PayPal board of directors accepted a proposal by eBay to buy PayPal for a consideration that includes each share of PayPal common stock will be exchanged for .39 shares of eBay common stock.
eBay was also a growing company, and having PayPal under its wing would also have allowed PayPal to continue its expansion. It also allowed PayPal to take advantage of eBay's existing networks and client-base. However, the problem with the merger is market segmentation -- under eBay, PayPal will only be known as the means of making payments from eBay auctions, rather than as an area for small businesses to trade, which has a greater market.
If I were the CEO and Board Chairman of PayPal, I would have adjusted the company's IPO strategy to be able to obtain more proceeds. Among other things, I would have waited for the litigation on patent infringements and illegal banking so that the company would net more proceeds rather than giving gifts to speculators who bought the stock so cheaply then selling them at high prices.
- Peter A. Thiel. CEO of PayPal. Prospectus. Filed 28 Sept. 2001. Retrieved 2 Aug. 2008, http://www.sec.gov/Archives/edgar/data/1103415/000091205701533855/a2059025zs-1.htm
- Peter A. Thiel. CEO of PayPal. 2001 Annual Report submitted to the Securities and Exchange Commission. Filed 13 March 2001. Retrieved 2 Aug. 2008,
- Hennessey, R. (2002).Deals & Deal Makers: PayPal's Debut May Not Signal Web-IPO Trend, Wall Street Journal; New York, N.Y.; Feb 19, 2002
- Wingfield, N. & Bransten, L. (2002). PayPal Insiders to Sell Shares Valued at About $141.9 Million. Wall Street Journal; New York, N.Y.; Jun 13, 2002;
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