A Closer Look at eBay's Payments Opportunity

eBay (NASDAQ: EBAY) and PayPal (NASDAQ: PYPL) aren't renewing their operating agreement that was penned when the online marketplace business spun off the payments business. The two companies jointly announced the plan about a year ago during their respective earnings calls for the fourth quarter of 2017.

Over the next couple of years, eBay will ramp up the percentage of payments it manages directly with its partner, Adyen. It expects the transition to result in a $2 billion revenue opportunity at scale, a number management reiterated during the company's fourth-quarter 2018 earnings call last month.

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eBay started rolling out its managed payments service to a small number of U.S. sellers in the third quarter. Here's how it's going so far, and what investors can expect going forward.

Early results

eBay has worked with 3,500 sellers on its U.S. marketplace since starting payment trials at the end of the third quarter. In the four months since it started managing payments for those sellers, eBay says it saved them $1.2 million in payment processing fees for $143 million of gross merchandise volume. Overall, eBay says sellers saw a reduction of 25% over what they would have paid for transactions processed at PayPal's standard rate.

Management hasn't provided any details on what that means for eBay's own revenue or profit. In the short term, though, any benefits on the top line will be cancelled out by investments in payments infrastructure.

"... I do think ... in the second half of the year payments will reverse, start to reverse from an investment to a revenue contributor," CEO Devin Wenig told analysts on the fourth-quarter earnings call. "The opportunity is there to go further if that's the most efficient way to drive operating income growth." Long term, management estimates that the $2 billion in additional annual payments revenue eBay could generate will produce $500 million in operating income.

Benefiting the ecosystem

Beyond boosting revenue and operating income from eBay's existing marketplace sales, managing its own payments will provide an opportunity for eBay to grow its marketplace.

eBay has already shown that it's capable of significantly reducing the fees sellers pay for processing payments on its marketplace via PayPal. Those reduced seller fees ought to attract more sellers to the platform. Keep in mind, eBay is still the second-largest online marketplace in the United States. There are plenty of buyers on the platform, but for many sellers, the cost of doing business might be higher than on competing marketplaces.

On the other side of the transaction, eBay's move to manage payments will open up more payment options for buyers and reduce the number of steps it takes to complete a transaction.

"[W]e have looked at historical credit card purchasers on eBay and Apple Pay users on eBay, and both are showing higher conversion [on] the new payment experience," Wenig said.

Reducing the amount of friction in a transaction is PayPal's whole pitch to online merchants. However, for marketplaces with considerable size already, PayPal's value proposition isn't as strong. Larger marketplaces with considerable volume and repeat customers like eBay will see lower friction in the long run from implementing their own payment processing.

A third benefit for eBay's marketplace is greater access to purchase (and refund) data. That should enable it to exert more control over its buyers and sellers and reduce the risk of transactions going badly. Over time, that could improve the eBay experience all the way through to shopper satisfaction after the purchase.

Together, these three factors ought to drive faster growth in gross merchandise volume, which in turn creates a greater revenue and profit opportunity for processing payments -- not to mention the benefits to eBay's core marketplace business.

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Adam Levy owns shares of eBay. The Motley Fool owns shares of and recommends PayPal Holdings. The Motley Fool recommends eBay. The Motley Fool has a disclosure policy.