Better Buy After the Separation: eBay or PayPal?

Source: eBay.

eBay is splitting its Marketplaces and PayPal businesses in the coming weeks, and investors will receive one share of PayPal for every share of eBay they own. The distribution is expected to occur on July 17, and PayPal will begin trading on the Nasdaq on July 20, with the ticker symbol PPL. After that, eBay will include only the e-commerce business, while PayPal will be an independently operated digital payments company trading separately from eBay.

Luck is what happens when preparation meets opportunity. With this in mind, investors may want to do their homework in advance, so that they know how to approach both eBay and PayPal after the separation.

A tale of two businessesPayPal is clearly the star of the show. The company is the market leader in the global digital payments industry, and growth has been nothing short of breathtaking over the past several years. Revenue increased from $5.7 billion in 2012 to $6.7 billion in 2013 and $8 billion in 2014, while free cash flow grew at 29% annually over the past three years.

Total payment volume grew 18% in the first quarter of 2015, and the business processed over 1 billion transactions during the period. As of the end of the last quarter, PayPal has 165 million active customer accounts, so the platform has built an impressive scale which provides a formidable source of competitive strength and fosters acceptance from both customers and merchants.

On the other hand, eBay needs to compete against Amazon.com in e-commerce, and this is a major headwind for the company. Amazon reported product sales of $17.1 billion in the first quarter of 2015, growing 9% year over year. The company is famous for its aggressively low prices, since Amazon prioritizes revenue growth over profit margins, and this puts considerable pressure on eBay from a competitive point of view.

Marketplaces has delivered uninspiring performance over the past several quarters, and gross merchandise volume fell 2% in the first quarter of 2015. Currency headwinds were responsible for this decline to a good degree, since gross merchandise volume in constant currency increased by 5%. However, eBay's performance is still no match to the staggering growth rates being reported by PayPal, regardless of the transitory impact from currency fluctuations.

The right priceNevertheless, investment decisions are not only about growth and competitive position. Price is an important consideration to keep in mind, and everything is indicating that PayPal will trade at a substantially higher valuation than eBay.

To begin with, there is far more appetite for PayPal than for eBay among growth-hungry investors. In fact, many investors were pushing for the spin-off to be able to make a pure bet on PayPal without necessarily investing in eBay, and this is one of the main reasons management finally decided on separating the two businesses.

PayPal is already trading on a "when issued" basis, meaning the stock is being transacted, but those transactions will be settled once PayPal stock is officially issued. Based on early indications from these prices, PayPal could be valued at nearly $36.40 per share, which would mean a market capitalization of $44 billion for the payments company, so it would account for nearly 58% of eBay's total market value before the split.

Payments represented only 47% of eBay's revenues during the first quarter of 2015, so investors are clearly willing to pay considerably more for every dollar of revenue from PayPal than for the company's e-commerce business.

This is quite reasonable, considering PayPal is performing much better than Marketplaces, but it's also important to keep in mind that an excessively high valuation can limit upside potential and create some serious risks for investors.

Choosing between eBay and PayPal ultimately comes down to your own investment philosophy and vision for the two companies, and we still need to find out at which valuation levels eBay and PayPal will trade once the separation is finally official to make a better-informed decision.

However, if the valuation gap between the two companies becomes excessively big, eBay could even outperform PayPal stock after the split, even if PayPal will most probably continue outgrowing eBay by a considerable margin over the middle term.

The article Better Buy After the Separation: eBay or PayPal? originally appeared on Fool.com.

Andrs Cardenal owns shares of Amazon.com. The Motley Fool recommends Amazon.com and eBay. The Motley Fool owns shares of Amazon.com and eBay. 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.