Major North American stock markets are still shaky after the attacks on New York and Washington, the Dow Jones industrial average and the Nasdaq market index are near their lows and investors seem generally tense and nervous. On top of all that, the technology sector is firmly in the grips of a bear market. Sounds like the perfect time to launch an IPO, doesn’t it? That appears to be exactly what the folks at PayPal, the on-line payment service, were thinking: They filed a prospectus for an initial public offering on Friday.
To say the least, this seems like a bizarre – if not doomed – choice of timing. Apart from the malaise infecting technology stocks, the IPO market is virtually dead. It was on life support even before the terrorist attacks in the United States, and the events of Sept. 11 more or less pulled the plug completely: September was the first month since 1975 that saw no U.S. IPOs launched at all. Not just a few – none.
Not only that, there’s a recent cautionary example of just how wrong such an IPO can go: A network services company called Loudcloud – backed by former Netscape founder Marc Andreessen, among others – went public in March, just as the Nasdaq cratered. It raised $150-million (U.S.) but is still struggling, burning through $35-million per quarter, and the company recently laid off an undisclosed number of staff. From $7 after the issue, the stock is at $1.20, having lost over 82 per cent of its value.
But that hasn’t stopped PayPal from going ahead with its issue – which raises the question: Why the hell not? Why would any company decide to wade into the public markets now? The most likely answer is that it can’t afford to wait. Like many startups, PayPal has financed itself over the past two years with funding from venture capital groups, including Sequoia Capital, Clearstone Partners and Nokia Ventures, an arm of the Finnish cell-phone giant. But even venture capitalists have gotten stingy.
Its IPO filing shows that PayPal burned through about $30-million in the most recent quarter – although the company claims that its burn rate is decreasing. Rather than having any equity, it currently has a shareholders’ deficit of more than $164-million, as a result of losing over $230-million since its inception two and a half years ago. After the issue, which is expected to raise about $80-million, the company says it will have shareholders’ equity of $114-million and cash or cash equivalents of $123-million.
And what about the company’s business? PayPal is an on-line payments company, handling e-commerce transactions between individuals or companies. In many ways, it acts as a kind of virtual Western Union, allowing buyers and sellers on eBay or Yahoo’s auction Web site to exchange funds by cheque or credit card. It also functions as a bank, in the sense that users can withdraw funds from their PayPal accounts, are paid interest on any balance they have, and can access their account from automated teller machines.
One of the problems with that model, obviously, is that by functioning as a near-bank, PayPal is vulnerable to competition from actual banks – including Citigroup in particular, which runs an on-line payment service called c2it that has co-marketing arrangements with AOL Time Warner and Microsoft. Not surprisingly, Western Union also has its own services called BidPay (for auctions) and MoneyZap. But the real issue for PayPal is that eBay has its own on-line payment service known as BillPoint.
This is a serious problem because the majority of PayPal’s business comes from auctions – 70 per cent or so in the most recent quarter – and much of that comes from eBay (Yahoo, which also runs an auction site, has its own payment service called PayDirect). EBay promotes its own service prominently on all auction sites as the preferred method of payment. In fact, PayPal recently sent a letter to eBay users telling them the auction site was changing their payment preferences to BillPoint (also called eBay Online Payments) without their knowledge, a charge that eBay has denied.
On the plus side, the company says it has 10 million registered users, and handles an average of 165,000 transactions a day worth about $8-million, for a total of $747-million worth of transactions in the second quarter. But there’s no question the company faces a stiff headwind, particularly in the current economic environment – and the fact that it is going ahead with an IPO anyway has to be seen as a sign of desperation.