Why might ICE bid for eBay?

ICE is rumored to be bidding $30B for eBay.
If ever there was a merger made for me to write about, it’s this one.

A Merger of Opposites?

The Wall Street Journal reported yesterday that ICE, the owner of several exchange and data businesses including the New York Stock Exchange, the InterContinental Exchange, and Interactive Data Corp, is interested in buying eBay, for a price quoted to be around $30 billion.

On the surface, this seems to be an unusual alliance. Sure, ICE and eBay both own marketplaces, but beyond that, they appear to have very little in common.

eBay is many things: an auction-based, p2p market for fairly unique physical goods, an e-commerce storefront, an online classifieds business, and a group of vertical marketplaces (for used cars, event tickets and more).

ICE is also many things: a set of trading venues for liquid, fungible financial instruments (stocks, futures, bonds), an information business selling market data and indices, and a vendor of technology to other marketplace firms.

But the two sets of competences have hardly any overlap. ICE is institutional, eBay is consumer. ICE is capital markets, eBay is retail. ICE is sales and product driven, eBay is marketing and platform driven. You would be hard-pressed to find two marketplace businesses that are less similar.

What’s going on?

What This Is Not: Tech, Diversification, Crypto

Let’s begin with some weak-ish arguments.

Is this a technology play? Almost certainly not. The needs and tech stack of the eBay consumer marketplace are dramatically different from the needs and tech stack of any of ICE’s financial marketplaces (NYSE, ICE, Euronext, NYBOT et al). Using capital markets trading tech to reinvent eBay, as some have suggested, makes no sense to me.

Is this a diversification play? Perhaps, but it’s a weak case. ICE’s business is fairly pro-cyclical, while you can make the case that eBay’s business is somewhat counter-cyclical – in a soft economy, buyers want to economize and sellers want to make extra cash, both of which help eBay relative to other e-commerce merchants. So buying eBay could hedge some cyclical risk for ICE. But this alone doesn’t seem a strong enough argument to motivate the entire transaction.

Is this a crypto play? I don’t see it. ICE appears committed to Bitcoin via its Bakkt subsidiary, which recently added options and physical delivery to its previous cash-settled Bitcoin futures product. But eBay’s commitment to Bitcoin and other cryptocurrencies seems ambivalent at best.

Possible But Unlikely: The Data Play

Let’s move on to some more interesting possibilities.

Is this a data play? This is where it gets intriguing, albeit still not fully baked. Like a few other financial data players, ICE has a virtuous cycle going where they buy data assets, create market indices and analytics on top of them, and monetize both the data and the derived products. Their 2015 acquisition of IDC for $5B is a great case study for this playbook; here’s CFO Scott Hill describing it on ICE’s last earnings call:

The business we bought four years ago sold one product. It sold bond prices. And each year, it would raise prices a couple percent, and it would hope that it could [retain] customers. What we’ve built is a superstore where it’s not just bond prices. It’s reference data. It’s feeds. It’s connectivity solutions … the IDC business that used to grow 2% to 3%, we’re growing it twice as fast.

So what’s the data asset here? I would say that eBay has a pretty good finger on the pulse of the US economy. In theory, one could use eBay data to build indices around US consumer activity, productivity, inflation, used car sales, even real estate and regional dynamics.

Realistically, though, all those ideas are quite nebulous; right here and now, eBay doesn’t have data assets that could justify a classic data acquisition approach by ICE. So this too appears premature at best.

Customers, Distribution, and … Robinhood?

Is this a distribution play? Now we’re getting somewhere.

Let’s digress a little bit, and talk about Robinhood. Why is Robinhood so popular? It’s because they’ve gamified investing. At $0 commissions, Robinhood is the best free game ever. Sure, sometimes you lose money, but at worst you can lost 1x your investment, while at best you can make many times that. The combination of upside and uncertainty is addictive.

Now, what’s the only other app in the world with the same psychological profile? eBay!!! Bargain-hunters on eBay experience exactly the same combination of thrill and monetary reward, which is why eBay addiction is a thing.

By buying eBay, ICE gets that home-screen real estate and mind-share and screen-time from 100s of millions of customers who are primed to expect a dopamine rush.

Enter eBay Stocks, powered by ICE!

All of a sudden, ICE enters the discount brokerage space, unlocking a huge new source of order flow for their core business, and getting exclusive access to a phenomenal new data asset (retail financial activity) that they can build indices and analytics on top of. That might actually be worth the $2B premium that they’re bidding, and explains why (if reports are to believed) ICE has reached out to eBay multiple times in the last few months and years.

Making the Math Work

Now, obviously all of this is highly speculative. But that’s okay!

All ICE needs is a plausible story, and multiple expansion takes care of the rest. Let me explain how.

The first thing to understand is that ICE is a famously acquisitive company. Their founder and still CEO Jeffrey Sprecher is not afraid of bold moves: Creditex (2008, $625M), Climate Exchange (2010, $622M), Euronext (2012, $8.2B), IDC (2015, $5.2B), Trayport (2015, $650M), Euroclear (2017, 1B for a 10% stake), Virtu BondPoint (2017, $400M), TMC Bonds (2018, $685M) – the list goes on. Even in the Age of Unicorns, these are not small deals, especially at that pace.

ICE also has a reputation for being excellent operators of the businesses they acquire: cutting costs, boosting growth, and finding opportunities to cross-sell and up-sell, all of which lead to consistent EPS growth and cash returned to shareholders. (The IDC example from above showcases all of these). Markets reward this operational excellence with a high multiple on ICE’s earnings – and Sprecher uses this high multiple as ammunition for his bids.

Let’s look more closely at eBay. It has the reputation of a company and a business that’s past its prime. There’s $3B of earnings, but GMV in the core marketplace is actually declining; as a result the forward P/E ratio is just 11, leading to a market cap of $30B.

Contrast ICE which has a very similar $3.2B of earnings, but trades (pre-WSJ story) at a forward P/E ratio of 24, leading to a market cap of $57B. And ICE does this with just 5,000 employees, less than half of eBay’s 14,000.

Here’s the trade. If ICE buys eBay and even a little bit of their magic rubs off on them, then eBay’s earnings will be given a higher multiple by the market. And that difference will be enough to pay for the acquisition premium!

Let’s put some numbers on that. An increase in eBay’s P/E ratio from 11 to 13 – well short of ICE’s 24 – would result in an extra $6B in market cap. That’s easily enough to cover the $2B that ICE is supposedly bidding above eBay’s current price. It all depends on whether the market believes that ICE can unlock value from eBay – whether through data, or distribution, or just good old fashioned discipline.

Asking the Right Question

Here’s Jeffrey Sprecher from the same Q3 earnings call:

The market [seems] to like some of the deals that were done in our industry where essentially, a public company that had a low multiple can move to a company that has a high multiple and there’d be a multiple expansion. Same business, same company, different hands, different management team that the market likes better and you get a multiple expansion.

Mind you, the effect can go both ways. If the market doesn’t believe in the possibility of joint value creation, ICE’s P/E ratio will drop because it’s now a lower quality business. And Sprecher is aware of that too:

Because we have a good management team here (…) people are presenting deals that are simply multiple expansion deals. Those are interesting, but we have other metrics that we use: return on invested capital being one of them. Our ability to feel like as a management team we really could do something different than other management teams and – or that our network provides some kind of acceleration of sales because of its unique distribution.

In other words: we have to create value, otherwise it doesn’t work long term. Note especially the point about distribution.

Also worth noting here is that ICE generated $1.7B of free cash flow in the first 3 quarters of 2019, and returned $1.6B of it to investors via buybacks and dividends. That’s a pretty clear signal that they can’t find strong organic growth opportunities. But why buy back your own stock when its P/E ratio is so high? Much better to find inorganic opportunities! ICE would much rather buy eBay stock at 11x earnings than buy back its own stock at 24x earnings.

(None of this is particularly original; indeed it’s M&A 101. For more on this, I recommend The Outsiders by William Thorndike, about Harry Singleton of Teledyne and other “asset allocator” CEOs. The key message: if you can buy another company’s cheap stock using your own expensive stock, that’s almost always a good trade.)

So now the eBay bid can be seen in a different light. The question is not “does this acquisition make inherent sense?”. The question is “what’s the lowest multiple company we can buy that is plausibly adjacent to our own business and where we have some potential opportunities for value creation?”. And eBay ticks that box. If it works, it’ll be Sprecher’s boldest move by far, and perhaps his most brilliant.

Ironing Out the Details

Now we move from the strategic to the tactical. Why did the story leak? Usually when news of an M&A process leaks, it favours the target, because it might attract new bidders. But this feels a bit different. If the WSJ is to be believed, ICE has been courting eBay for some time, but eBay has refused to dance. That may no longer be tenable, especially given that eBay has activist investors who are pressing for change.

Another interesting point about the leak is that it could be a trial balloon to gauge the market’s reaction. Will markets buy the value creation story? Obviously there will be some P/E convergence if the merger goes through; how much and where will it settle? Initial signs are that the market doesn’t love this trade, but it’s early.

The final wrinkle is that tomorrow (Thursday 6 February) marks ICE’s quarterly earnings call. That’ll be interesting! One way or another, this seems primed to be one of the most stimulating corporate actions of the year.