Market got you down? Just when we were starting to think the economy was on its way to recovery, along comes a massive finance scandal to cast doubt on everything once again. Thankfully, Wall Street has the perfect cure for those Enron blues. What could be better than a return to the good old days with another high-flying Internet IPO?
Online-payment service PayPal is the latest dot-com to hitch its fortunes to a public offering. It's the first company to attempt such a feat in almost a year — and, in fact, many have questioned the wisdom of its timing. PayPal filed its petition with the Securities Exchange Commission just two weeks after September 11.
Despite a few stumbles along the way, however, PayPal's February 15 IPO seemingly couldn't have come at a better time for investors. Its share price soared to $20.09 by the close of its first day of trading, a 54.5 percent gain.
But though that might normally be a good sign — both for the company in question and for the economy at large — in this case you have to wonder a little bit. Have we learned nothing? While for the moment PayPal appears to be an overnight success, when you consider the larger picture, the company has many of the earmarks of another dot-com cautionary tale in the making.
Shaky Ground
For one thing, characteristic of many so-called "pure" Internet companies, PayPal has no track record of return on investment, having been a consistent money loser since launching its service in December 1998. In the quarter ending December 31, 2001, the company posted losses of $18.54 million, even with $40.4 million in sales.
This leads us to the inevitable question that any sane investor should be asking: Can this Internet startup really expect to succeed where so many others before it have failed? So far, the evidence doesn't look particularly positive.
The concept behind PayPal's service itself is simple and ingenious enough. PayPal's founders perceived a market for a service that would allow Internet users to transfer funds in a way that's analogous to a Western Union wire transfer, only transmitted via e-mail rather than to a physical address.
The company has managed to build a strong niche for itself in the world of online auctions, where it's particularly attractive to low-volume, individual sellers who lack a merchant account with which to process credit card transactions. Today, some 60 percent of the sellers on popular auction site eBay accept PayPal as payment.
That's not to say the company has it easy. It's lately been forced to contend with increasing competition from a number of newer services looking to carve out their own piece of PayPal's pie. The latest is C2It, an online-payment service backed by Citigroup.
The really worrisome competitors, however, are the payment services offered by PayPal's mainstay auction sites themselves. Billpoint, eBay's service, is partially backed by Wells Fargo, while Yahoo! offers its own system, called PayDirect. While neither of these sites has chosen to limit its customers to a single payment method so far, there's nothing to say that won't ever happen.
What's more, PayPal could face even tougher competition should the credit card companies decide to get in on the action. Much of PayPal's business relies on the interface it creates between its customers and the existing credit card infrastructure.
Don't Bank On It
It wasn't always that way, though. Earlier in its history, PayPal relied more on its own system of debit accounts to facilitate transactions. Customers would deposit funds into a PayPal account, as they would with a bank account, and could then transfer those funds into other customers' accounts to purchase goods and services.
PayPal executives are careful not to compare their business to a bank too closely, however, and with good reason. Doing so could run the company afoul of strict federal laws governing the banking industry. Instead, CEO Peter Thiel prefers to stick to the Western Union comparison.
To its credit, PayPal has been diligent in demonstrating its observance of all the laws that apply to the financial-services industry. It's also been deemphasizing the debit-account side of its business, instead positioning itself as more of an intermediary for credit card payments. Nonetheless, as a payment service, PayPal is still subject to legislation at the state level, something that's already becoming a problem.
In early February, Louisiana regulators asked PayPal to cease doing business in that state until it obtained a license to operate a payment service. So far, PayPal has such a license only in Oregon and West Virginia. The move by Louisiana was the first sign that states might pursue legal action against the company, which so far has enjoyed largely unregulated status.
It's not the first time states have voiced concern about the nature of PayPal's business, however. In the past, officials in Louisiana, as well as in New York, California and Idaho, have questioned — some using stronger language than others — whether PayPal might be operating an illegal banking operation.
PayPal is doing its best to comply with the states' requests. According to its SEC filings, the California-based company has blocked Louisiana residents from using its service, and it has applied for licensing as a payment service in 14 other states.
There's no guarantee that it will actually be granted those licenses, however. The states could refuse. That could be a harsh blow for PayPal, which relies on the ubiquity of the Internet as one of the key selling points of its service.
Taking It Public
But another problem that could prove to be even more dire than that posed by the state courts is that of the court of public opinion. Many past PayPal users believe that the payment service's quality is at an all-time low, as evidenced by postings on anti-PayPal sites like PayPalSucks.com and PayPalWarning.com.
Unpopular business decisions are at least partly to blame. In an effort to increase revenue, PayPal recently began charging transaction fees on all payments made by credit card. In the past, individual users with PayPal Personal accounts could use the service for free, no matter what funding method they chose.
However, most disgruntled PayPal customers cite the company's poor track record of customer service as their top complaint. Unlike banks, deposits to PayPal accounts are not federally insured, and the company is free to handle accounting disputes in any means it chooses. Reports abound of user accounts being frozen in response to disputed transactions, and PayPal is notorious for offering few avenues for customer support. The phone number of its Palo Alto headquarters is not publicized on its site.
If the public ever had a love affair with PayPal, that romance seems to have cooled somewhat. So why, then, were investors so hot to buy into this company's IPO?
Maybe it just feels good to be rooting for an Internet stock once again. Once upon a time, the market seemed to be full of young companies building on bright ideas. It seemed as though there might be another success story like Netscape around every corner, and enough wealth being created for everybody. But then reality set in. Scores of those dot-com darlings failed, and many of their ideas turned out to be not so bright after all.
Make no mistake; PayPal does have a pretty bright idea. Though the hype of B2B and B2C has cooled, e-commerce still has a promising future. But if Enron should have taught us anything, it's that the idea of a company isn't enough. It's the execution that matters, and PayPal's business model is far from a sure thing. Investors would do well to remember that when IPOs like PayPal's come along. If we're too eager to return to the days of the dot-com stock bubble, we're liable to get just that.
