Google Up Against Paypal - Analyst Blog

Google Inc (GOOG) announced its digital wallet payment system amongst much controversy. Very soon after the company announced the new payment system at its New York offices along with partners Citibank, a subsidiary of Citigroup (C) and Mastercard Inc. (MA), eBay Inc (EBAY) and its payment unit Paypal slapped a suit on Google, as well as a number of key Google personnel.

The digital wallet is a point-of-sale (“POS”) solution that would enable an Android phone user to wave the phone near a POS terminal to make a purchase. The technology that makes this possible is called Near Field Communication (“NFC”) and is already available in parts of Europe.

For example, in the U.K., Orange has made this kind of payment possible with a preloaded Barclaycard on a specific Samsung handset. O2 Micro (OIIM) has also announced plans of launching a similar payment service in the back half of the year. Visa (V) too has announced similar plans through tie-ups with 14 financial institutions, including the likes of Barclaycard USA and the Royal Bank of Canada.

The reason Google's digital wallet is of such great importance is its Android operating system, which has become the leading mobile phone OS in the U.S. Android-based phones have seen the fastest growth in the past year, displaying significantly higher growth rates than Apple Inc's (AAPL) popular iPhone. Google's strategy behind Android was originally to maintain its position in search, which was increasingly moving from the desktop to the notebook and then to mobile phones.

However, the past year or so has seen a huge change in consumption patterns, with a corresponding increase in demand for location-based services. In 2009, a number of Internet research companies coined the word m-commerce, pointing out that consumers were already purchasing fast-food and other low-range products through their mobile phones.

This greatly increased the window of opportunity for Google, which already had sophisticated machinery in place to predict consumer behavior and provide relevant information regarding nearby eateries, points of interest and the like.

The problem was that credit card information and shipping addresses still needed to be entered, which was not easy, given the size of the devices. Therefore, something more sophisticated was required that could make payment from the phones easier.

With half the battle already won, Google tinkered around with its Checkout payment platform, which did not gain momentum for a number of reasons. However, Google made its most serious attempt to tap the m-commerce market only recently with the development of its very own digital wallet.

And this is where it ran into some trouble as well. eBay and its payment unit Paypal have alleged that Google misappropriated trade secrets by buying out key personnel employed at eBay and encouraging them to spirit away strategically critical information regarding Paypal's product roadmap, its prospective strategic partners as well as a detailed analysis of the problems with Google's existing system.

The lawsuit repeatedly mentions that the allegations were based on “information and belief,” so there could be room for doubt regarding Google's wrong-doing. Although the fact that Google engaged in extended negotiations and meetings with Paypal over the past couple of years and obtained a significant amount of information regarding Paypal to facilitate its incorporation into Android phones and then abruptly changed plans just as the agreement was about to be signed does look suspicious.

A first-read of the complaint clearly vindicates two key personnel - Google's VP of Commerce Stephanie Tilenius and Osama Bedier (a key executive in Google's payments division) both of whom were former eBay employees.

eBay and Paypal are claiming willfully malicious behavior on the strength of which they are asking for punitive and exemplary damages (for irreparable harm), as well as an injunction to stop Google from using any of the trade secrets that were allegedly misappropriated.

It will be interesting to see how the case unfolds, since it could go either way. But we see Google parting with a good amount of cash.

Both Google and eBay shares currently carry a Zacks Rank of #3, which implies a Hold rating in the near term (1-3 months).