Description

PYPL is an attractive business selling at an attractive price.  It has, in my opinion, unfairly been lumped in with fintech and crypto and taken out to the woodshed and murdered accordingly.  However, I still see a very attractive franchise with plenty of additional monetization potential and runway for growth.

For an excellent overview of the business I’ll refer you back to Kerrcap’s write-up on 12/15/21.

So what has changed since that write-up?

1. Strategy Change: The company has shifted its strategy from user growth at all costs to a focus on profitable user growth.  This was articulated well on the Q4 earnings call on Feb 22:

“Moving forward, we will continue to grow our users, but our focus will be on sustainable growth and driving engagement. To be very clear, this is a choice on our part. We could increase our spend and accelerate our net new active trajectory, however, we believe there are better ways to achieve our financial results. We strongly believe that we are making the right decisions in redirecting our spend toward high-value customer acquisition and engagement channels.”

As an owner of PayPal this is exactly the trade off I want them to make.  Grow profitable customers, don’t just add customers to keep up with the cool kid money incinerating fintech peers.  They will probably churn out some low value customers in the next couple quarters, but long-term this is exactly what I want management to do.

2. CFO Departure:  In April, PayPal announced their CFO John Rainey was moving over to Wal-Mart.  Most people perceive this as just a career upgrade for him, but when a CFO leaves, it always generates uncertainty and especially when he leaves after numbers have been lowered.  Maybe the new CFO comes in and resets the bar even lower.  However, I also view the new CFO as an opportunity to get behind the focus on profitable customers strategy.

3. Crypto Meltdown:  It will be news to exactly no one that there has been a complete crypto meltdown. Bitcoin has fallen from around 50k to around 20k this year.  Paypal started offering crypto trading in both the Paypal and Venmo apps in 2020.  It is my belief that revenue from this market is immaterial to the company at this point because I think Paxos is probably getting most of the trading economics.  This comment from John Rainey at a recent conference suggests as much:

"Crypto is a great example. Right so everybody has got their own view of crypto but our customers now have the ability to buy and sell crypto in the wallet and while that's maybe just a nice little feature, and that by itself is not driving outsized benefit to our financial performance.

What is, is when a customer sells crypto. We see a very, very high degree of reuse or re-spend in the wallet. The principal in terms of what they saw and that's coming basically at 0% funding cost because that's about trust…"

4. Fintech Meltdown:  Fintech has almost become a dirty word.  The industry is in complete meltdown.  The press is all over it: https://observer.com/2022/06/a-brief-history-of-the-fintech-meltdown/

https://www.wsj.com/articles/klarnas-valuation-set-to-slip-bringing-fintech-star-down-to-earth-11656008601?mod=itp_wsj&ru=yahoo

https://www.protocol.com/newsletters/pipeline/fintech-startup-valuation-reset?rebelltitem=3#rebelltitem3

Cash incinerating startups are laying people off.  It’s not pretty.  But it is good for PayPal for two reasons: 1) people are going to demand that fintech businesses make money, which makes it easier for PayPal to compete with the many features they have added to their wallet like BNPL and 2) there is going to be a lot more talent available which should be good for PayPal.  Those overly ambitious employees who jumped ship for a startup may ultimately come back chastened and appreciative of the stability PayPal can provide.

5. Strong dollar:  Paypal has a significant international component to its business.  In 2021 46% of revenues came from customers outside the United States.  The dollar has strengthened materially and this is likely to weigh a little bit on the topline.  I doubt such a move is permanent, but in the near-term it hurts.

6. Inflation:  Everyone knows inflation is running hot.  Long-term I don’t expect inflation to impact PayPal’s business that much.  Higher prices means more total payment value (TPV) to charge fees on.  Costs may rise too, but to the extent much of the investment that powers PayPal is already in place, inflation may actually help this business.  It certainly will increase the float income PayPal can earn as interest rates rise.  Of course, a temporary offset is that consumers who are feeling the squeeze will spend more on food and gas which PayPal has limited exposure to and less on other goods where PayPal has more mix.  Also, to the extent the Fed induces a recession and the odds of that are rising, that is temporarily bad for all retail-centric businesses including PayPal.

7. Ebay Headwind abating: Next quarter is the final quarter that PayPal is lapping the headwind from ebay going away.  It should only be a $200 million headwind in Q2 and that should be the final quarter one has to worry about it.

8. Upcoming changes for business accounts:  PayPal announced that all business accounts will be ineligible for free transfers starting July 28th.  

https://newsroom.paypal-corp.com/2022-06-Upcoming-Changes-to-PayPals-Pricing-Structure

They are also lowering the fixed fee on small transactions likely to throw some of the people that have been skirting paying merchant fees a bone.  

9. Venmo coming to Amazon and other monetization opportunities:  PayPal announced last year that Venmo will come to Amazon checkout this year, so far we haven’t seen it yet.  It is well known that Amazon has a beef with the credit card companies and their fees:  https://www.theguardian.com/technology/2022/feb/17/amazon-visa-resolve-credit-card-dispute-global-deal-payments

While Visa and Amazon ultimately settled the dispute above, I do wonder if Venmo at checkout could be one way for Amazon to try to get around the credit card duopoly.  It makes sense to me that Venmo could offer terms to Amazon that are better than the credit card companies at scale.  In the end, I think Venmo is in the very early days of monetization and with 80 million users, there is a lot more to come potentially.

That is a lot that has changed in six months!  Many of the changes are temporary headwinds but, I don’t think the business itself has fundamentally changed that much.  I expect most of the headwinds to abate within 6-12 months.  In the end, this is a play on the growth of ecommerce.  Different people measure it differently, but ecommerce penetration is between 12% and 18% in the United States.  In my mind, there is still a long runway for growth and PayPal is well positioned to capture its fair share as ecommerce penetration continues to grow.  

PayPal also has ambitions to become the de facto digital wallet with the PayPal/Venmo apps.  I think this will be tough to do, but I do think other wallet competitors like Apple Pay and Google Pay are likely to face a lot of antitrust scrutiny which may just play to PayPal’s benefit.  If PayPal becomes the de facto digital wallet with add on services like banking/investing/etc. there could be another significant leg of growth to the story beyond traditional ecommerce.  I view the digital wallet as mostly just a call option at this point.  However, if WeChat in China is any guide, the winning digital wallet could become the gateway to almost all commerce and, in turn, be extremely valuable.

Valuation:  This is VIC so some discussion of valuation is warranted.  I’m not sure where they come in this year, but for the last couple of years PayPal has successfully done $5 billion in FCF give or take.   They had a bit of a rough start this year, but I would expect another roughly $5 billion this year and significant acceleration as the focus on profitable customers takes hold next year.  With an $89 billion EV and $87 billion market cap, a 5.8% FCF yield looks pretty attractive to me for a market leader that I think can drive double digit revenue and earnings growth for many years to come.

Relative to past history PYPL is as cheap as it has been since it has been public.  Using Bloomberg blended forward year estimates it is trading at 17.7x P/E and 12.3x EV/EBITDA which are both pretty much all time lows and a 50% discount to its five-year average.

Compared to peers, PYPL looks attractive to me in terms of valuation.

V and MA are the best comparables in terms or quality of franchise and growth potential.  They trade at 28 and 25x EPS and EV/EBITDAs of 22 and 20x respectively.

Fintech competitor Block (aka SQ) still trades over 50x EPS and 40x EV/EBITDA.

Much slower growing processors such as GPN, FISV, and FIS trade at 12ish x EPS and 11ish x EV/EBITDA. I think their discount is justified by their anemic growth prospects.

Bottom-line, PayPal remains an attractive company with good economics.  They are transitioning to a more profit focused model from a revenue and user growth at all costs focused model.  I think 3-5 years from now today’s prices will have proved to be an attractive opportunity to buy.

Risks:

• Many of the aforementioned headwinds are macro and will last as long as they last.
• PayPal faces plenty of well funded competition, they are going to have to compete to win.
• There may be another reset of numbers before things turn due to the headwinds and/or when the new CFO comes in.
• The stock could still get cheaper. 5.8% FCF yield seems like a fine place to buy long-term, but it may bottom out even cheaper.

Please note:  This write up should not be considered investment advice, it merely expresses the opinions of the author.  Information provided here is believed to be accurate, but might not be complete or accurate.  You should do your own work. The author of this write up may change his position at any time without notice.  

Catalyst

• Ebay headwind is gone.
• Venmo ramp at Amazon and other Venmo monetization.
• Focus on profitability instead of user growth pays off.
• New CFO comes in and tells a better story and helps management regain credibility after a bruising period.