Description

PYPL was written up close to a year ago and another time in 2021.  I encourage you to look at those write-ups here and here.  My goal is to focus on some of the ins and outs of the business that haven’t yet been covered in much detail and talk through why I view the stock today as a loaded spring waiting to be released.  I let my membership lapse over the last month so if you like what I’ve written, do me a solid and vote for reinstatement.  Thanks.

Recommendation: Long PYPL

PayPal Holdings (ticker:  PYPL) is a pure-play compounder tied to global eCommerce and the adoption of digital payments, capable of growing revenue in the low- to mid-teens with EBITDA margins and ROIC of 20%+.  The company will generate 7% of its market cap in FCF this year and has net cash of $5.5bn (6% of mtk cap). 

Shares plunged 76% from their 2021 highs as eCom growth slowed post-COVID, PYPL wound-down its relationship with eBay, and the normalization of credit metrics combined to make 2022 the first year in the company’s history in which it reported a decline in adjusted EPS.  Over the last two quarters, shares have oscillated higher on shareholder enthusiasm of activist investor Elliot Management’s involvement in the stock and related cost-cutting actions reported by the company, only to fall back down as fears of market share losses and slowing eCommerce growth took hold.  The result is that shares have de-rated and now trade at 10x 2024 consensus Adj. EBITDAS (13.6x EPS), a 40% discount to pre-COVID levels, and well below businesses with similar characteristics.  We view this as a rare opportunity to buy a high-quality business with exposure to some of the most favorable secular trends in the market at an attractive price.  The headwinds facing PYPL over the last year and a half are largely transitory and already abating as the company has now lapped the exiting of eBay and the most challenging COVID comps.  Management has taken bold moves to reorient the company’s cost structure to drive mid-teens earnings growth in even a dire eCommerce environment.  But as it stands today, eCom spend is much better than “dire” and is accelerating again following several quarters of slowing growth.  With the combination of an improving industry climate and sizeable cost cuts, PYPL will begin to report accelerating revenue growth and improving margins, leading to a re-rating of the stock.  On defensible assumptions, we see upside to 2023 consensus EPS of at least 12% and believe shares could re-rate to between $127 (Base Case) to $150 (Bull Case) vs. $74 today, offering upside of 65% - 100% from current levels, and a risk/reward of 3:1 vs. our Downside Case target price.

Business Description

PYPL operates a global two-sided eCommerce payment network consisting of 35m merchants and 400m consumer accounts.  The company generates 92% of revenue from transaction fees based on the volume of payments processed (“take-rates”).  PYPL reports just two lines of revenue, however the company consists of several different businesses with varying take-rates and cost structures.  The company doesn’t consistently disclose metrics for each of these businesses but based on occasional disclosures and comments from management we can make an educated estimate of their contours.

• PayPal Branded Checkout/Digital Wallet:  also known as branded acceptance, this is PYPL’s core offering, which enables online merchants to accept payment from PayPal’s 400m digital wallet users, including through differentiated structures such as buy-now-pay-later (“BNPL”) and PayPal credit.  PayPal Checkout typically accounts for approximately 30% of payment volumes for its merchants.  In exchange for enabling customers to pay with the PayPal button, merchants pay PayPal a fee of 3.49% + $0.49 per transaction.  Consumers can fund their PayPal digital wallets with a variety of sources, including ACH (checking accounts), debit and credit cards, crypto holdings, and other forms of currency.  PYPL’s net transaction margin is a function of the funding source – transactions funded with ACH or existing balances carry high margins while those funded with credit cards carry lower margins given the need for PYPL to pay interchange and network assessment fees for each transaction.  We estimate net yields (transaction fees less costs, divided by total payment volume) for this business are approximately 2% (excluding eBay volumes) and our work suggests branded checkout accounts for ~90% of total transaction gross profit, making it the most important component of the business.

• Braintree/Unbranded Processing:  Acquired in 2013, Braintree provides merchants with gateway services and end-to-end eCommerce payment processing, inclusive of myriad payment forms (credit, debit, etc.; not just from PayPal account holders).  This offering competes directly with other enterprise eCom acquirors such as Adyen and Stripe.  Clients include Uber, DoorDash, Airbnb, Google, Facebook, TikTok, and Live Nation.  Braintree’s rack-rate take-rate is 2.59% + $0.49 but the mix of large customers who pay negotiated rates brings the overall take-rate down, likely to around 1.5% - 1.75%.  While eCommerce processing is a fairly commoditized service among new-age platforms like Adyen and Stripe, Braintree’s ability to bundle its service with favorable pricing of PayPal branded checkout provides a competitive differentiation.  Because of the competitive nature of this business and the fact that credit cards are a large component of funding methods, we estimate unbranded processing carriers a net yield of ~25bps. 

• Venmo:  PayPal’s second largest digital wallet.  Venmo is most known for its free peer-to-peer payments offering, which PYPL uses as a customer acquisition vehicle.  The Company is now increasingly layering on additional services for which it earns revenue, enabling it to monetize its base of 80m+ annual users.  For example, users incur no fees when sending funds to other users, however transactions between user and merchants are subject to fees.  PYPL also monetizes Venmo by offering debit and credit cards on which it earns interchange fees, as well as other consumer financial products.  In November 2022, PYPL launched Pay-with-Venmo on Amazon, its first ever offering on Amazon, a site that accounts for ~40% of U.S. eCommerce volume.  In 2022, Venmo volumes reached $246bn and generated estimated revenue of $1.3bn, for a take-rate 0.54%, well below the corporate average of 1.86%.  However, as these various new monetized product offerings ramp, we expect Venmo’s take-rate to trend toward the corporate average.

• Other Merchant Services:  PYPL offers merchants a variety of products aimed at driving sales and streamlining business operations, including inventory and returns management, invoicing, risk & fraud solutions, employee payout solutions, and physical point-of-sale software and hardware.

• Other Value-added Services (8% of 2022 revenue):  consists of revenues from partnerships (e.g. co-brand card fees from SYF), interest revenues from merchant and consumer loans, interest on customer cash deposits, and other miscellaneous sources.  This is a beneficiary of rising interest rates as higher yields flow through the income statement with no incremental costs associated with them.

PYPL’s Moat

With a two-sided network consisting of 35m merchants and 400m consumers, PYPL operates one of the largest payments networks in the world outside of China.  The company’s checkout button, end-to-end processing capabilities, and other merchant-services enable merchants to seamlessly accept payments from a variety of sources, including PYPL’s PayPal and Venmo digital wallets credit and debit cards, crypto currencies, and other alternative payment methods (“APMs”).  According to a ComScore study, PayPal drives a 60% improvement in sales conversion vs. other payment methods.  On the consumer facing side of the ecosystem, PayPal’s broad merchant acceptance is its core value-add.  PayPal is accepted at 79% of the top 1,500 U.S. and E.U. online retailers, vs. just 28% for Apple Pay, 15% for Amazon Pay, and 7% for Shop Pay (per PYPL data).  Beyond that, PYPL offers consumers tools for improving their financial lives, including credit products such as BNPL, peer-to-peer payments, and Bill-pay.

We view PYPL as having a strong competitive position, but by no means an impenetrable one.  Unlike V and MA, which combine to operate a shared payments monopoly connecting banks to merchants and consumers, PYPL’s business faces greater levels of competition.  In branded checkout, PYPL competes with Apple Pay, Shop Pay, Google Wallet, and other digital wallets for customer attention, as well as hand-entered credit/debit card information.  In processing, PYPL’s Braintree business competes directly with eCom processors Adyen and Stripe, as well as the online platforms of brick-n-mortar processors such as Chase Paymentech and FIS’s Worldpay.  And in digital wallets, it competes with Apple Pay and SQ’s CashApp in the U.S. and myriad alternative payment methods internationally.  Yet, despite the existence of formidable and well-capitalized competitors, PYPL’s combination of double-sided network effects, captive capabilities (any merchant seeking to accept PayPal transactions must use PYPL to process them), and scale have enabled it to thrive for the last two decades, outgrowing the broader eCom market, producing stable margins, and earning ROICs in the low-twenties. 

Economic Model

The chart below illustrates PYPL’s economic model.  Put simply, revenue is a function of transaction volume multiplied by a spread (“take-rate”), where the magnitude of the spread is determined by the range of services being offered, degree of competition, and funding mix.  Costs fall into two buckets:  transaction expenses, which include the cost of getting customer funds into the digital wallet (via ACH, credit cards, debit, crypto, etc.), and operating expenses, which consist primarily of sales & marketing, technology, and G&A.

PYPL’s Relationship with eBay

To understand PYPL’s business today, we need to look back to its foundation.  When the company first came public in 2002, eBay merchants accounted for 60% of revenue.  Appreciating the importance of PYPL’s processing to its business, or perhaps envisioning the role it would play in the evolution of broader eCommerce, eBay acquired PYPL just 4 months after it went public and made it the primary payment method on its marketplace.  For the next 13 years, PYPL grew both within and outside of eBay as eCommerce penetration grew from 1.5% to 7% of total U.S. retail sales.  In 2015, facing mounting shareholder pressure, eBay spun-off PYPL into a separate publicly-traded company.  As part of the separation, eBay and PYPL entered into a 5-year operating agreement whereby PYPL continued to be the site’s exclusive payment processor.  However, in Jan. 2018, eBay announced that it would not renew its agreement with PYPL (set to expire in 2020) and instead offer merchants its own payments capability, with back-end processing handled by Adyen.  Because the actual processing relationships existed with each individual merchant, the transition away from PYPL lasted for the two, coming to an effective end in 3Q22. 

Over the years, the amount of PYPL’s revenue generated by eBay has steadily declined, largely because PYPL’s growth from other customers has greatly outpaced that of eBay.  As a result, eBay’s contribution declined from 29% at the time of PYPL’s IPO in 2015 to 14% in 2019, even as the absolute dollar value of revenue generated from eBay was flat.  However, over the last two years, both the quantum and percentage contribution of eBay revenue declined steeply, amounting to $1.3bn (6%) in 2021 and $760m (3%) in 2022.  This headwind is now behind the company, enabling core revenue growth to shine through.

The Good and Bad of COVID

As a primarily online payments processor, PYPL benefited greatly from the pandemic-induced surge in eCommerce sales.  In the early stages of the pandemic (March 2020 to March 2021) PYPL’s Total Payment Volume (“TPV”) growth accelerated to 30% - 45%, from 20% in 4Q19.  However, as illustrated below in Exhibit 6, TPV growth peaked in 1Q21 and decelerated in six of the subsequent seven quarters, reaching 9% (FX-neutral) in 4Q22.  Active Accounts – a KPI reported by the company – saw a similar surge in growth (Exhibit 7) that is now normalizing, and bringing with it elevated levels of churn.  In February 2021, management, mistaking the surge in growth as a new normal, issued overly-aggressive 5-year revenue and profitability targets that they have since had to walk back as growth rates trended back toward, and eventually below, pre-COVID levels.  As it stands today, management is guiding to 2022 revenue growth of 11% - 13%, the lowest in the company’s history. 

Elliott’s Involvement, Cost Cutting, and Capital Return

In July 2022, Elliott Management disclosed it had taken a $2bn (~2%) stake in PYPL and was in discussions with management to create value through operational improvements and improved capital allocation.  Shortly thereafter, PYPL announced a $1.3bn cost cutting plan and $15bn share repurchase authorization.  The cost cutting plan, which has since been upsized to $1.9bn, is aimed at leveraging PYPL’s significant scale to reduce transaction costs, and cutting inefficient opex by eliminating 7% of headcount and focusing resources on the company’s three primary growth initiatives:  improving checkout; driving adoption and usage of the PayPal and Venmo digital wallets; and growing Braintree.  With the benefit of these cost actions, management is now projecting at least 125bps of margin expansion in 2023, a significant improvement over the 352bps of margin decline in 2022.

Thesis

• The market is misinterpreting transitory issues and difficult comparisons as structural problems; in reality, secular tailwinds remain favorable and revenue growth will reaccelerate 2023 and 2024.  At 10% (FX-neutral), 2022 was the slowest year of revenue growth in PYPL’s history, and the first in which it saw a decline in Adj. EBITDA and Adj. EPS.  Both bulls and bears agree on this.  Where the two camps differ is in their assessment of why fundamentals softened and how they are likely to evolve from here.  Bears argue that PYPL’s growth is slowing due to increasing competition from Apple and Google in branded checkout, and players such as Adyen and Stripe on the processing side of the business.  As evidence for this, they cite the fact that Core PayPal volume growth has lagged that over several benchmarks of U.S. eCom growth over the last year.  The shorts view this underperformance as indicative of a secular headwind likely to persist for years to come that will push PYPL’s growth rate below that of that of broader eCom spending.  We could not disagree more.  While it is true that PYPL faces competition in each of its lines of business, that has been the case for many years, and there is scant evidence to suggest that there has been any seismic shifts in the competitive landscape in recent years or that elevated competition is driving the recent slowdown in the business.  Our research suggests that although Apple Pay has cannibalized some of PayPal’s share on the margin in recent years, in aggregate PayPal has gained share from prior to the pandemic, particularly if Pay-with-Venmo volumes are included, given growing penetration of digital wallets at the expense of traditional credit/debit transactions.  On the Braintree side of the business, our research indicates that Braintree’s growth has kept pace with that of Adyen and Stripe, with all three vastly outgrowing the broader eCom market; and the recent integration of Braintree and PayPal’s tech stacks could be a catalyst for accelerating Braintree soon.

In our view, the more accurate explanation of recent performance is that 1) lapping issues; 2) post-COVID normalization in the mix of goods and services purchased online; and 3) PayPal’s outsized exposure to the U.K. and Germany have combined to produce an air-pocket in performance relative to U.S. industry-wide spend (what PYPL is typically benchmarked against), and that as these factors fall away, PYPL TPV will return to growth rates at or above the industry.  Taking these issues in turn: 

1)   In the charts below we compare the growth of PYPL’s branded checkout TPV – a figure that backs out eBay, Venmo, and Braintree to isolate just the core business – with several metrics of broader U.S. eCom spend.  This is an imperfect comparison in that the Core PayPal growth rates include international markets whereas the other metrics are U.S.-only.  Nonetheless, it’s the best comparison we have and the one that most bears cite as evidence of share loss.   If we look at year-over-year growth rates, we can see that PayPal has grown at a slower rate than the market throughout 2022.  However, when we look at PayPal’s growth indexed to 2019 levels – to adjust for the extreme pandemic-induced swings in year-over-year growth rates (Exhibit 9) – we see that it is only in the most recent quarter that core PYPL has underperformed industry growth.  If some meaningful share loss has occurred, it strains belief to think that it has happened acutely in a single quarter.  More likely, what we are seeing is simply continued normalization of spending trends, with PYPL normalizing a bit more in the recent quarter than other metrics.  

2)   Core PayPal over-indexes to spending on goods relative to services.  Throughout the first year of the pandemic, spending on goods dominated that of services, with categories such as electronics, furniture, and general merchandise drastically outperforming travel, hospitality, and entertainment, for example.  For the last year, the reverse has been true, driven by the easing of COVID restrictions domestically and abroad.  As a result, it stands to reason that PYPL would underperform the broader market.  While we do not have good data on the relative rates of growth in the U.S., we do have it for Germany, where in 2022 goods purchased online declined 9% while digital services grew 40%, resulting in an overall market contraction of 9%.  A similar dynamic, even if much less extreme, explains how data from the U.S. Census Bureau, Visa, and Mastercard – metrics that include both goods and services – would outperform PayPal in a period with a dramatic mix shift.  Fortunately, recent comments from Visa indicates that the mix of goods and services in the U.S. is beginning to approach pre-pandemic levels, suggesting this headwind to PYPL’s volume growth will soon subside.

3)   eCom sales in the U.K., PYPL’s second largest market (9% of rev.), declined 10% in 2022, the first ever decline in reported data, as energy prices surged upon the commencement of hostilities in Ukraine and broad-based inflation cooled discretionary consumer spending.  eCommerce sales in Germany, PYPL’s #3 market, declined 5%.  Because the Core PayPal TPV metric analysts use to compare against U.S. eCom data includes the negative impact of these and other foreign markets, it stands to reason that it would underperform the U.S. centric benchmarks.  That said, PYPL is now beginning to lap the U.K.’s biggest declines of last year, so the ongoing headwind is moderating.  While the consumer remains pressured in the U.S., the acute declines in spending have abated.  From PYPL’s perspective, at a minimum this headwind has moderated, and more likely, it will turn into a tailwind as the economy finds its footing.

PYPL’s recent results have also been impacted by renewed lock-downs in China.  The closure of factories in China caused 2022 to experience the first year of decline in cross-border TPV in PYPL’s history.  Cross-border volume makes up just 13% of total TPV, but yields are strong given a 1.5% surcharge imposed on such transactions.  In the five years prior to the pandemic, cross-border volumes grew at a 19% CAGR.  With China now reopening its economy at a rapid pace, we should see cross-border volumes flip to positive growth in 2023, driving up both aggregate TPV and take-rates. 

• Account Growth Likely to Reaccelerate.  For many investors, the most distressing element of PYPL’s messaging over the last year has been the lowering of expectations around net new active customer growth (“NNAs”) and the change in strategy away from focusing primarily on account growth to instead prioritizing improving engagement.  In Exhibit 10 below, we can see the trend in NNAs.  When management originally provided medium-term guidance in early 2021, it contemplated 15% annual account growth.  In putting out this target, management clearly failed to appreciate that just as they’d seen elevated account growth during the pandemic, they would see elevated churn as it subsided.  In early 2022, management lowered its NNA expectation for the year from 64m to just 10m.  This wholesale lowering of expectations has led many in the market to assume NNAs will no longer be a meaningful driver of PYPL’s economic model going forward.  We disagree.  Though PYPL does not break out gross adds and churn, we can surmise from ad hoc comments by management and what we see in the data that the primary cause of the recent issues is elevated churn related to cohorts onboarded during the pandemic, not a top of funnel (gross adds) issue.  We estimate ~40m (10%) users churned-off in 2022.  We expect that this severely elevated churn will be largely limited to 2022 and early 2023.  After that, PYPL should return to a more typical pace of user growth.  With a number of recent new product introductions and enhancements (relaunched PayPal app, Bill-pay, broadening merchant acceptance of pay-with-Venmo, broadening BNPL acceptance, etc.), we believe NNA growth can return to at least the high-single-digit level over the coming years.

• With eBay out of the mix, take-rates will stabilize.  Take-rate pressure is a reality for most successful payments companies given that as they grow, they tend to attract larger and larger customers.  As those customers get bigger and hit certain volume thresholds, they receive preferential pricing, putting pressure on take-rates.  However, with higher levels of volume and semi fixed cost structures, profitability per customer (the more relevant metric) grows even as take-rate contracts.  This is a normal and healthy dynamic.  However, for the last several years, PYPL’s take-rate has been under an unusually high degree of pressure given the historic relationship with eBay.  Because eBay merchants were captive to PYPL for transaction processing, and because their agreements were at the individual merchant level rather than platform level (e.g. no bargaining power), PYPL earned take-rates of ~4.0%, double what it makes on non-eBay customers.  Over the years, as non-eBay volumes have outgrown eBay volumes, PYPL’s take-rate has declined by 15 – 20bps per year.  The decline in 2020 and 2021 was especially acute as PYPL exited the eBay business.  With the eBay roll-off now behind it, take-rate should stabilize, with future changes being a function of the relative growth rates of core checkout and Pay-with-Venmo (high take-rate) and Braintree (low take rate).

• Expectations are low and beatable.  After two years of negative revenue revisions, management has finally set the bar low enough on 2023 numbers that it should be able to easily dance over it, even in the face of a challenging macro backdrop.  For the first time in memory, PYPL declined to give TPV or revenue guidance for 2023, but mgmt did commit to achieving a minimum of 18% Adj. EPS, even in an environment in which revenue grows only in the mid-single digit range.  By their admission, for this to happen, they would need to experience a consumer recession in both the U.S. and Europe.  At the time they gave the guidance, they indicated that actual trends were tracking ahead of that dire scenario, and in the two months since, eCommerce trends have further improved, including data out this morning.  Regardless, consensus estimates continue to assume mid-single-digit revenue growth in both 2023 and 2024.  In a normal environment, we think eCommerce spending should grow 10% - 12%.  Assuming PYPL keeps pace with the market, plus or minus 1% to 2%, we believe there is significant upside to consensus estimates (which predictably anchor to guidance).  Specifically, on our Base Case assumptions, we model $5.48 in 2023 Adj. EPS, 12% above guidance/consensus of $4.88. 

• Margin pressure in 2022 was transitory; in 2023 margins will begin expanding again.  PYPL operating margin contracted 352bps in 2022, the first material contraction since coming public.  Management has acted assertively to reverse this trend, implementing the aggressive cost cuts described above and committing to at least 125bps of margin expansion this year.  While Bears argue the outsized margin gains are a one-time measure, we disagree.  Management has said explicitly they expect non-transaction operating expenses to grow below their historic mid-single-digit level for the next few years.  If revenue is growing HSD to LDD, PYPL should continue to see operating leverage of at least 25bp to 50bps per year for the foreseeable future. 

• PYPL is a fundamentally attractive business with durable revenue growth, strong margins, a clean balance sheet, and significant cash flow generation.  In the five years prior to the pandemic, PYPL grew TPV at a CAGR of 25%, revenue by 17%, EBITDA by 18%, Adj. Net Income by 21% and Adj. EPS by 22%; EBITDA margins expanded to a company-high of 27.2%; returns on capital reached 22%; and PYPL generated $14bn of FCF.  The company today has $6b of net cash and limited refinancing needs over the next 5 years.  Beginning in 2023, revenue growth should reaccelerate to the 18% - 20% range and EBITDA margins should begin to expand again, leading to $7bn+ of free cash flow in 2023.  Put simply, PYPL is a high-quality asset with continued growth avenues and an attractive economic model that will produce high returns on capital and free cash flow.  This was true prior to the pandemic and remains true as we emerge from it.

• Announced wins with major platforms have yet to show through in the numbers.  While the market has focused considerable attention on the negative aspects of PYPL’s loss of exclusivity with eBay, few investors seem to be focused on the upside.  During the five years post-spin, PYPL was barred from integrating with certain large online marketplaces.  With the eBay agreement now terminated, PYPL is free to do so and has made significant inroads, some of which have yet to show up in reported numbers.  In particular, in 4Q22, PYPL launched Pay-with-Venmo on Amazon (40% U.S. eCom share).  This mark’s PYPL’s first inroad into monetizing AMZN’s massive volume (Amazon does not accept traditional PayPal payments).  Additionally, Walmart (#2 U.S. eCom merchant with 7% share) recently added PayPal as a checkout option.  Neither of these deals is likely to be a huge needle mover (I estimate AMZN could add 1-2% to revenue), especially in the near-term, but they are indicative of the large untapped opportunity set still in front of PYPL. 

• Venmo is an underappreciated asset with improving monetization.  In 2021, Venmo, PYPL’s peer-to-peer payments business, achieved $900m of revenue on $230bn of TPV.  The business, which accounted for 19% of TPV, generated just 3.5% of revenue and produced an undisclosed amount of operating losses.  The take-rate that year was just 39bps, well below the company average.  The delta is a function of the fact that PYPL offers its core peer-to-peer payment service at zero cost to customers as a customer acquisition vehicle; it then seeks to monetize users (now 83m strong) by charging for services such as using Venmo to pay merchants at the point-of-sale and through interchange fees on Venmo debit and credit card purchases.  Until recently, these fee-generating businesses were a small portion of overall volumes (<10%), but they are now beginning to get traction, and should see acceleration with the inclusion of Venmo as a payment option on Amazon and a growing roster of other retailers’ websites.  As a result of these new lines of business, in 2022, Venmo added $440m of revenue on $16bn of new volume, for an incremental take-rate of 2.8%, in-line with what PYPL earns on core PayPal checkout.  Venmo currently has ~90m active accounts, generating ~$15 per year in revenue.  That compares to SQ’s CashApp (which we view as the closest comp) at greater than $50 per account (excluding Bitcoin revenue).  Assuming no new customer adds, if Venmo were to achieve CashApp’s monetization rate over the next three years, it would drive 70% revenue growth within Venmo.  Assuming a 20% incremental margin, Venmo could contribute $900m of incremental operating income. (15% of 2022 consolidated EBIT).

• Double Digit Earnings Upside.  We see upside to consensus Adj. EPS of 12% in 2023 and 2024 predicated on revenue growth of 10% and 9%, respectively.  This assumes core PayPal branded checkout TPV accelerates to +5% in 2023 (from +1% in 4Q22) and stays at that level in 2024, and Braintree decelerates from +32% in 4Q22 to +25% in 1H23 and +15% in 2H23 as it laps the launch of several large customers; we assume 15% growth in 2024 and beyond.  And we assume Venmo grows 7% in 2023, in-line with 2022, and accelerates to +15% in 2024 on the back of greater Pay-with-Venmo monetization.  We layer this onto a now streamlined cost structure in which opex grows <5% for the next couple of years.  We assume management makes good on their commitment to use 75% of FCF for share repurchases.

• Attractive Valuation.  After declining by 75% over the last 18 months, PYPL trades today for 10x consensus 2024 Adj. EBITDAS, 13.6x Adj. EPS, and 13x FCF.  Since coming public in mid-2015, the stock has traded below this level just twice, and for the briefest of periods.  Prior to the onset of the pandemic, shares traded for 21x EBITDA and 30x Adj. EPS; at the height of the pandemic they traded for 36x and 54x, respectively.  PYPL has no perfectly comparable publicly-traded peers, but there are a handful of businesses that share certain attributes. 

- Card Networks (V/MA):  V and MA are PYPL’s closest comps:  they have asset-light businesses with high returns on capital, mid-teens revenue growth, and strong balance sheets.  However, as a shared monopoly, V/MA are far more insulated from competition, enabling them to have higher ROICs and margins.  PYPL’s high-teens revenue growth has historically exceeded that of V/MA in the low-to-mid teens, however V and MA will put up better numbers over the next year or two as the normalization of cross-border travel drives super-normal near-term growth.  PYPL traded at a premium to V/MA for much of the last four years, but now trades well below V/MA’s 18x/19x EBITDA and 23x/24x EPS.  (note:  V/MA figures are GAAP.  On the same basis, PYPL trades at 12.4x consensus (10.5x our) EBITDA and 13.6x (12.2x) GAAP EPS.

- eCom Processors (ADYEN/NVEI):  These businesses share PYPL’s primary exposure to eCommerce payment processing, high growth rates, and strong EBITDA margins.  ADYEN, in particular, is the closest comp to PYPL’s Braintree business.  Both ADYEN and NVEI are younger companies, currently still in the hyper growth phase of their maturation.  Adyen trades for 31x 2024 EBITDAS; NVEI trades at 9.4x.

- Legacy Acquirers (FIS/FISV/GPN):  The legacy acquirors are the most mature companies within the payments landscape.  Margins are strong in the mid-40s range, but revenue growth is half that of PYPL and the networks.  They generate strong FCF but carry significant leverage as a result of years of acquisition-driven growth.  These businesses trade today for 9x – 11x 2023 GAAP EBITDA, down from 13x – 15x pre-pandemic. 

In our Base Case, we apply a 15x multiple to PYPL’s 2024 Adj. EBITDAS.  This figure is consistent with the multiple at which PYPL traded in 2016 – 2017, a time when revenue growth was a bit stronger than today but ROIC was modestly lower, and with our view that PYPL should trade at a discount to the more defensible card networks and a premium to the legacy acquirors, which are growing slower, levered, and more susceptible to competitive threats.  At 15x EBITDA, PYPL shares are worth $127, 65% above today’s price.

In our Upside Case, we apply a more generous 18x multiple (more in-line, though still at a discount to where PYPL traded in the 2 years prior to the pandemic) to our Base Case Adj. EBITDA, resulting in a $150 implied value, 100% above today’s price.

In our Downside Case, we apply an 8x multiple (in-line with the depressed multiples at with the Legacy Acquirers trade today) to an EBITDA figure that assumes 700bps less volume growth and greater take-rate compression in 2023 than in our Base Case, resulting in fair value of $55, 28% below today’s price.

With 65% upside in our Base Case and a 3:1 risk/reward, we view today’s valuation as a compelling entry point for a business with inflecting fundamentals, a clean balance sheet, exposure to favorable secular tailwinds, and significant FCF generation. 

• Insider Buying.  While not dispositive on the investment case, it is worth noting that CEO Dan Schulman purchased $2m of stock in the open market in February at prices in-line with where the stock currently trades.   

Risks

• Slowing eCom growth.  As PYPL’s business is a derivative on global eCommerce, any structural slowing could lead to negative earnings revisions and further de-rating of the multiple.  We use the term “structural” to draw a distinction with the pandemic-induced cyclical slowing we have seen in the market over the last year today (lapping tough comps, supply chain issues in China, reallocation of consumers’ funds from goods to services after 2 years of a heavy goods skew).  We take the view that the pandemic was a long-term net positive for eCommerce growth as it 1) introduced new cohorts of consumers to the convenience of eCommerce; and 2) opened merchants’ eyes to the needs and benefits of integrating new payments capabilities (e.g. QR codes, BNPL).  With eCommerce penetration at just 16% of total U.S. retail sales, we believe eCom sales should continue to outpace broader retail sales for decades to come.

• Intensifying Competition.  As we discuss above, PYPL is not immune from competition.  There are more digital wallets today than there have ever been.  New payment methods such as BNPL are growing fast and discrete providers are winning real estate on merchants’ checkout pages.  Well-capitalized competitors such as Stripe and Adyen are achieving extraordinary growth rates even as they reach significant scale.  Yet for all of these concerns, we see PYPL as well positioned to compete.  Though myriad digital wallets abound, PYPL’s breadth of acceptance is multiples greater than its next largest competitor and PYPL continues to grow acceptance in existing and new markets.  While it can be tempting to view a new payment option such as BNPL as a threat, PYPL’s experience has only illustrated the strength of being able to layer a new product onto a scaled platform.  PYPL launched a BNLP offering in late 2020, 7 years after U.S. market leader Affirm.  Yet, as of the most recent quarter, PYPL has more merchants using its service than Affirm and is able to offer the product at a fraction of the cost to merchants as competitors.  Lastly, with respect to eCom processing, though the market is competitive, PYPL’s Braintree remains one of the largest and fastest growing players in the market (volume grew 40% y/y in 2022), and we see no evidence to suggest it is losing share.  Given how large and fast growing the market is, PYPL, Adyen, and Stripe are likely to all see many years of elevated growth at the expense of legacy merchant acquirers. 

• Management Vacuum Creates Uncertainty.  CEO Dan Schulman has announced he will be retiring at the end of 2023, possibly sooner if a replacement is found quicker.  Additionally, CFO Blake Jorgensen, who was only in the role for 6 months, recently left for health issues.  With no CFO and an outgoing CEO, there is a risk that whomever steps into the role takes the company in an unexpected strategic direction or otherwise fails to execute on the current strategy.  Given the issues the company has had over the last two years, we view the departure of Schulman as a positive despite the uncertainty it creates.  As for the CFO, the job is being temporarily filled, for the second time, by PYPL’s IR, Gabby Rabinovitch.  So despite the hunt for a permanent CFO, the office is in capable hands.

Catalyst

The pieces are largely in place.  Now it's about watching the progression of earnings beats.