Is PayPal (PYPL) A Dinosaur?

10/6/2023

PayPal's stock price was once soaring at over $300 a share and has now plummeted by a jaw-dropping 80%. It's trading at just $55 a share.

Is this the end of the road for PayPal, or could it be a golden investment opportunity in disguise?

There is actually a debate going on Wall Street. Some say PayPal is a financial technology dinosaur, losing its market leadership, Others believe it's a sleeping giant waiting to rise from the ashes. The million-dollar question: Who's got it right?

Today, I answer that million-dollar question.

Let's talk about that!

I'm Hoda Mehr, founder, and CEO of Stock Card, and on this blog and its accompanying YouTube channel and Podcast show, I share detailed fundamental analyses and interesting investment stories.

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Every now and then, Wall Street calls a company the new IBM. By that, they mean a market leader that has lost its touch, fallen behind competitors, and there no hope of recovery for the company and its stock price.

For example, In 2019, most of Wall Street called Apple the new IBM as the company's stock price crashed from $58 per share in August 2018 to $38 per share in December of the same year, going down more than 30% in less than a quarter. Apple survived and thrived to $175 per share now, a 360% return in 5 years.

What made Apple succeed, and do we see similarities between Apple of 2019 and PayPal's of 2023?

Three Things That Worry Investors About PYPL

Its total transaction volume growth has slowed down, mostly in the 10% range.
Competition from Apple Pay and other digital payments is growing.
And, the company's transaction margin is shrinking.

Are these valid concerns? Purely and mathematically, they are right. Slow growth, competition, and margin concerns.

But investing is all about the context behind the numbers. Here's the context:

The Digital Payment industry is expected to grow by 11%+ per year in the next few years. The growth in the U.S. is expected to be faster at around 14%+ annually. PayPal's business is quite international, and its total payment volume growth is about the same as the overall market’s growth. It's moving at the market's pace. That's not bad!
Concerns about competition are valid too. Let’s take Apple Pay. Apple is patient, and can leverage its devices to push its own payment system. Other digital payment companies aren't sitting idle either. However, PayPal has a headstart and a strong base in this market. It has over 400 million active accounts, vs. Apple Pay's 55 million, and offers more than a payment button. PayPal has a product portfolio that covers all aspects of digital payments. From PayPal's payment infrastructure that consumers use directly to buy things, to peer-to-peer payment through its Venmo division and digital payment processing infrastructure through its Braintree platform, PayPal has a robust product portfolio. So, yes, Apple is competing in one segment, PayPal has peer-to-peer and payment processing infrastructure to grow with. In fact, Apple of 2019 was in the same boat. Revenue from iPhone was going down, but Apple already had a rapidly growing services segment by leveraging its device user base. Similarly, PayPal has rapidly growing Braintree and Venmo to rely on for growth.
The last point is the transaction margin. This figure is going down from 51.0% a year ago to roughly 46% in the latest quarter. It represents the ratio of total revenue, less transaction expense and transaction, and credit losses, to the total revenue. It's very similar to gross margin. How much does the company keep after it removes all its variable costs. This figure is critical to the company's continued profitability. If it keeps going down, the stock price will go down with it. But the context matters. Right! Braintree is the reason for the lower transaction margin. The company has explained that as it focuses on selling higher-value add-on solutions to Braintree customers, it will be able to improve its margin in Q4 this year and beyond. I buy that story. Technology product's success is all about upselling. This means you get a new client and keep selling more to them. That's precisely what Braintree is after. With large clients such as Uber, Booking.com, Meta, and even TikTok, PayPal has a strong base to upsell new products such as transaction fraud prevention and other services to improve its margin.

PayPal's Fundamental Analysis

Now, we have the context behind what concerns PayPal's investors, let’s recap PayPal's fundamentals quickly:

PayPal is a $64 B company
With $28.5 B in annual revenue, 3.5% Q-over-Q and 6.5% Y-over-Y revenue growth
It's profitable with positive net income and EBITDA, but we do have to keep an eye on profitability and transaction margins that are shrinking.
It generates $5B in free cash flow and uses it to buy back shares, which is good for investors, especially at the current lower stock price level.
It has a solid balance sheet. But carries $10B in long-term debt. Even with that amount of debt, its financial health ratios, such as debt-to-equity or debt affordability ratio, are healthy.
The company’s stock price is valued at 16 times its earnings, 10 times its future earnings, and 2.3 times its sales.

These valuation ratios are lower than PayPal’s peers and the average of companies in the S&P 500, giving its stock an undervalued valuation.

Is PayPal A Buy Now?

Buffett says "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."

We know we can buy PayPal at a great price. But is PayPal, a wonderful company or just an average digital payment provider hanging in the balance?

What’s the definition of a wonderful company? A monopoly or a company with such a strong competitive moat that cannot be bothered by the competition, has pricing power, and is run by a solid management team.
That definition is simple to understand but not always obvious. In the case of Apple of 2019, when investors were calling it the new IBM, it was its strong customer base who loved their Apple devices that gave it a competitive most. These devices were so entrenched in the customer’s day-to-day lives that Apple could upsell its services and other devices and grow.

To me, PayPal has a similar moat. Many businesses all around the world have PayPal as an integrated part of their payment. The company has 42% market share of the global digital payment volume. With 400M active accounts in more than 200 countries, PayPal has a solid customer base to upsell new products and services.

I own shares of PayPal, and I will add a bit more to it. The risk is that I overestimate the company’s competitive moat. To mitigate that risk, I may spread out my investment and wait to hear the next quarterly earnings, especially because I want to hear from PayPal’s new CEO too.

This episode goes well with a 6-step Fundamental analysis guide that I published recently. If you want to learn or brush up your skills in how to do Fundamental analysis that's a good post to read right after this.

I’ll see you next time!

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