PayPal’s Evolution and Investment Potential in 2024
PayPal is a pioneering digital payment platform that facilitates secure and convenient online transactions for individuals and businesses worldwide. Founded in 1998, PayPal has become one of the most widely used payment systems globally, processing over $936 billion in transactions in 2019 alone. PayPal empowers users with a suite of secure payment solutions, enabling them to link multiple bank accounts and cards, eliminating the need to share sensitive financial details directly with merchants. PayPal’s expansive merchant network seamlessly integrates with millions of websites and mobile applications, providing users with a global reach for their online purchases. Today, PayPal is a cornerstone of the digital economy, offering secure, fast, and convenient payment solutions for consumers and businesses of all sizes.
2023, has been a tumultuous year for PayPal, marked by numerous challenges including an increasingly competitive landscape, increased expenses, and slowing user growth. All of which have contributed to PayPal’s poor stock performance, down 22% year-to-date falling well short of the S&P 500’s 18% return over the same period. To address these challenges, PayPal has brought on a new executive team, comprised of seasoned industry professionals with a track record of driving innovation and growth, particularly in the world of small business.
Despite facing an uphill battle in the coming months and years, Pay Pal’s new leadership team is poised to make strategic decisions that will help the company regain its footing and continue to be a leader in the digital payment industry. Additionally, the recent decline in share price makes PayPal an appealing option for value investors seeking potential opportunities.
PayPal’s Competitive Edge in the Thriving Digital Payments Landscape
PayPal operates within the digital payments industry which is experiencing significant growth and is expected to continue expanding in the coming years. According to projections from Statista, the total transaction value in the industry is set to reach an impressive $9.46 trillion by year end. Furthermore, the industry is projected to maintain a strong annual growth rate of 11.80% from 2023 to 2027, resulting in a projected total transaction value of $14.7 trillion by the end of the forecast period. In this thriving market, digital commerce remains the largest segment, with a projected total transaction value of $6.03 trillion, this is the segment for which PayPal operates in. This highlights the increasing popularity and widespread adoption of digital payment methods in the global economy.
PayPal faces intense competition in the rapidly growing digital payment industry, contending with key players like Stripe, Square, Amazon Pay, Adyen, Apple Pay, Google Pay, and Shopify Pay. Each competitor brings unique strengths; for example, Stripe is known for its API-driven payment infrastructure, Square tailors solutions for various business sizes, Amazon Pay leverages the trust of its vast user base, Adyen offers a global payment platform, and Apple Pay and Google Pay are integrated mobile payment systems. Shopify Pay streamlines payments for online merchants on the Shopify platform.
To keep ahead of the competition PayPal possesses several advantages that contribute to its leading position in the digital payment industry. One of the company’s key strengths is its large user base of more than 430 million active users which is almost 100 million more people than the entire US population. This large user base completes more than 24 billion transactions per year, which provides a strong network effect and fosters trust among consumers and merchants alike.
Additionally, PayPal benefits from its strong brand recognition, which has become synonymous with online payments, instilling confidence and familiarity among users. Consumers benefit from PayPal because the company enhances the online shopping experience by providing secure, convenient, and global payment solutions. PayPal simplifies online payments by eliminating the need to share sensitive financial details directly with merchants. It acts as a middleman, authorizing transactions and managing payments securely. At the same time, PayPal empowers merchants to streamline payments, enhance security, and expand global reach, fostering a thriving online business.
Another advantage is its global reach, as PayPal operates in more than 200 global markets and supports transactions in 150 send currencies. This extensive international presence allows PayPal to cater to a wide range of customers and merchants worldwide, giving it a competitive edge in facilitating cross-border transactions. These competitive strengths contribute to PayPal’s ability to attract and retain users and merchants, solidifying its position as a leader in the digital payment industry.
Analyzing PayPal’s Financial Landscape
In evaluating PayPal’s financials, a notable facet emerges in the disparity between its impressive total Free Cash Flow growth and the comparatively modest increase in its share price. Over the past decade, PayPal has exhibited a remarkable Free Cash Flow growth of 219.10%, accompanied by a compounded annual free cash flow growth rate of 12.30%. Traditionally, share prices tend to track the trajectory of free cash flow growth over the long term. However, despite these robust financial metrics, PayPal’s shares have only seen a 58% increase over the same period. This discrepancy raises the possibility that PayPal’s current market valuation may not fully reflect its intrinsic value, suggesting that the company could be undervalued.
PayPal’s profitability has been mixed in recent years. The company exhibits a strong Return on Equity (ROE) of 18.82%, surpassing the sector median of 11.66%, showcasing its efficiency in generating returns for shareholders. Over the past decade, PayPal has maintained a commendable 10-year average ROE of 14.13% highlighting improving returns on equity. On a per-employee basis, the company stands out with an annual revenue of $125,000, outperforming the sector median of $91,470.
However, challenges arise when it come’s to the company’s margins. PayPal’s gross margins currently lag behind the sector median, standing at 40.20% compared to the sector’s 60.37%. This is further emphasized when compared to PayPal’s own five-year average of 45%. The decrease in gross margins can be attributed to the company’s growth in low-margin business products while it’s higher margin branded products have come under pressure from competitors like Apple. To combat these margin pressures that company has embarked on several cost savings initiatives totaling an estimated $1.3 billion an annual savings, including laying off close to 2000 employees earlier this year.
PayPal’s Strategic Evolution
In a strategic move, PayPal announced in August the appointment of Alex Chriss as its President and CEO. A distinguished business leader with a wealth of experience, Chriss has been a pivotal figure at Intuit, serving as Executive Vice President and General Manager of the Small Business and Self-Employed Group since January 2019. Over the past five years, under Chriss’s leadership, the Small Business segment experienced remarkable growth, achieving a compound annual growth rate of 20% and 23% in customers and revenues, respectively. Notably, in 2021, Chriss orchestrated Intuit’s successful $12 billion acquisition of Mailchimp, expanding the platform’s capabilities and broadening its customer base.
In the foreseeable future, PayPal is set to maintain a strong emphasis on small and medium-sized businesses (SMBs), recognizing their pivotal role in the online merchant landscape. The expansion of merchant reach is a key strategy, leveraging the substantial and growing segment of SMBs to tap into a diverse pool of potential customers and enhance transaction volume. A notable trend among small businesses is the aspiration to transition to a cashless model, with 95% of entrepreneurs expressing the intent to embrace this shift in the future, representing a clear tailwind for PayPal in the future.
In a significant move towards enhancing its digital currency offerings, PayPal has introduced a U.S. dollar-denominated stablecoin named PayPal USD. This fully-backed and regulated stablecoin aims to establish a seamless connection between traditional fiat currencies and their digital counterparts. Eligible U.S. customers on the PayPal and Venmo platforms can now enjoy a range of functionalities with PayPal USD. This includes the ability to transfer the stablecoin between PayPal, Venmo, and compatible external wallets, engage in wallet-to-wallet transfers using PayPal USD, fund purchases by selecting PayPal USD at checkout, and conveniently convert any of PayPal’s supported cryptocurrencies to and from PayPal USD.
PayPal can leverage its new stablecoin, PayPal USD, to generate additional revenue streams in several ways including charging transaction fees for transfers, purchases, and conversions involving PayPal USD and the company can earn interest on these reserves in U.S. dollars backing PayPal USD.
PayPal’s capital allocation strategy reflects a judicious approach to maximizing shareholder value since becoming an independent entity in July 2015. Over this period, the company has generated an impressive $31 billion in free cash flow (FCF). In terms of capital deployment, PayPal has allocated $21 billion to share repurchases and $13 billion to strategic acquisitions and investments since its separation.
In the third quarter of 2023 alone, the company returned $1.4 billion to stockholders through the repurchase of approximately 23 million shares at an average price of $63.02 per share. This commitment to returning capital is further evident in the trailing 12-month basis, with PayPal having returned $5.4 billion to stockholders through the repurchase of around 75 million shares, resulting in a 5% reduction in weighted average shares year-over-year.
Financial Projections and Valuation Analysis
PayPal’s forward guidance paints a robust financial trajectory, the company anticipates expanding its Non-GAAP operating margin by approximately 75 basis points, showcasing a commitment to operational efficiency. PayPal is projecting a Non-GAAP EPS of approximately $4.98, reflecting an impressive growth rate of around 21%. If we apply PayPal’s five year average forward Non-GAAP PE multiple of 34.94 to it’s projected earnings of $4.98, we achieve a valuation of $174.00 which represents a 204% premium to PayPal’s current share price.
Furthermore, PayPal aims to generate a minimum of $4.6 billion in free cash flow over the next 12 months, we can use this free cash flow figure as a starting point of a discounted cash flow analysis to provide second valuation estimate.
Drawing insights from the estimates provided by nearly 30 analysts, we will leverage their average revenue growth rates over the next three years as an initial benchmark. We plan to transition to a secondary growth rate determined by PayPal’s 10-year average revenue growth rate, standing at an impressive 15.13%. Acknowledging the challenge of sustaining such a high growth rate over the next seven years, we will use a conservative approach by halving this rate, arriving at a more realistic and tempered growth rate of 7.5%. This calculated growth rate will be applied to model years 4-10 in the discounted cash flow (DCF) exercise, ensuring a balanced projection for future growth.
Employing a terminal growth rate of 2.5% in perpetuity, derived from the long-term average inflation rate, and applying a discount rate of 10%, reflective of the market’s long-term return with reinvested dividends, our DCF analysis yields an intrinsic value of $82.55. When compared against PayPal’s current stock price, this intrinsic value indicates a potential return of 44.49% for investors. This suggests that PayPal is currently positioned at a discount, as indicated by various valuation techniques.
PayPal’s Path Forward
Amidst challenges in 2023, PayPal, a global digital payment giant, faces increased competition, rising expenses, and slowing user growth, resulting in a 22% YTD stock decline. To navigate these issues, PayPal revamped its executive team, emphasizing innovation and small business growth. Despite recent setbacks, the company holds a strong position in the booming digital payments industry, showcasing resilience through its extensive user base of 430 million, robust brand recognition, and global reach.
Financially, PayPal’s impressive Free Cash Flow growth and Return on Equity contrast with lagging margins. A strategic shift includes the appointment of Alex Chriss as CEO, emphasizing small and medium business focus, and the introduction of a stablecoin, PayPal USD. The capital allocation strategy aims at shareholder value maximization. PayPal’s forward guidance hints at a promising future, and diverse valuation methods suggest it may be undervalued, presenting potential opportunities for investors.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of AAPL either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I have no business relationship with any company whose stock is mentioned in this article.
The Pineapple Investor’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. The Pineapple Investor is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
