PayPal: Priced For Failure, Poised For Success.

PayPal Holdings remains a leading global fintech player and continues to benefit from the strong secular tailwinds behind its industry.

While the stock price remains stagnant, PayPal's operational performance tells a very different story. The company continues to exhibit solid growth across its diverse range of payment businesses.

PayPal is heavily undervalued with a 9.5x trailing P/FCF ratio, strong balance sheet, and forecasts for continued growth.

Under new management, the company is prioritizing newer growth initiatives such as unbranded checkout and digital advertising.

Though PayPal has been undervalued for a while, accelerating share buybacks should help force the issue, resulting in faster per-share earnings growth and squeezing the stock price higher.

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PayPal Holdings, Inc. (NASDAQ:PYPL) has been gaining investor attention throughout the first half of 2024, driven by its beaten-down valuation, fresh growth strategies, and several high-profile bets made by famed money managers. While longtime shareholders largely view the stock with disgust following its 80% decline over a 3-year period, others are taking the opportunity to jump in at these depressed levels. The hordes of optimistic PayPal shareholders include not only value investors enamored with the company’s strong growth and low valuation, but also technical traders and those betting on the powerful principle of reversion to the mean.

While PayPal’s stock price remains mired in a sideways trading pattern, the company’s operational performance is anything but stagnant. Revenues and profits continue to grow, the company’s service offerings are becoming increasingly diversified, and CEO Alex Chriss is making bold moves to supercharge the company’s innovation and competitiveness. Moreover, PayPal’s management team is devoting 100% of the company’s powerful free cash flows to share repurchases, supporting the thesis that the stock is extremely undervalued.

At its core, PayPal remains a vibrant company with healthy growth across its various businesses. The post-COVID sell-off is dramatically overdone, and shares are trading at a steep discount to the company’s fair value. The opportunity to buy into a fintech industry leader at <10x trailing FCF is simply too compelling to pass up, especially with book value comprising close to a third of its market cap. With one of the most forceful share buyback programs in existence, it’s clear that the company’s insiders agree.

Operations
PayPal is arguably the world’s OG fintech company. Founded a quarter of a century ago, PayPal quickly gained near-universal name recognition as the leading digital wallet and online payment system. The PayPal product remains one of the most widely-used fintech platforms globally, with hundreds of millions of active users. In 2013, the company acquired digital payment platform Venmo, which is one of the key U.S. fintech players in its own right with tens of millions of active users.

PayPal also operates in a number of other adjacent niches, including e-commerce checkout systems, payment cards, and digital advertising. In fact, PayPal has so many balls in the air that it would be impossible to detail them all. PayPal is broadly in the business of facilitating all sorts of financial transactions, and it is consistently innovating and expanding into new financial services and product offerings.

Some of the company’s faster-growing initiatives include Fastlane by PayPal, which is intended to make e-commerce payment processes more streamlined, as well as the “unbranded checkout” division, which similarly seeks to expand the company’s footprint in the facilitation of global e-commerce transactions. E-commerce payment service revenue grew 26% YOY in Q1, and CEO Alex Chriss stated in a CNBC interview earlier this year that “we’ve got a quarter of the world's e-commerce running through PayPal.”

The vast majority of PayPal’s revenues are derived from transaction fees across its various products and services, with the remainder (~9%) attributable to value-added services. Value-added services refer to additional services PayPal offers to existing customers of its transaction facilitation businesses, such as fraud prevention and business process automation services.

Post-Pandemic Fall From Grace
PayPal’s stock tripled between the start of the COVID-19 pandemic and mid-2021, following the trajectory of other stocks viewed as beneficiaries of the pandemic. PayPal was anticipated to benefit from the boom of online retail and digital payments during the social distancing era, and many market participants forecasted an enduring acceleration of remote payment adoption as a result of the pandemic and the overnight changes it caused to consumer habits. Super-low interest rates also contributed to general bullishness around the fintech industry during that period.

As we now know, those rosy predictions did not meaningfully materialize for PayPal or other COVID bubble stocks. PayPal shares soon crashed back to earth following their July 2021 peak of >$300, with the stock declining by >80% from peak to trough. PYPL now trades at a massive discount to its pre-pandemic price. In my view, the sell-off is at least as overdone as the preceding run-up. The company’s revenue has grown significantly since the pandemic, with 2023 sales 67.5% higher than 2019 sales. Profit has grown at an even higher rate over the same period; 2023 net income was up 72.7% as compared to 2019. On its face, it seems extremely illogical that the stock is down ~45% since the start of 2020.

Solid Growth
If a company is actively growing but the market reacts like it’s dying, is it truly growing? This philosophical question holds important implications for PayPal, a company that has received little credit for increasing its sales every year since going public. TTM revenues and profits are both roughly double 2018 levels, with management and analysts forecasting continued growth moving forward.

Admittedly, bottom-line growth has lagged behind sales growth in the past couple of years, as top-line expansion has been driven largely by lower-margin unbranded checkout growth. (Credit losses also contributed to impairing the company's margins last year.) That said, essentially all units of the company are growing across the board – so even as margins deteriorate, net profits can be reasonably expected to continue increasing. In spite of falling margins, the company posted 20%+ non-GAAP EPS growth YOY in Q1 (partially attributable to share buybacks) and guided for “low double-digit” EPS growth in Q2. A number of other key metrics, such as total payment volume (TPV) across PayPal’s platforms, further indicate that the company’s strong historical growth trend remains very much intact.

Fortress Balance Sheet
Unlike many of its fellow growth companies, PayPal has a healthy balance sheet that comfortably positions the company to weather any storm that may migrate its way. With $17.7B of cash and investments versus $11B of debt, PayPal’s financial position is a significant competitive advantage within its industry. Book value of $19.66 per share comprises nearly a third of the market cap. While much of the book value is intangible due to numerous past acquisitions, it is likely still a fair proxy for actual net asset value since there is little indication that PayPal has overpaid in the course of said acquisitions. In fact, some of the acquired companies (including the merchant-facing payment processor Braintree) are among the primary drivers of the company’s present growth. In any event, tangible book value is also positive at $8.85 per share.

Single-Digit P/FCF
In the context of PayPal’s consistent growth coupled with its positive book value and net cash position, the company’s market valuation feels like the punchline of a bad joke. On a TTM basis, PayPal's GAAP P/E is 14.3 and its P/FCF is 9.54. The P/FCF multiple would tick up to 12.4 based on management’s guidance for $5B of free cash flow in 2024, but this guidance seems to be sandbagged considering that the company already generated $1.8B of FCF in the first quarter of the year. Moreover, 2024 has been dubbed a “transition year” by PayPal’s management, so it would be logical to assume that 2024 earnings mark the low point of management’s near-term expectations.

Whether FCF for the year comes in at $5B or significantly higher, PayPal’s P/E and P/FCF multiples are well below market averages. This is despite the company’s growth rate being significantly higher than the market average. While PayPal is cheap from every angle, its P/FCF multiple does an especially good job of illustrating the evident undervaluation. When further considering PayPal’s substantial book value, the valuation appears all the more divorced from reality.

Digital Advertising
Consumer data is the lifeblood of digital advertising, and few companies in the world have more data than PayPal with respect to consumer spending habits. The new CEO has expressed his intentions to monetize this data in the forms of digital ads on the company's payment platforms, tailored cash-back rewards based on consumers' spending histories, and "smart receipts" that advertise complementary products to consumers after they've made a purchase. Rather than providing advertisers with access to its users' spending data, PayPal intends to keep the data in-house and make use of AI to build out a proprietary digital advertising platform.

The prospect of monetizing user data may have consumer privacy advocates fuming, but it would be very much in line with modern-day corporate norms. Considering PayPal’s broad reach with hundreds of millions of users, the monetization of consumer data is clearly a multibillion-dollar, high-margin opportunity to accelerate both top- and bottom-line growth moving forward.

Aggressive Buybacks
PayPal’s management team clearly views the company’s equity as undervalued and is betting 100% of the company’s free cash flows on that conviction. Taking share buyback logic to its ultimate conclusion, the company is presently dedicating every last dime of its free cash flow to repurchasing shares on the open market. In 2023, the company spent $5.35 billion on share buybacks, surpassing its levered FCF for the year. In 2024, the company anticipates FCF of “approximately $5 billion” and “at least $5 billion in share buybacks.” If, like me, you believe that PayPal’s stock is a bargain at current prices, the breakneck pace of share retirements is truly a beautiful sight to behold.

Risks
Competition
Intensifying competition is easily the single greatest threat to PayPal’s operational performance. PayPal faces robust competition across its operating markets, with rivals like Zelle, Apple Pay, and Cash App long eating into its market share in digital wallets and upstart payment processor Stripe mounting a challenge in online checkout. Stripe has seen tremendous success with a growth strategy targeting the web developers who construct payment sites, surpassing $1 trillion in TPV last year.

Among the ranks of PayPal competitors, Apple Pay has caused the most angst to PayPal shareholders in recent years. With high-double-digit adoption growth and hundreds of millions of global users, Apple Pay constitutes a serious challenge to PayPal. Apple Cash, a digital card feature that allows U.S. users to send funds to friends and family, presents a particular threat to the Venmo product. Earlier this month, Apple further announced the expansion of Apple Pay into the e-commerce realm, whereby consumers will be shown an Apple Pay option when making purchases from participating online retailers. This move marks a direct challenge to PayPal’s dominant share in online checkout processing.

Notably, the entry of new competitors into PayPal’s operating markets is by no means a new phenomenon. In 2011, the big banks launched clearXchange, a digital payment platform intended to rival PayPal. The clearXchange product later morphed into Zelle in 2017, which has since become a key PayPal competitor. In 2013, Square launched the Cash App product to great success, accumulating tens of millions of users over the ensuing decade.

Due to the strong growth of the fintech industry since its inception and through the present day, the success of PayPal’s rivals has not prevented the company from growing rapidly. A rising tide lifts all boats, and PayPal remains one of the biggest ships on the ocean. While Apple’s increasing focus on digital payments is cause for concern to the existing fintech players as well as traditional credit card issuers, judging by history it’s unlikely to nix PayPal’s steady growth.

User Count
PayPal’s stock sold off following its most recent quarterly earnings report in late April, in spite of blowout earnings. One likely culprit for the sell-off was the decline of monthly active accounts from 224 million at year-end 2023 to 220 million at the end of March. This slight drop-off in monthly users was an unexpected aberration from the company’s historical user growth trends, and it’s too early to tell whether it’s cause for serious concern.

On the bright side, monthly active users were nonetheless up 2% YOY in Q1. Moreover, TPV grew a staggering 14% YOY due to increased average transaction volume per active user. While nearly all of PayPal’s vital statistics are heading in the right direction, Q1 results indicate that user count may be a potential area of weakness for the company at the present juncture. Accordingly, investors would be well-advised to keep a close eye on active user metrics moving forward.

Shareholder Dilution
PayPal’s share count is on the decline, but that does not negate shareholder dilution as a concern for investors. This is because stock-based compensation has been significant and growing, though the new management team has expressed intentions to scale it back. While there is nothing wrong with share-based comp in theory, what makes it particularly egregious in PayPal’s case is that this form of compensation has grown significantly amid a sustained period of share price decline – causing a multifold expansion of stock-based comp as a percentage of the company’s market value. When a company’s stock price is down so dramatically, stock-based comp should be shrinking in dollar terms rather than growing.

As noted, the new management team is shifting away from stock-based compensation in favor of cash compensation, which I believe is a favorable development considering the market’s persistent undervaluation of the company’s shares. On the company’s Q1 earnings call, CEO Alex Chriss made the following comments on share-based compensation and the alignment of incentives with operational performance:

“In addition to our annual incentive plan, shifting to cash payment from stock, we have also better aligned our incentive programs to performance, particularly focusing on transaction margin and non-GAAP operating income growth. We will continue to focus on a pay-for-performance culture that appropriately aligns pay with results.”

Brand Reputation
It isn’t hyperbole to say that PayPal is one of the world’s most hated brands. Controversy has dogged the company for years, and consumers have made their feelings known. On Trustpilot, the PayPal platform has a 1.3-star average rating with >25,000 1-star reviews. Its ConsumerAffairs rating is somehow even lower at 1.2 stars. Complaints largely relate to the freezing of customer accounts and funds, with the company facing multiple lawsuits over the years related to this practice. Additionally, PayPal stirred up controversy in 2022 over a line in its user policy allowing the company to fine users up to $2,500 for spreading “misinformation” on its platform, which the company quickly revoked following widespread backlash.

The glass-half-full perspective would be that PayPal’s brand reputation has nowhere to go but up. Frankly, I would rather own a company that’s universally hated than one without name recognition. Despite its decidedly negative brand image, PayPal ranks as the seventh most valuable commercial services brand globally with an estimated brand value of $14.8 billion. More to the point, PayPal’s long-standing unfavorable reputation has not prevented the company from growing in the past, which is a strong indicator that it is unlikely to prevent it from growing in the future.

Conclusion
There’s so much going on under the hood at PayPal Holdings that a book would be more appropriate than this article for purposes of covering its business and the investment proposition offered by its stock. In this analysis, I’ve done my best to focus on what I view as the key points that are most relevant to the company’s current performance and future prospects. As I see it, PayPal remains an innovative and successful company with multiple promising avenues to drive future growth. The proof is in the pudding, as the company’s underlying growth remains impressive despite sustained weakness in its shares.

With a depressed valuation, strong balance sheet, consistent growth, and one of the most aggressive buyback programs in the universe of public markets, PayPal checks all the right boxes for value investors. From what I’ve seen, the bears’ main arguments focus on competition, which is a real risk but one that has never prevented the company from growing before, and the fact that the stock has gone nowhere in spite of its stellar operational performance. The latter factor may dissuade short-term investors with weak stomachs, but it is precisely the sort of dynamic that should have long-term value investors salivating for a piece of the action.

PayPal’s valuation deems it a value stock at worst, but all the evidence points to the fact that it can be more accurately characterized as a growth stock. The market seemingly views PayPal as a slowly dying cigar butt, yet somehow the cigar is getting longer over time. There’s no better stock to buy than that of a growing company with a promising future that’s priced as if it’s contracting. With a long track record of profitable growth behind it and analysts forecasting nothing but growth ahead of it, PayPal is an obvious buy at 9.5x trailing FCF.