PayPal is a provider of online payment technology which, alongside the brand PayPal, also operates a family of brands including Venmo, Xoom, Simility, Paidy, Hyperwallet, Honey, Happy Returns, Chargehound, Braintree and Zettle. The company has gained a significant network of users and merchants, and now dominates the online payments sector. The company went public in 2002, before becoming a wholly-owned subsidiary of eBay later that year. The company was spun off to eBay shareholders in 2015.
PayPal remains the world's most accepted digital wallet by a significant margin. The company receives 16% of online transactions, with second placed Apple pay taking a 5% share. While it seems likely that PayPal will grow at slower rates than digital peers, we expect the company to continue to expand its share of online transactions. According to salesforce, over 50% of online payments are still completed directly by credit card, we believe this figure could decline further as users become more security conscious.
PayPal offers retailers access to the PayPal's branded and unbranded checkout, as well as custom solutions for larger customers. Alongside online checkout, the application allows frictionless payments between PayPal and Venmo accounts, external payments, a buy now/pay later offering, as well as credit and debit cards. The increasing number of competing checkout solutions has, however, become a concern for the company. One upside from recent disruption, however, is the possibility to clear in-store transactions via a user's mobile device. Integration of IOS apps within the Apple wallet is expected in the coming year.
The company separates transactions into six categories: PayPal branded checkout, unbranded processing, Venmo, P2P ex Venmo, Other merchant services and eBay. The highest volume growth has recently come from Venmo, which delivered a 55% CAGR from 2018 to 2021, and now makes up 18% of transactions. Venmo is a social payment platform. The app provides payment splitting, messaging, transfer, and crypto services. The key differentiating factor to Venmo's peers is the integrated online checkout solution. At the same time, eBay volume is in decline since it no longer makes use of PayPal to pay sellers. “Other merchant services” represent approximately 10% of total transactions.
Financials
Paypal's results have been mixed recently, but we are more confident on the company's prospects in FY23:
-
The growth in the number of user accounts slowed, which was not unexpected after the Covid-induced boom. Paypal currently has approximately 435 million active accounts, which increased 2% y/y in FY22.
-
The total number of transactions grew 13% y/y, with the average number of transactions per account increasing to 60.
-
Our expectation is for revenue growth to increase from 9% to 11% from 2023 through to 2025 and then to fall off in line with our long-term simple fade model.
-
Statista expects the e-commerce sector to grow at a 9% rate between 2023 and 2027, we believe this rate should be seen as a pessimistic base case revenue growth rate for PayPal.
-
Two of the highest transaction volume growth areas, Venmo and PayPal P2P, are not likely to contribute significantly to revenue. Greater monetisation of P2P transactions will provide upside risk to our estimates.
-
Margins have been under substantial pressure due to higher funding costs resulting from increased credit/debit card funding and a change in transaction mix, particularly the high growth in unbranded processing.
-
While these volume-related trends seem relatively permanent in nature, the company has emphasised a focus on efficiency - reducing non-transaction expenses by 6% in 2022. For reference, volume-based expenses represent 49% of revenue while non-transaction expenses represent 29% of revenue.
-
The company has guided for adjusted operating margin expansion of 1.25% in 2023 translating to adjusted earnings per share of $4.87 or 18% growth.
-
The balance sheet is strong. Net debt is 0.3 times EBITDA. Paypal has guided for capex to remain at 3% of revenue. Share buybacks are expected to continue at 75% of free cash flow going forward.
Investment case
-
Despite the recent increase in competition, we believe the company's large network of accounts and vendors should prove resilient, providing the firm's technology can continue to keep up with peers.
-
We consider the brands visibility and wide recognition to be highly valued by customers. In payments, the “trust” factor will play a role among buyers and sellers.
-
A focus on cost containment and efficiency in the areas it can control will result in less margin pressure.
-
Although not split out in company accounts, PayPal has previously stated that Venmo should be profitable by 2022.
-
The company boasts a strong balance sheet with low debt, reasonably low capital expenditure and complementing continued high levels of share buybacks.
Risks
-
Competition is a major risk - there have been several new entrants into the market. A loss of market share to faster growing peers will be the biggest investor concern going forward.
-
Technological change may eventually allow users to bypass digital wallets. Technology changes very quickly and there is a very real possibility that Paypal gets left behind when the next technological breakthrough in payments emerges.
-
A slowdown in e-commerce growth will be negative for transaction volumes and by extension, payments.
-
In any event, growth going forward is likely to be significantly slower than that experienced in the past.
Consensus and Outlook
-
Consensus is positive on PayPal stock, with 71% of sell-side analysts maintaining a “Buy” on the stock.
-
Consensus forecasts adjusted earnings per share growth of 17% y/y this year after a 31% contraction in earnings in FY22.
-
The company trades on 16 times adjusted earnings per share, considering the upside potential and relatively low downside risk, we consider this an attractive valuation.
-
The forward PE is less than half the five-year average - although likely due to intensifying competition in on-line payments.
-
Comparisons to peers are limited by the small number of independent payment technology firms. The company trades close to the median valuation for the broader financial technology peer group.
Investors can also gain exposure to Paypal on the JSE via the FNB ETNs under the share codes PPETNC (with currency exposure) and PPETNQ (without currency exposure).
