PayPal Holdings (NASDAQ:PYPL) has not gained the favor of investors this year, with the stock down 22% while the S&P500 is up 12%. However, I believe PayPal’s recent underperformance presents an enticing investment opportunity for two primary reasons:
- Despite the stock’s decline, PayPal has a strong track record of growth and robust business performance. I believe the stock will rebound in the medium to long term as market performance catches up with the company’s business performance.
- The stock’s underperformance has led to an attractive valuation, with PayPal currently trading at 12.5x EV/FCF based on adjusted TTM free cash flow and 11.8x P/E based on guidance for non-GAAP EPS of $4.95.
Understanding PayPal’s Business Performance Year-to-Date
PayPal’s net revenues grew by 8% in the first half of the year, with operating income growing by an impressive 45%. This growth is due to the company’s successful cost-cutting efforts, which have reduced operating expenses related to sales, general and administrative (G&A), and customer support.
The improved cost structure is reflected in the company’s operating margin, which increased by 400 basis points to 15% in the first half of the year. However, the stock has not responded accordingly to this positive development.
For a detailed overview of PayPal’s revenues and operating performance, refer to the table below:
Evaluating Total Payment Volume Growth
PayPal’s total payment volume (TPV), a crucial metric indicating the net value of payments processed by the company’s platforms, grew by 10% to $731 billion in the first six months of the year. This growth suggests that active PayPal accounts are increasingly relying on the platform for payment transactions.
One factor contributing to the higher TPV is the current high inflation environment, as TPV is reported in nominal terms. This inflation-resilient characteristic positions PayPal favorably in highly inflationary environments, as its revenue rises along with inflation.
Addressing Active Account Growth
While PayPal experienced rapid active account growth in the past, recent trends show a deceleration in growth, with the most recent quarter reporting only 0.47% year-over-year growth in active accounts.
Despite this, PayPal’s number of payment transactions continues to increase. Year-to-date, the company reported a 12% growth in total payment transactions, indicating that existing users are conducting more transactions on the platform.
This data suggests that PayPal can sustain revenue growth without necessarily acquiring new active accounts. Instead, the key is to ensure that existing users continue to utilize the platform, which aligns with the current trend.
The Strategic Alliance Between PayPal and KKR
In a strategic move, PayPal recently announced a multi-year partnership with KKR to sell up to ~$42 billion (40 billion Euros) in buy-now-pay-later (BNPL) receivables originated in several European countries. This collaboration benefits PayPal in multiple ways:
- It frees up PayPal’s capital, enabling the company to pursue share repurchases. Given the attractive valuation, this move is commendable.
- The partnership with KKR provides opportunities for PayPal to expand its BNPL offering, leveraging KKR’s extensive size and established platform. This mutually beneficial arrangement allows KKR to efficiently access consumer credit at scale.
This collaboration empowers PayPal to repurchase approximately $5 billion of its own stock this year, contributing to around 8% repurchase of its market capitalization.
Analyzing PayPal’s Balance Sheet
Although PayPal carries approximately $10.6 billion in debt, its sizable cash balance of ~$9.9 billion and consistent free cash flow generation provide stability and flexibility. The net debt amount of ~$700 million is relatively small compared to its market cap and enterprise value.
Furthermore, PayPal’s well-laddered debt maturity schedule ensures liquidity for debt repayment through available cash and free cash flow. The company’s prudent debt management and cash position mitigate potential concerns.
For more details on PayPal’s debt structure, see the table below:
Evaluating PayPal’s Enterprise Valuation
Calculating PayPal’s enterprise value (EV) at approximately $64.9 billion, derived from an equity market cap of ~$64 billion and net debt of ~$700 million, the company’s valuation appears attractive. This aligns well with PayPal’s strong revenue growth, profitability, and potential for increased free cash flow through BNPL receivables.
With PayPal generating around $5.2 billion in free cash flow over the trailing twelve months, the stock’s valuation at 12.5x EV/FCF represents an appealing FCF yield of approximately 8%. Given the company’s growth trajectory, pristine balance sheet, and potential for additional free cash flow from BNPL receivables, this valuation offers a compelling investment opportunity.
Risks to Consider
While PayPal presents an enticing investment case, it is essential to acknowledge potential risks. Competition in both the peer-to-peer payment process and merchant businesses poses a significant threat to PayPal’s growth. Competitors like Zelle, Square, Facebook Pay, and others are vying for market share in this space. PayPal’s ability to retain its existing user base and sustain TPV growth will be crucial in mitigating this risk.
Additionally, the recent change in PayPal’s CEO brings an element of uncertainty. Although the new CEO, Alex Chriss, has a successful track record at Intuit, his impact on PayPal’s business performance remains to be seen.
Lastly, a potential slowdown in inflation poses a risk to TPV growth, which relies on inflation levels. If inflation rates decrease, PayPal may experience a corresponding decline in TPV growth.
Despite the aforementioned risks, considering PayPal’s compelling business prospects, valuation, and its transitions within the investor base, current conditions offer an opportune moment to invest in the company. PayPal’s solid business performance, TPV growth, attractive valuation metrics, and the strategic partnership with KKR suggest strong potential for future gains. As such, considering PayPal as a valuable addition to an investment portfolio seems viable.