PayPal (NASDAQ:PYPL) investors are seeing red as the stock plunges to 6-year lows, marking one of the most astounding crashes in the growth sector today.
The financial bloodbath is well-founded considering the internal flaws within the business, decelerating growth, and surging interest rates.
However, most of the misery seems to have already been baked into the stock price. And with a fresh set of favorable developments on the horizon, the prevailing sentiment towards the stock is slowly shifting towards the positive.
With a Forward PE ratio of merely 11x, PayPal finds itself in the depths of value territory.
To me, PayPal represents one massive asymmetrical bet.
The quarter witnessed an exceptional surge in Total Payment Volume, reaching $388B in Q3, marking a 15% year-over-year increase, marking the third consecutive quarter of accelerated TPV growth.
This robust growth was primarily propelled by unbranded processing, which escalated by 32% year-over-year, surpassing the 28% growth in Q2 and 30% in Q1. Conversely, the larger branded checkout unit only saw a meager 6% year-over-year growth in Q3.
The upswing in TPV was further boosted by an increase in the Number of Payment Transactions, which climbed to 6.3B, an 11% increase year-over-year, as well as a 13% year-over-year surge in Transactions Per Account, registering at 56.6. This highlights robust engagement across the platform, despite a loss of approximately 3 million Active Accounts quarter-over-quarter.
The decline in Active Accounts isn’t surprising, given the management’s emphasis on retaining highly engaged accounts while allowing “minimally engaged accounts” to churn off.
Furthermore, Q3 Revenue leaped to $7.4B, an 8% increase year-over-year, surpassing analyst estimates by $35M. It’s evident that Revenue growth appears to be settling in the high-single digits.
Breaking it down by segment, Q3 Transaction Revenue, representing 90% of Revenue, witnessed a 7% year-over-year growth due to the surge in TPV and Braintree. This was somewhat counterbalanced by a slowdown in PayPal’s core products and services.
On the flip side, Other Revenue secured a 25% year-over-year hike, chiefly owing to increased interest income on customer balances.
Despite the upbeat figures, Revenue continues to lag behind TPV growth, with PayPal’s Total Take Rate and Transaction Take Rate consistently dwindling to 1.91% and 1.72%, respectively. Management attributed this to several factors:
- Lower gains from FX hedges
- Reduced FX fees
- Comparison with elevated merchant compensation last year
- Larger merchants constituting a greater TPV proportion
Encouragingly, TPV growth continues to pick up pace, anchored by PayPal’s unbranded processing business making substantial headway in the fiercely competitive payments industry.
Merchants’ faith in PayPal as a Payment Service Provider is evident, given its world-renowned branded checkout solutions and a network of over 400M customers — a compelling choice for merchants over other providers.
The challenge persists with declining Take Rates, fueled by reports of PayPal slashing prices to seize market share. It’s imperative for PayPal to tread cautiously with pricing its services too low, as it could usher in the commoditization of payment services.
Fortunately, the new CEO, Alex Chriss, appears to be adopting a different stance on lowering prices. In fact, it seems that he intends to raise prices for Braintree solutions, potentially enhancing Take Rates moving forward.
On the merchant front, we’ve achieved significant penetration into small businesses and enterprises. We’ve now made headway with Braintree, and I’m truly excited about it. And I believe we now have the right to expand margins and ensure that we’re truly pricing based on value and guaranteeing that we are delivering what’s needed across the board.
(CEO Alex Chriss — PayPal FY2023 Q3 Earnings Call)
Q3 Gross Profit (or Transaction Profit) plummeted to $3.4B, marking a 3% year-over-year dip. This translated to a Gross Margin of 45%, about 600 basis points lower than the previous year.
The downward trajectory in Gross Margin is a cause for concern among investors, given that it diminishes PayPal’s profit potential.
However, management hinted at a potential reversal in Gross Margins, suggesting that Q3 might have represented the “low point”. Hopefully, this trend persists into 2024 and beyond.
That said, we did witness a decline in our Q3 transaction margin dollars. We anticipate further declines in Q4, albeit to a lesser extent. Hence, I perceive Q3 as the nadir, and we anticipate an improvement in the profile in Q4.
(Acting CFO Gabrielle Rabinovitch — PayPal FY2023 Q3 Earnings Call)
Descending the income statement, Operating Profit clocked in at $1.2B, equating to a 16% GAAP Operating Margin and a 22% Non-GAAP Operating Margin. In a year-over-year comparison, both metrics essentially plateaued, notwithstanding the 6-percentage-point yearly drop in Gross Margins. This is largely attributed to Non-Transaction Operating Expenses shrinking by 12% year-over-year, as PayPal continues to harness operating leverage from cost and productivity initiatives.
On the bottom line, Q3 GAAP EPS came in at $0.93, a decline from $1.15 last year, due to a diminished positive impact from PayPal’s strategic investment portfolio.
Conversely, Non-GAAP EPS reached an all-time high of $1.30, marking a 20% uptick year-over-year. This surpassed analyst estimates and management’s mid-point guidance by $0.07. Moving ahead, I anticipate this metric to strengthen as PayPal continues its trajectory of growth, drives operating leverage, and executes share buybacks.
All in all, the fundamentals of the business remain robust.
Nevertheless, PayPal needs to enhance Gross Margin to create tangible value for shareholders. While the company can enhance its bottom line by slashing costs, curbing Operating Expenses only offers limited potential.
Gross Margin must improve — or at the very least stabilize. Doing so will enable PayPal to sustain double-digit EPS growth, which will undoubtedly reward shareholders over the long haul.
Turning to the balance sheet, PayPal returned to a Net Cash positive position in Q3, boasting Cash and Short-term Investments of $11.5B and Total Debt of $11.2B, resulting in a Net Cash position of $0.3B.
In Q3, PayPal generated $1.1B of Free Cash Flow, representing a 15% FCF Margin.
As a reminder, PayPal inked an agreement with KKR to offload up to €40B of BNPL loan receivables originated by PayPal. Consequently, PayPal’s Free Cash Flow has been adversely affected, as these loans have been classified as held for sale. This is why Q2 exhibited a negative FCF ($1.2B negative impact).
In Q3 specifically, FCF encompassed an $0.8B adverse impact from the BNPL loans as held for sale. Excluding this impact, FCF would have stood at $1.9B, reflecting an FCF Margin of 26%.
Notably, PayPal has already disposed of “the first tranche of back book credit receivables sale to KKR in October, acquiring ~$1.4B in proceeds,” and plans are afoot to “finalize the next tranche” shortly. In the previous quarter’s Investor Update, management suggested that this deal should churn out a total of $1.8B in cash proceeds.
All in all, this should bump up PayPal’s FCF in Q4.
In another development, PayPal also sold Happy Returns to UPS for $465M as management reoriented their focus toward the “core business and strategic priorities”. It’s plausible that more divestitures will follow, considering a slew of puzzling acquisitions over the last decade. By accentuating its core competencies, PayPal is poised to emerge as a much more agile and formidable business moving forward.
Given robust FCF and cash proceeds from divestitures, PayPal will continue its aggressive share repurchase drive, especially with its stock price plummeting.
In Q3, PayPal repurchased ~23M shares for $1.4B, at an average price of $63.02. Considering the current share price of $56, I reckon the buyback spree will pick up pace.
In fact, as of Q3, PayPal still has $11.5B available for future repurchases, approximately 19% of its current market cap of $61B.
Here comes the most thrilling segment concerning PayPal: its future.
There have been numerous shifts happening of late, particularly in management, but let’s briefly peruse through management’s guidance first.
- Revenue anticipated to expand by 6% to 7%, a deceleration from Q3’s 8% growth. According to management, the growth in branded checkout has been slower than expected heading into Q4.
- Non-GAAP EPS expected to grow 10% year-over-year to $1.36 — a tad conservative in my view.
- Transaction Margin likely to improve sequentially, albeit still down year-over-year.
- Non-GAAP Operating Margin to contract year-over-year.
- Revenue set to accrue at 7.5% year-over-year.
- Non-GAAP EPS forecasted to escalate 21% year-over-year to $4.98. This was revised upward from $4.95, driven by Q3’s outperformance.
- Non-GAAP Operating Margin projected to fortify by 75 basis points, albeit 25 basis points lower than earlier projections, on account of the outsized growth of Braintree, in conjunction with lower-than-anticipated growth in branded checkout.
- Free Cash Flow anticipated to hit at least $4.6B. This has been adjusted downward from $5B in the previous quarter. In the initial three quarters, PayPal generated $1.8B of FCF, hinting a potential Q4 FCF of about $3B, which is substantial.
- Share Repurchases earmarked at $5B. In the initial three quarters, PayPal already repurchased $4.4B worth of stock, leaving roughly $0.6B yet to be utilized in Q4. I see this as conservative guidance from management — I anticipate at least $1B of share repurchases in Q4, which will bolster Non-GAAP EPS, consequently leading to a beat in guidance.
In summation, the guidance appears overly cautious, particularly with regards to Non-GAAP EPS. Given the impending FCF influx and the depressed stock price, I believe PayPal will seize the opportunity to ramp up its share buybacks even more aggressively, potentially yielding mid-teens Non-GAAP EPS growth in Q4, rather than 10%.
Yet, setting guidance aside, PayPal’s Q3 earnings was among the most eagerly anticipated in the company’s history for one reason and one reason alone: Alex Chriss.
Following the stock’s 80% nosedive, investors were in despair and sought a stabilizing force for the company.
Enter Alex Chriss.
As you’re aware, Alex Chriss took the helm from Dan Schulman, who has steered PayPal as CEO for close to a decade.
I won’t go through his resume, but let’s suffice it to say that Alex Chriss seems perfectly positioned to steer PayPal out of its quagmire.
During his inaugural earnings call, Mr. Chriss exuded confidence and resolve. He was direct, perceptive about PayPal’s potential, and unafraid to call out the company’s deficiencies.
Ultimately, he summed up his priorities as PayPal’s new CEO.
To encapsulate my insights and focus areas, our assets and extensive reach are unparalleled. Our innovation is moving at an accelerated pace and will have a significant impact. However, we need to focus and execute. The entire weight of the organization will be squarely behind:
- Reinventing our consumer experience to foster a clear and enduring value proposition centered around checkout;
- Improving and scaling PayPal Complete Payments