If you know me personally, you would know that I was super close to picking up some shares of Paypal over the past few months based on the strength of its overall ecosystem growth/engagement. For those of you who are unaware of the Paypal ecosystem, they are essentially a digital wallet that has recently expanded into a ton of ancillary services. Starting out as Ebay’s payment method, and then spun off in 2018, the company skyrocketed during the pandemic as millions migrated to online payments. The company’s eventual goal is to create a super-app that fits all of a consumer’s financial needs. The primary offering is very similar to a debit or credit card, but is in many cases much safer since Paypal guarantees your payments in case of fraud, which is especially important for cross-border or unknown transactions. They have pivoted through this success in checkout for online merchants to providing things like crypto investing (and soon to be equities as well), donations, bill payments… They also own Venmo which is the 2nd biggest Peer-to-Peer facilitator on the market, and recently inked a massive deal with Amazon to start payments through Amazon as well.
Problems with the Report
Paypal completely disillusioned investors with their report. There is no other way to say it, they bombed it, it was bad. First of all, since just November, the revenue guidance for 2022 was dropped to 15-17% from 18+%. Additionally, even this smaller number is the result of optimistic assumptions suggesting significant revenue growth acceleration in the back half. Essentially, the once rosy relationship between Paypal and its once parent company EBay has seriously deteriorated as EBay has been heavily pushing for the migration of its platform payments from Paypal. This has muted growth for the past two quarters and is the primary result of the company's lower earnings forecast in the front of the year. The big problem has essentially been that Ebay is a very high margin business, and represented 10% of their revenues last year (despite only being 6% of TPV) - it now only represents 3%. Paypal management believes that Ebay revenues should be fully off their books by Q3 2022, and is also setting up for calmer inflation, and a better supply chain that should cause rebounds in their lower income user base. Other problems reported was a decrease in margin, in decent part related to the high margin EBay business decrease. Finally, they reported that they had identified 5 million fake accounts.
A few Bright Lights
Despite the incredibly disappointing guidance revision downwards after another downwards revision just 3 months earlier, the actual long-term impacts are relatively muted. Although it sucks to lose a high margin recurring business partner in EBay, and it is unfortunate that their overall growth rate is slower as a result, it does seem that the company’s consumer business is only getting stronger. They hit 1.25T (yes, with a T), in TPV this year, and are forecasting 1.5 next year. Also, ex-EBay, the company grew TPV 28% this year, and are forecasting 23% for 2022, with revenue growth of 22% this year, and 20% for 2022. Additionally, they say that revenue growth should reaccelerate as Ebay is no longer a factor in the back of the year and expects to resume 20% GAAP revenue growth. On top of all this, the company says that Venmo grew over 80% this year and should grow another 50% on top next year. This is likely to continue with the recent announcement of Venmo as a payment option for Amazon, which could drive significant growth, in addition to the other engagement drivers like Shopping, Bill Pay and donations, not to mention Crypto.
Is it a Buy now?
At the end of the day, the company remains the same Paypal we all know. They maintain an excellent payment ecosystem with some of the best network effects I have ever seen, with 76% of merchants accepting Paypal, 3x more than its closest competitor. Not to mention the fact that its primary function of comfortability makes them an incredibly valuable proposition to both consumers and sellers. Studies have shown that customers are 54% more likely to buy something if Paypal is an option, 19% of people prefer keeping money in Paypal vs even their bank, and 59% of us have aborted a transaction simply because it wasn’t a checkout option. All of this is all the more pronounced cross-border, something that is only growing with an increasingly global economy, and is fast-recovering from the pandemic (especially in the back half of the year). The company is riding the secular trend in e-commerce and digital payments, and along with Venmo, is likely to drive serious ARPU expansion over time with new features. In general, Paypal is poised for years of long-term growth, despite the disappointing quarter.
All of this is why I think it has dropped low enough to be more than a screaming buy. Why is this? Well, let’s go through a quick valuation analysis on the company:
Using an exit multiple 10 years from now, and assuming the company can grow 15% over the next 5 years (despite the expected 20%), and will grow only 10% for the 5 years after that, you get a valuation of 186B, with a required return of 11% and a net profit margin of 21%. This assumes the company would trade for 25 times forward earnings by that point.
If we take some more optimistic results, and assume the company can grow 20% for the next 5 years, and 15% after that for the next 5 years after that, with a 21% net income margin and an 11% required return, you get a value of 345B for the business. This assumes 30 times forward earnings by that point.
A midpoint would be 17% and 13% growth rates, with the same net income margins and the same 11% required return. This would give you a value of 211B. This suggests 25 times forward earnings for the company by that point.
If we consider that the company has a 7B net cash position and a market cap of 120B, you get an enterprise value of 113B. This would give you a range of undervaluation between 65% and 205%. No matter how you look at it, Paypal remains a company with serious earnings potential over the long run, and is likely to keep growing for many years to come despite its current headwinds. To illustrate this, I want to do one final exit multiple analysis, trying to mathematically determine what the inputs required are to arrive at the company's current valuation:
You would need to have the company grow sales only 11% for the next 5 years and then 7.5% for the 5 years after that. They would need to trade for only 20 forward earnings by that point and have a net profit margin of 21%.
All of these numbers are incredibly pessimistic and if you think Paypal will basically stagnate and doesn't have an excellent business model that would allow it to outperform these estimates, then you shouldn't invest in the company anyways. Otherwise, you are probably seeing dollar signs and recognize why I am finally jumping in.
That is why I think the selling is way overdone. Keep in mind though, that in the current violent market, the serious negative sentiment is likely to keep the stock as dead money until probably at least the next earnings report. If you have a long-term view, this is a steal at current prices, and if you don’t want to risk missing out I wouldn’t blame you for locking it in right now, though you may want to keep some dry powder for the rest of earnings season.
By: Mateo Gjinali
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