PayPal is not a payments company
Super app strategy
After this clickbait title got some of you interested, I will present my review on PayPal, a company that has been misunderstood forever (even if it was hyped up a lot in 2021). I have held it for 10 years (pre split eBay) in family accounts on a buy and hold basis, when it was value. I am not a genius on PayPal, but I have seen enough earnings releases to get an understanding of the business.
Usually I am more into purely value investing, but I am exposed to some growth stocks and these can provide good returns if the growth runway is clear.
Most analysis on PayPal was of very weak quality after Q4 earnings and price tumble. It’s just putting numbers in some charts and tables and showing multiples. Obviously the stock crashed a lot.
In order to analyze a growth stock you have to understand if the compounding machine is working or broken, and what are the drivers of the revenue and margins. I am not going to focus on numbers, and will not predict future earnings (false precision), I am going to explain the business key transformation.
First on the earnings:
Earnings were pretty good, forward earnings are weak because of
Tough comparison (2021 stimulus checks and lockdowns)
eBay volume business ramp down: This will affect 2022 only.
Non operating and tax changes planned for 2022.
The market is also confused because there is a change of strategy from growing users at any cost to lower user growth and focus on engagement, and the management gave up on the user base target of 750 million, which was given less than a year ago! It seems that the management was misguided.
In addition to that, prior to the earnings, some events weakened the stock.
PayPal attempted or said to buy Pinterest at a very high multiple showing lack of fiduciary duty for shareholders.
Then PayPal walks back when shareholders complained, showing no strategic conviction.
The management lacks credibility as stewards of shareholders funds, doing buybacks or planning acquisitions at high multiples.
The valuation coming into the earnings was very high, the shareholder base was weak and shaken by the big 2021 tech bust.
In my opinion, there is nothing wrong with the business. It grew very fast in the pandemic years, and now it is digesting the growth. It is still planned to growth 15 to 17% revenue this year, and FCF to grow as well.
The concerns should be about management of shareholders funds (I will cover that further down in the article).
PayPal business dynamics compared to Payments companies
Let’s take Payments companies: typically, Visa and Mastercard, plus Stripe and Adyen.
These companies handle payments. They have their fees stable across their business mix.
I am not an expert on these companies, but I think it goes like this:
They have online/offline payments, maybe the fees differ a bit, and the mix changes a bit, but overall it is stable. The take rate is fairly stable, revenue grows and earnings grow.
On top of that ,Visa and Mastercard, with their duopoly, implement or raise fixed fees such as chargeback fees, dispute appeal fees, monthly fees and the like, with no business churn.
So we can see a business where everything is well correlated. Excuse the crude designs.
TPV: Total Payment Volume.
PayPal is totally different. The take rate goes down and good growth in TPV does not show in revenue. Typically, TPV goes up 30% and revenue 18-20%.
Why is the take rate going down?
If you read online commentary, it is due to competition, or that PayPal is too expensive, etc. Usually mixed with some comments like “on my website, I pay a lot of fees with PayPal, competition is cheaper”.
There could be some of that of course. but the main reason is the the payment mix.
I have done some quick illustrations to demonstrate PayPal’s TPV, with made up numbers.
2016, my average take rate is 2.2%, my TPV is 100:
Two years pass, the eBay and small merchants volume who pay a higher fee decreases because Ecommerce gets more professionalised, and due to the eBay move to Adyen, PayPal signs more deals like Uber, Ali express, and Venmo grows. My take rate is now 2.1%, TPV is 160.
2021, my take rate is 1.9%, TPV is 250. Here is why take rate goes down as TPV goes up. The volume mix changes.
There are signs that take rate is going up or stabilizing in the last earnings call:
Monetizing Venmo from 0% to X% and having eBay going away, plus some pricing increase, is going to increase the take rate. This is huge for PayPal. This is bullish.
There could be a time where revenue grows as fast as TPV, in the 30%.
PayPal is not a payments company
This one is the main difference.
PayPal has users with logins and passwords. Stripe, Visa and Mastercard cannot interact with the customer. The customer has a card and he can pay, and that is all. No cross sale, no up sale, no advertising, no emails. Mastercard and Visa are trying hard to own the customer interaction with Apps.
PayPal has an account with login and password, financials and address, that is exploited in the form of an app or the website, that many customers visit. And this account is a virtual bank account with shopping abilities. Once the customer visits, PayPal owns the interaction, and the customer is highly qualified because he provided a payment method to PayPal with an intent to buy or manage finances.
cross sell financial products
affiliate sell financial products
provide loans or loans to buy items (Buy now pay later).
use purchase history to send offers, and retargeting (new service in 2021)
provide offers in the app and shop (Launched 2021)
Why not have a full marketplace within the app ? There is already payment and shipping address, PayPal can offer 1 tap buying and repeat ordering. PayPal could also earn marketplace fees.
There could also be investing.
For the seller, it can also provide services and loans (it does already: PayPal working capital - using the seller activity data analysis).
This is why, if it brings value and app engagement, PayPal can become a super app, a bit like Alipay.
And the company knows it very well, and is working a lot on the super app strategy.
If customers go from using one product (checkout) to using 4 or 5 in the app, the earnings upside is exponential. That is because PayPal can earn revenues and commissions on new services for existing customers, with marginal acquisition cost.
It is not a payment company, it is a consumer finance company. It wants to own the customer with his/her finances and payments.
Risks to this strategy:
A lot of PayPal customers do not use the app, they just pay sometimes and cannot be qualified for the customer finance strategy yet. The strategy relies on increased adoption.
-Low success of the app, with only a few percentages of PayPal customers being Monthly active users: This would still leave the PayPal checkout button function and Venmo app upside. I did not find stats on app active users unfortunately.
-Usually, due to bureaucracy and size, PayPal products and apps have been slow to develop and clunky. The app could disappoint in execution, but so far it has good reviews.
-Other companies owning the customer interaction: Apple pay is widely popular to pay and could launch a fintech app, or take share in the regular payments business. Similar risks can come from Google pay. However I am not sure that they want to get into that. Their approach is very light touch.
We need an activist:
This would be good to have one to protect the capital investments and ensuring that acquisitions (like Pinterest) or buybacks do not destroy shareholder value, and to push the company to be more aggressive and ambitious on the super app strategy (overseas functionality, stock investing, marketplace).
Paidy acquisition in Japan (a buy now pay later company) for 2 times GMV and $2.7 billion USD sounds to me like a waste of capital, an acquisition that will be dilutive to earnings!
Paidy has more than 6 million registered users. Maybe it is just go get a foothold in Japan since PayPal only has 4.3 million users in Japan, but it is an expensive one.
Paidy will compete against PayPay from Zholdings and Softbank with a dominant market position in Japan and some of the best operators in the world (Masa Son and Yahoo Japan in Japan) analyzed here:
PayPay has 44 million users and is growing very aggressively.
PayPal could buy a company with a marketplace technology to integrate it in the app. A big multiple is ok if it is a small amount, and it is used for technological assets and integrations.
The company issues stocks as part of the stock compensation, which is a good thing for employees, but the buyback of this stock should only be done at good valuations. If we are at 60 PE, I would rather be diluted, and pay the employees with expensive stock. The company reduced the buyback when the stock was over 250$, and increased it in Q4 under 200$, but it could do better.
I would not be surprised if Mr Ackman buys a stake.
Conclusion and Valuation
We are now at 26 times non GAAP earnings, so higher real earnings, over 30, as non GAAP earnings excludes stock based compensation from costs, which is a real cost for shareholders. It is not a cheap stock at all, and I do not recommend buying in particular. Value investing works and protect the downside. Buying stocks at elevated multiples does not protect the downside at all, this is what happened, combined with short terms headwinds and noise.
However, if the superapp strategy works and converts many users, we will have a great rise in earnings, making current earnings low in retrospect. I think Venmo will also provide upside in becoming a super app in itself.
Looking at these underlying trends (take rate, super app, Venmo), my guess is that the PayPal earnings growth trajectory is going to continue after a short term slowdown.
Disclaimer: this is just my personal review and not financial advice or recommendation. I am long PayPal
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