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Paying for services online is the way of the future, and PayPal remains an interesting idea to play this theme. Its powerful network effect creates considerable barriers to entry.
By Brian Nelson, CFA
“As a customer champion and a leader in financial technology, our goal is to provide simple, affordable, secure, and reliable financial services and digital payments that enable the hopes, dreams, and ambitions of millions of people and businesses around the world, including those who have been underserved by the traditional financial system. This focus and clarity enabled us to achieve strong growth across every key aspect of our business in 2015. For the year, revenue increased 19 percent* to $9.24 billion, and our total payment volume reached $282 billion, an increase of 27 percent. We also generated $1.8 billion in free cash flow.” – PayPal’s 2015 Annual Report
Best Ideas Newsletter portfolio holding PayPal (PYPL) had once been synonymous with eBay (EBAY), but after more than a decade as one entity, the split-off provided investors with a pure-play opportunity to capitalize on the trend of proliferating online payments. PayPal’s future is incredibly bright. Money has become digitalized, and the rapid adoption of mobile platforms everywhere has changed how people purchase goods and how businesses transact with their most valued clients. PayPal’s vast network is one of its strongest competitive advantages, in our view, and its technology interface connects millions of consumers to merchants across the globe.
For individuals that only use cash and rarely use their credit cards, it may be hard to believe that the world is moving to a cashless society, but the evidence is clear. Many do not carry cash anymore, and no transaction amount appears to be too small to use a credit card. Online, the story is the same. People need a place to move and manage money, and PayPal has become the de-facto online provider, and its presence in mobile continues to expand aggressively. In 2015, for example, nearly 30% of its nearly 5 billion transactions were made on mobile devices. PayPal helps to power car-service Uber on Facebook’s Messenger service, and it continues to facilitate the connection between merchants and buyers on Pinterest, among notable clients.
The trading session October 21 was a very good one for PayPal with shares leaping more than 10%. The market seemed to like the idea that gross-margin pressure won’t be as bad as previously feared as a result of its deals with Visa (V) and MasterCard (MA) as we had mentioned in the note, “Reiterating Our Fair Value Estimate of PayPal (July 2016),” but we’re focused more on the growth trajectory at PayPal, perhaps more than anything else. During the third quarter of 2016, for example, revenue advanced 21% on a foreign-currency basis, as the company grew non-GAAP earnings per share 14%, to $0.35. Operating cash flow of $800+ million (up from ~$650 million in the year-ago period) and free cash flow of ~$620 million (up from ~$520 million in the year-ago period) were solid numbers for the period.
In its third-quarter press release, we were very pleased to hear management reiterate their opinion that PayPal’s opportunities to “grow and gain share have never been greater,” and we think there may be no better focus than ‘embracing the mantle of ‘Customer Champion’ and “further expanding the ubiquity and value of the PayPal brand.” It may be hard to believe that the company is still growing at such an incredible pace given its size (190+ million active customer accounts), but millions of people are signing up every quarter, 19 million new active customer accounts in the last quarter alone. PayPal’s new arrangements with Visa and MasterCard will pave the way for even more growth, and its ties with Uber, Facebook (FB), Pinterest and many, many more fast-growing organizations offer considerable promise.
Though the payment process industry is fast-changing, the world continues to progress towards PayPal’s functionality. The company will be a holding in the Best Ideas Newsletter portfolio for the foreseeable future. We still believe shares are undervalued. More on the Best Ideas Newsletter portfolio >>
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