The Big Problem with PayPal
“What do you think of PayPal, Tim?”
I tried my best to actively avoid these kinds of corridor conversations with my old boss. He’d have inevitably read something in the weekend press about a stock and was actively seeking to fulfil his confirmation bias. Be it from me, the intern or just a vague nod from the cleaner.
I wouldn’t have minded if he had a knack of picking good stocks, but with a nickname of ‘the reverse indicator’ I’ll let you fill in the blanks.
So lacking was his stock picking prowess, one of the brokers on the floor even made a nice little side-line of taking the opposite position of anything he muttered.
Boss: “I quite fancy some of these PoKeMan Go shares all the kids are playing…”
Broker: “Hi, is that Peel Hunt? Can I have your entire short float of Nintendo at market please”
*No thanks, if it’s all the same
Years before the likes of Will Smith had firmly requested people keep his wife’s name out of their mouth, a similar feeling was felt if the ticker code of your newly initiated position was even murmured by him. He would unwittingly hand out death knells upon portfolios by merely breathing near them.
However, even a broken clock can be right twice a day – and his PayPal pick happened to be a rare shining beacon on an otherwise dismal track record. From that point onwards (late 2016), PayPal had a lovely run from just below $40 to the dizzying heights of $70 and my god, were we reminded of it.
“Told ya you should’ve had some of those PayPal shares Tim”
Fast forward to today, and the reverse stock picker’s pick of PayPal is finally representing the kind of form you’d expect – perpetually down.
“Holders of PayPal will have night terrors remembering the February released Q4 results which saw a quarter of the company’s value wiped out in a single trading session. “
December 2018. That’s how far I’d have to go back to find PayPal shares changing hands at $83 a throw. Their revenues must have endured a hardship akin to that of a BlockBuster if the dwindling line of the chart is to be taken at face value.
Trouble is, when you blow the dust off the balance sheet, the company looks to be in good order and certainly not in keeping with a corporation whose fortunes are diminishing like the share price would suggest.
Just look at their progress from year end 2018 to 2021. Top-line revenue has increased from £15.45bn to $25.37 and operating profit has almost doubled from 2.19bn to 4.26bn in that same period. Ending cash balance is a hefty $18bn which is a nice footnote to end 2021 with.
Most recent Q1 earnings call also confirmed that PayPal are forecasting revenue for 2022 to come in between $28.16bn to $28.67bn with underlying earnings per share of $3.81 to $3.93.
Admittedly a wee bit lower than their earlier estimates, but was well received by investors as it provided some certainty on numbers which had been otherwise raising a few suspicious eyebrows from analysts. Not as much as they’d like, but believable and attainable numbers indeed. Very much room for the business channels to shout ‘EARNINGS BEAT’ when the later quarters roll around.
Remove any forward-looking context and it’s all hunky-dory at PayPal. There, sits an absolute behemoth of its industry accounting for 50% of its market share, healthy top and bottom-line growth and all available for an incredibly affordable 21X forward EPS.
Sadly, for PayPal, we need to add some slightly concerning context to understand exactly why, not even the British Red Cross are taking in PayPal shares certificates.
The Problem
Like the headline figures of PayPal, my very own subject line is slightly misleading too. Because it’s not just one big problem, but a few.
Competition -
Their once iron grip is continuously being pecked at with the likes of Square, Strike, Stripe, Skrill and plethora of trendy sounding disruptors laying a claim to the online payment market share. Throw in some of the mega-cap outfits like Apple and Google Pay who will be vying for position and a re-shuffling of the pecking order becomes a very real possibility.
There’s no doubt of PayPal’s dominant position, but just the idea of future vulnerability is enough to un-lodge their once premium valuation.
Weaker Outlook –
One too many times now has PayPal CEO, Dan Schulman, been the bearer of bad news. I mentioned earlier that they’ve now settled on around $28bn of revenues for 2022, but this hasn’t been the first time Mr Schulman has had to taper the expectations, having trimmed their outlook in February this year and November last year.
A weakening rate of growth is awful news for US tech, especially when double-digit growth is their supposed forte. A forward P/E multiple compression has been felt by most, but then exacerbated when you consider PYPL’s top-line growth for 2022 will drop to around 11%-13%, notably lower than its 5-Year average of 18.5%.
Investor’s historically have no qualms in paying a premium valuation for high growth, if it’s plausible.
But it simply doesn’t appear to be plausible; not in the near-term at least.
Poor economic conditions –
Holders of PayPal will have night terrors remembering the February released Q4 results which saw a quarter of the company’s value wiped out in a single trading session.
If ever there were an apropos moment to insert a risk warning relating to investing in equities, let that be it.
The reason for the violent sell-off was pinned on worsening economic conditions. Having previously reaped the fruits from a new wave of pandemic customers, their bloom quickly dissipated when times got tough.
Replaced with slower economic growth, supply chain woes and a weakening e-commerce environment, this ultimately caused severe hurt for payment volumes. And right now, it’s difficult to argue this backdrop has improved. In fact, I’d struggle to argue that those problems aren’t worse.
Conclusion
If I saw PayPal sat near the bottom of my portfolio, I certainly wouldn’t feel aghast. Nor would I be rushing out to buy more of it, either.
On a historic valuation basis, I’d maybe consider it cheap. Maybe. But would stop short at cheerful.
Regardless of their recent troubles, they’ll eventually find an inception point where relative value will match their growth trajectory.
The market has done a thorough job of pricing in their weaker growth profile and Schulman was possibly poor in initially telegraphing this for what could have been a softer landing. However, expectations aren’t exactly high now and I can’t help but feel the inception point is close. The market has very much digested the worser case scenarios.
With such low expectations, you’d like to think there’s more scope for a positive surprise in their outlook going forward vs more downside.
If you do have patience, and I mean several years rather than months, then there’s every chance PayPal can still experience good upside – even just as proxy in an eventually recovering economy.
The price and valuation down at these levels may even tempt out a takeover bid, you never know.
Barring a deluge of sudden downgrades, then the average 12-month price target for PYPL is still $168.69 a share.
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