PayPal Holding Inc’s share price has plummeted 65% over the year, from a high of $300 a year ago to roughly $100 presently. Year to date, the company is the 7th worst performance on the S&P500.
So, what happened?
With the firm announcing its Q2 earnings and full-year projections, let’s see what transpired and whether PayPal is a good buy at the current price or a value trap.
PayPal’s business
PayPal is a global platform that facilitates digital payments and streamlines commerce experiences for companies and customers. In a nutshell, it enables merchants and consumers to connect, interact, and complete payments, whether online or in person.
PayPal is much more than just a channel to third-party payment networks. The company has grown its services by leveraging its network.
For merchants, PayPal offers credit solutions, provides fraud prevention and risk management solutions, help reduces losses through proprietary protection programs, and offers tools and insights for utilizing data analytics to attract new customers and improve sales conversion.
For the consumer, Paypal offers person-to-person payment solutions and credit products to consumers as an alternative financing method at checkout
Overall, Paypal generates revenue from both merchants and consumers by collecting a percentage of transactions, while also generating interest and service fees from its other venture.
Since 2015, the company has more than doubled its active accounts and net revenue. Paypal had approximately 426 million active accounts as of August 2, 2022, comprising of 394 million consumer active accounts and 35 million merchant active accounts in over 200 markets worldwide.
More impressively, total payment volume surged more than fourfold to $1.25 trillion, growing at a considerably higher rate than active account growth, demonstrating the benefits of its network effect.
Competition
We must not disregard competition. The global payments sector is extremely competitive, constantly evolving and increasingly subject to regulatory scrutiny. Such a firm can be disrupted overnight, potentially changing the company’s fundamentals.
Paypal’s current competitors include banks and financial institutions (via traditional payment methods such as credit card and bank transfer), digital wallets and mobile payment providers, and even their own merchants developing their own payment systems.
To stress the impact of competition, consider the recent case of eBay.
After 15 years of collaboration, the ecommerce company separated from Paypal in 2021. As a replacement, eBay has switched to Adyen, a payment company whose clients include other technology sector titans such as Netflix and Uber.
The reasons provided by eBay were to streamline the end-to-end experience for customers and sellers, which seems logical because if you’ve used PayPal before, you’d know that it always takes you to another tab instead of being handled at the backend, which Adyen does.
I am bringing this up here before we go over the earnings so you’ll be able to see the impact of this pull out in the next part.
Earnings review
FY2022 Q2 highlights:
- Net revenues increased by 9% to $6.8 billion; without eBay, revenue increased by 14%
- Earnings per share fell to ($0.29) in Q2’21, down from $1.00 in Q2’21
- The number of payment transactions grew by 7% quarter over quarter and by 16% year over year (Slowed down)
- Total payment value increased by 5% quarter over quarter and 9% year over year (Slowed)
- Operating margins fell from 18.1% to 11.2%
Ending the quarter with a positive growth rate is undoubtedly commendable given the current conditions. In actuality, its latest revenue and EPS exceeded expectations, resulting in a recovery in its share price following the announcement.
However, this growth is significantly lower than that of a year ago. For the past six quarters, Paypal has been experiencing declining growth and margin compression.
Touching a little more on its margins, Paypal’s CEO stated that margins would be expanded in the years ahead as cost savings are implemented. However, given the recent trend of margin compression due to rising transaction costs, it remains unclear whether they will be able to pull it off.
Let’s dig a little deeper and look at its financial statements.
From the first line, net revenue had increased year over year. However, as we move down to operating income (2nd highlighted line), we observe that income has actually declined. This is primarily due to two major factors: increased transaction expenses and credit losses.
Its credit losses are caused by the fact that Paypal now provides credit services to both merchants and customers. This segment includes corporate finance solutions as well as buy now, pay later payment products. With the economy in decline, many people are unable to repay their loans, resulting in further losses.
Going all the way down to net income, we see a negative profit for the quarter after accounting for a net loss in other income as well as an increase in income taxes.
In terms of cash flow, you now add back any non-monetary transactions such as credit loss and depreciation. As a result, while net profit fell, operating cash flow increased by 12% year on year to $1.5 billion.
PayPal’s net profit, in my opinion, was overly pessimistic because it included losses on strategic investments, which are inescapable during a market downturn.
However, we should use its cashflow from operations with caution too. For example, stock-based remuneration is a non-cash transfer but ultimately dilutes the equities and hence the shareholders. Similarly, credit losses are ultimately losses that the corporation had to write off.
Finally, we take a look at its balance sheet. There are two major points here. Cash and cash equivalents fell, while total liability rose.
Despite this, PayPal’s latest twelve-month interest coverage ratio is 15.1x, placing it in a solid position to service its debt, so there isn’t much of a problem.
Overall, Paypal’s financial results were neither startlingly fantastic nor shockingly terrible. This recent financial report, however, reassured investors that Paypal was not performing as poorly as previously assumed. Yes, the pullout of eBay, coupled with the economic slowdown, had an influence on Paypal, but it wasn’t too bad, with its cash flow from operations even expanding year on year. On the balance sheet, the company appears robust and would likely be able to withstand a downturn.
Wait, why did its stock price skyrocket if its financial results weren’t particularly impressive? As you may have noticed, fundamental no longer matters; okay, it still does in a way. But expectations are more crucial. Even if a firm performs poorly year over year, we might see a significant increase in its share price because, more often than not, investors have very low expectations for it, which is what we see in the current situation as interest rates rise, the economy slows, and so on. Another ‘good’ piece of information came from its guidance.
Guidance
Paypal had announced its Q3 FY2022 guidance as well as its full year FY2022 guidance. And it was ‘good’ because it wasn’t as bad as investors expected. Nonetheless, the forecast reflects what Q2 showed as well. For the fiscal year 2022, growth will be in the low teens.
Q3 Guidance:
- Net revenues are estimated to exceed $6.80 billion, up roughly 10% on a spot basis and 12% FXN. This is slightly greater than Q2 growth of 9% and 10%, respectively.
- GAAP earnings per diluted share are estimated to be in the $0.61-$0.63 range, down from $0.92 in the prior-year quarter.
Full-year Guidance:
- Net revenues are estimated to reach $27.85 billion, up over 10% on a spot basis and around 11% FXN. This brings Q4 growth in line with Q2 and Q3.
- GAAP earnings per diluted share are estimated to be in the $1.52-$1.62 range, down from $3.52 in FY2021.
Share buybacks
To round out the earnings review, Paypal is also planning a share buyback to capitalize on the depressed share price. The Board has authorized a new $15 billion buyback program, in addition to the $3 billion already authorized.
If all goes as planned, buybacks in FY2022 will be around $4 billion, which is equivalent to 3.5% of the current market capitalization, giving the excellent opportunity to return capital to shareholders.
Valuation: is Paypal cheap?
So, should you consider purchasing PayPal?
PayPal’s share price jumped 10% shortly following the earnings announcement, and it has since risen by 40%. As previously stated, this is not a spectacular performance by Paypal, but expectations were already quite low for the company, which is why the company share price went up when the management revealed the numbers.
Paypal has rebounded to its pre-pandemic PE of 58. This indicates that the company is now trading at or around its fair value.
However, before that, the rate of growth was significantly higher. Indeed, the revenue growth rate has been slowly declining over the last five years, raising the question of whether it is worthwhile to pay the same price but with slower growth.
Definitely, this is merely a hiccup for the company, and with the management projection of margin improvement, we may see its growth return to the mid-teens, as it did before the pandemics.
To be honest, analysts are not expecting much from Paypal in the next quarters. Year-on-year growth is expected to be in the low teens to even single digits. So, as long as you believe Paypal can beat these projections, even if its growth rate isn’t in the mid-teens or higher, I think its share price will continue to go up.
Concluding thoughts
Paypal has proven to be quite resilient, and its most recent quarterly results demonstrate that it is able to handle the current unfavourable macroenvironment. As an example, Block (NYSE: SQ), commonly recognized as Square, experienced negative revenue growth in its most recent quarter, despite growing at a significantly higher rate than PayPal in previous quarters.
Nonetheless, PayPal is ultimately a payment provider, and its revenue is based on the volume of transactions, which is dependent on consumers’ willingness to spend. With a recession looming, the company may face additional challenges down the road.
Aside from that, competition in this market remains fierce. Paypal now has more than 400 million active accounts, outnumbering its competitors. Indeed, Paypal adds some value to ecommerce sites and has acquired multiple other platforms, but new/existing competitors are offering more or even better services. Moving forward, Paypal must maintain its relevance as it competes with others such as Amazon Pay, Apply Pay, Stripe, Google Pay and Shopify Pay.
To end off, with its sluggish growth rate, competitive environment, as well as its relatively low risk-to-reward ratio, Paypal may not be an appealing option at the current price. That said, I see a few positive developments that could work in Paypal’s favour, including more favourable economic news and its recent relationship with Elliott Management, a prominent activist hedge fund, in which both recently signed an information-sharing deal (Something which signals Paypal attractiveness and shareholder friendly actions moving ahead).