PayPal: Is this market leader on sale?

PayPal is the clear global market leader among online payment processing software technology companies. Yet, PayPal stocks have tumbled since reaching their all-time high above $300 in the summer of 2021. Is this decrease in share price justified, or does it mean that PayPal stocks are now cheap? This is what I will investigate in this analysis.

This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.

Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.

For full disclosure, I should mention that at the time of writing this analysis, I do not own shares in PayPal or any of its direct competitors. If you are interested in copying my portfolio or viewing the stocks I currently own, you can find instructions on how to do so here. I have no personal stake in PayPal, which means it should not be difficult to maintain an unbiased analysis. If you want to purchase shares or fractional shares of PayPal, you can do so through eToro. eToro is very user-friendly and easy to get started with. You can start with as little as $50. Click on the picture below to get started.

PayPal was founded in 1998 under the name Cognify by Max Levchin, Luke Nosek, and Peter Thiel. It merged with Elon Musk founded x.com in 2000. It first went public in 2002 but became a wholly-owned subsidiary of eBay in 2003. In 2015, eBay spun off PayPal, and it IPO'd as an independent company once again. PayPal provides payment solutions that enable their customers to connect, transact, and send and receive payments online or in person. PayPal also owns other brands, such as Venmo and Paidy. PayPal's customers include both merchants and consumers. As of the end of 2022, PayPal had 435 million active accounts, with 400 million accounts belonging to consumers and 35 million accounts belonging to merchants. These accounts are spread across more than 200 countries. PayPal earns its revenue by charging fees for completing payment transactions, foreign currency conversions, instant transfers from the customer's PayPal or Venmo account to their bank account or debit card, and facilitating the purchase and sale of cryptocurrencies. PayPal is the clear market leader, and the total payment volume through PayPal in 2022 was $1,36 trillion. PayPal is one of the most trusted brands in the world, which is what gives PayPal its brand moat.

Their CEO is Alex Chriss. He joined PayPal as CEO in 2023. Prior to joining PayPal, Alex held various roles of increasing responsibility at Intuit for 20 years. He holds a Bachelor of Arts degree in Economics from Tufts University. He also possesses an entrepreneurial spirit, having successfully founded and sold two start-ups before joining Intuit. When he was appointed as the CEO of PayPal, he was described as a seasoned and highly successful business leader with extensive experience in technology and product leadership. This description appears to be accurate when examining his track record. When he led Intuit's Small Business segment, he achieved a compound annual growth rate of 20% and 23% for its customers and revenues, respectively. He was also responsible for successfully integrating the $12 billion acquisition of Mailchimp. Nonetheless, it will be the first time Alex Chriss will lead a company, and while he may very well be successful, there will be some uncertainty regarding the leadership in PayPal until he has proven himself.

I believe that PayPal has a strong brand moat. However, there are some uncertainties regarding the management. Now let us investigate the numbers to see if PayPal lives up to our requirements for a strong moat. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.

The first number we will investigate is the return on invested capital, also known as ROIC. We want to see 10 years of history, and we want the numbers to be above 10% in all years. As PayPal IPO'd in 2015, I do not have numbers prior to2015. PayPal has consistently achieved a solid return on invested capital (ROIC), with only three out of eight years fallingbelow the required 10% threshold. However, two of the years are the first two years, and they were close to reaching 10%.PayPal didn't reach the required 10% in 2022, but it was a challenging year for most companies. Overall, I am satisfied with PayPal's return on invested capital (ROIC), but I am not impressed. I would like to see PayPal return to the numbers we saw in 2020 and 2021 moving forward.

The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it moving forward. As you are accustomed to seeing numbers in percentage form, I have decided to share both the actual numbers and the year-over-year percentage growth. Again, we don't have any numbers before the IPO in 2015. PayPal has managed to steadily grow their equity in most years, with only two out of eight years experiencing a decrease compared to the previous year. I will give PayPal a pass on a very challenging 2022, and I hope to see PayPal return to growth in 2023 and achieve a new all-time high.

Finally, we will investigate the free cash flow. In short, free cash flow refers to the cash that a company generates after covering its operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has remaining after paying all its financial obligations. I use the margin to provide a clearer understanding. Free cash flow yield refers to the amount of free cash flow per share that a company is projected to generate in relation to its market value per share. Not surprisingly, PayPal has managed to deliver positive free cash flow in all eight years since its IPO. It is nice to see that PayPal managed to grow its free cash flow in a challenging 2022. Levered free cash flow has been fluctuating, but overall it is quite stable. Additionally, the free cash flow yield indicates that PayPal is currently undervalued. However, we will discuss this further in the analysis.

Another important aspect to investigate is the level of debt, specifically whether a business has a manageable debt that can be paid off within a period of 3 years. We do this by dividing the total long-term debt by earnings. Doing the calculation on PayPal, I can see that PayPal has 4,31 years of earnings in debt. It is higher than I would like to see, and it is slightly concerning. It doesn't put me off investing in PayPal, but it is something that should be monitored moving forward.

Based on my findings so far, I believe that PayPal is a reputable company. However, no investments are without risk, and PayPal has its own set of risks as well. One risk is macroeconomics. If we experience a prolonged recession, it is likely that online shopping will decrease. Thus, it would result in decreasing transaction volumes, which would lead to a reduction in fees and other charges that PayPal relies on. Management believes that discretionary spending will remain under pressure at least for 2023. Furthermore, there are other macroeconomic factors that could affect PayPal, such as a strong dollar. PayPal expects that foreign exchange rates will result in a one-point headwind in 2023. Another risk is competition. In its annual report, PayPal highlights competition as a risk. They mention that the global payments industry is highly competitive, and competition may intensify as new competitors emerge. Some of the new competitors could include traditional banks. Bank of America has recently expressed interest in digital wallets. We also have large tech companies such as Google and Apple promoting their payment solutions. In the Q4 2022 earnings call, management mentioned that Apple has inherent advantages in authentication and exclusive use of the NFC chip. Finally, regulations are a risk that needs to be monitored. In their annual report, PayPal mentions that their business is subject to extensive government regulations and oversight. They mention that regulators globally are increasingly exercising regulatory authority, oversight, and enforcement in a manner that impacts their business. These stringent regulations also make it difficult for a company like PayPal to innovate compared to companies in other sectors. Furthermore, we have probably only seen the beginning of regulations in the cryptocurrency market.

There are also numerous advantages if you choose to invest in PayPal. One is the growth of e-commerce. Management believes that the secular tailwinds that benefited PayPal have not changed, and that e-commerce growth will return to double-digit rates. Management could be right, as according to Statista, global e-commerce sales are projected to grow at a CAGR of 11,34% until 2027. In the Q4 2022 earnings call, management mentioned that PayPal is extremely well positioned to capitalize on the shift to e-commerce sales. This is expected to result in higher revenue growth and increasing margins. Winning Market Shares. PayPal is already the market leader, but management believes that they can continue to gain market share. PayPal is improving its checkout experience, which will result in a passwordless one-click experience. Improvements in the checkout experience have resulted in PayPal winning market share in the mobile sector, despite competition from companies such as Google and Apple. PayPal has also introduced Buy Now, Pay Later, which has experienced significant growth. Management mentioned that they are clearly gaining market share. Furthermore, PayPal will launch PayPal Complete Payments, which will target small and mid-sized companies in 2023. Management stated that it will expand its total addressable market by $750 billion, while also increasing margins. Share buybacks. PayPal continues to engage in buybacks, which is especially beneficial when the share price is trading at low levels. In 2022, PayPal bought back $4,2 billion worth of shares, which represented more than 80% of their free cash flow. In 2023, PayPal expects to generate approximately $5 billion in free cash flow and plans to allocate around 75% of that amount to repurchase shares. It is another $3,75 billion on buybacks. PayPal has also already reduced their shares outstanding from 1,222 billion in 2015 to 1,136 billion in 2022.

All right, we have gone through the numbers, potential and risk regarding PayPal, and now it is time for us to calculate a price for PayPal. To calculate price, we will need the numbers that I have explained in the "MY STRATEGY" section of the website, as I do not want to go through the whole calculation here. I chose to use an EPS of 2,09, which is the one from 2022. I chose an estimated future EPS growth rate of 15% for PayPal. This is based on the fact that PayPal has grown EPS by an average of 17% per year over the last 5 years, and management expects 18% growth in 2023. However, 15% is the highest growth rate that I use. Doing the calculations, we come up with the sticker price (some call it fair value or intrinsic value) of $62,70. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy PayPal at a price of $31,35 (or lower obviously), if we use the Margin of Safety price.

Our second way to calculate a buy price is the Ten Cap price, which is also explained at "MY STRATEGY". To do so, we need some numbers from their financial statements, keep in mind that all numbers are in millions. The operating cash flow last year was 5.813. The capital expenditures were 706. I tried to look through their annual report to see how much of the capital expenditures were used on maintenance. I couldn't find it, though. As a rule of thumb, you can expect 70% of the capital expenditures to be used for maintenance. This means that we will use 494,2 in our further calculations. The tax provision was 947. We have 1.136 outstanding shares. Hence, the calculation will be as follows: (5.813 - 494,2 + 947) / 1.136 x 10 = $55,16 in Ten Cap price.

The last calculation is the Payback Time. I also described in "MY STRATEGY". With PayPal's Free Cash Flow Per Share at 4,48 and a growth rate of 15%, if you want to recoup your investment in 8 years, the Payback Time price is $70,72.

I believe that PayPal is an interesting company. There are some uncertainties about management and PayPal will likely encounter some short-term challenges as many markets are experiencing a recession. Competition poses long-term risks as new competitors enter the market, but it is worth remembering that PayPal has a head start. Regulations will always pose a risk for PayPal, but thus far, they have been able to successfully navigate through regulations in various markets. I'm somewhat disappointed with the return on invested capital (ROIC) that PayPal has achieved, and I would like to see it increase in the future. PayPal should experience some tailwinds as the number of purchases made through e-commerce continues to increase, and it is difficult to envision this trend reversing in the near future. PayPal continues to innovate and introduce new products. If they successfully gain market share, the opportunity becomes even more intriguing. I also appreciate the fact that management is repurchasing shares when they are priced low. I believe that PayPal is an intriguing investment if it can be purchased below the Ten Cap price of $55,16 as you get a 50% discount on two out of three calculations.

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