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? It 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 the time of writing this analysis, I do not own shares in PayPal or in any of their direct competitors. If you want to copy the portfolio or want to see which stocks I hold, you can read how to do so here. I have no skin in the game when it comes to PayPal, meaning it shouldn't be hard to keep this analysis unbiased.

PayPal was founded it 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'ed as an independent company once again. PayPal provide payment solutions that enables 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 are both merchants and consumers, and by the end of 2022, PayPal had 435 million active account (400 million consumer active accounts and 35 million merchant active accounts) in more than 200 countries. PayPal earn their 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 to facilitate 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 Dan Schulman. He joined PayPal as a CEO in 2014. Prior to joining PayPal, he held various positions in companies such as AT&T, Virgin Mobile, and American Express. He has a bachelor's degree in economics from Middlebury College and an MBA from New York University Stern School of Business. Dan Schulman has frequently been recognized by Fortune as one of the top 20 businesspersons of the year, and in 2021 he ranked third on Fortune's list of the World's Greatest Leaders. He has also been named one of the top 100 Most Creative People by Fast Company and was named one of Glassdoor's top 50 CEOs in 2019. Dan Schulman is actively involved in the World Economic Forum, where he is a member of the International Business Council, and he is also serves on the Board of Directors at Verizon. During his tenure at PayPal, he has managed to triple payment volumes and free cash flow, which shows that he has been doing a great job. The only negative thing I can say about Dan Schulman was when PayPal investigated the opportunities to take over Pinterest, as I believe the company should stick to their circle of competence. Luckily, PayPal eventually abandoned its interest in taking over Pinterest. I believe that Dan Schulman is a great CEO, but he has recently announced that he will retire by the end of 2023. So far PayPal has not found a new CEO, which means that there are a lot of uncertainty regarding management at PayPal for the time being. However, Dan Schulman will continue to serve on the Board of Directors at PayPal once he has retired as a CEO.

I believe that PayPal has a 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 investment 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'ed in 2015, I do not have numbers prior to 2015. PayPal has delivered a solid ROIC despite having three out of eight years below the required 10 %. However, two of the years are the two first 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'm satisfied with PayPal's ROIC, but I'm not impressed. I would like to see PayPal getting back to the numbers we saw in 2020 and 2021 moving forward.

The next numbers are the book value + dividend. In my old format this was known as the equity growth rate. It was the most important of the four growth rates I used to use in my analyses, which is why I will continue to use it moving forward. As you are used to see the numbers in percentage, I have decided to share both the numbers and the percentage growth year over year. Again, we don't have numbers before the IPO in 2015. PayPal has managed to grow their equity steadily in most years, as only two out of eight years came in lower than the year before. I will give PayPal a pass on a very challenging 2022, and I hope to see that PayPal gets back to growth in 2023 and delivers a new all-time high.

Finally, we investigate the free cash flow. In short, free cash flow is the cash a company generates after it has paid for operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has left remaining after paying all its financial obligations, I use the margin for it to make more sense. Free cash flow yield is the free cash flow per share a company is expected to earn against its market value per share. Not surprisingly, PayPal has managed to deliver a positive free cash flow on all eight years since its IPO. It is nice to see that PayPal managed to grow their free cash flow in a challenging 2022. Levered free cash flow has been all over the place but is pretty solid, while the free cash flow yield suggests that PayPal is trading at a cheap price, but we will get back to that later in the analysis.

Another important thing to investigate is debt, and we want to see if a business has a reasonable debt that can be paid off within 3 years. We do so by dividing the total long-term debt by earnings. Doing the calculation on PayPal, I can see that PayPal has 4,31 years 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 good company. However, no investments are without risk and PayPal has some risks as well. One risk is Macroeconomics. If we see a longer recession, you ought to think that online shopping will decrease. Thus, it would result in decreasing transaction volumes, which in 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 one-point headwinds in 2023. Another risk is competition. In their annual report, PayPal highlights competition as a risk. They mention that the global payments industry is highly competitive, and that competition may intensify as new competitors emerge. Some of the new competitors could be traditional banks. One example is that Bank of America has recently expressed interest in digital wallets. We also have large tech companies such as Google and Apple promoting their payments solutions. In the Q4 2022 earnings call, management mentioned that Apple has some inherent advantages in authentication and exclusive use of the NFC chip. Finally, regulations are a risk that needs to be monitored. In their annual 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 impact their business. These stringent regulations also make it hard 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 cryptocurrencies market.

There are also plenty of positives if you decide to invest in PayPal. One is the growth of e-commerce. Management believes that the secular tailwinds that benefitted 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 will grow by a 11,34 % CAGR 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, and it should 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 win market shares. PayPal is improving their checkout experience, which will result in it being a passwordless one click experience. Improvements in checkout experience has resulted in PayPal winning market shares in mobile, despite the entry from companies such as Google and Apple. PayPal has also introduced Buy Now, Pay Later, which has grown significantly, and management mentioned they are clearly gaining market shares. Furthermore, PayPal will launch PayPal Complete Payments that targets small and midsized companies in 2023. Management stated that it will expand their total addressable market by $750 billion, while also increasing margins. Share buybacks. PayPal continues to do buybacks, which is particularly nice when the share price is trading at cheap 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 allocate approximately 75 % of that 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 (PayPal has grown EPS by 17 % a year in the last 5 years and management expects 18 % growth in 2023, but 15 % is the highest I use), Estimated future PE 30 (which the double of the growth rate, as the historically PE for PayPal has been higher) and we already have the minimum acceptable return rate on 15 %. Doing the calculations by using the formula I described in "MY STRATEGY" we come up with the sticker price (some call it fair value or intrinsic value) of $62,70, and we want to have a margin of safety on 50 % so we will divide it by 2, meaning that we want to buy PayPal at 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 was 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, so as a rule of thumb, you expect 70 % of the capital expenditures to be used on maintenance, meaning 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 like this: (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 the Free Cash Flow Per Share at 4,48 and a growth rate of 15 %, if you want your purchase back in 8 years, the PAYBACK TIME price is $70,72.

I believe that PayPal is an interesting company. There are some uncertainties about management moving forward, and PayPal will probably also face some short-term headwinds as most markets are facing a recession. Competition is a more long-term risks as new competitors are entering the markets, but it is worth remembering that PayPal has a head start. Regulations will always be a risk for PayPal but so far, they have been able to successfully navigate through regulations in various markets. I'm a bit underwhelmed by the ROIC that PayPal has delivered, and I would like to see it grow moving forward. PayPal should see some tailwinds as more purchases will be made through e-commerce, and it is hard to imagine that trend reversing at any point soon. PayPal continues to innovate and introduce new products, and if they successfully win market shares, the share is getting very intriguing. I also like that management is buying back shares when the shares are cheap. I believe that PayPal is an intriguing share if it can be bought below the PAYBACK TIME price at $70,72.

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