Despite thriving during the Covid-19 pandemic, PayPal Holdings Inc.'s (PYPL, Financial) fortunes have taken a turn as consumer behavior normalizes and economies worldwide reopen. Consequently, the company is experiencing a substantial slowdown in its growth trajectory.
The deceleration is evident in the decline of the stock price, with shares currently trading 35% below their 52-week high.
The current situation may soon undergo a transformation as PayPal's management actively pursues measures to derisk its balance sheet. Simultaneously, their strong emphasis on generating shareholder returns and the current valuation make it an incredibly attractive prospect.
Paring down debt
Last week, PayPal made an announcement regarding its strategic plans for its buy now, pay later business. The company revealed its intention to sell its European BNPL loan portfolio, valued at $44 billion, to KKR & Co. Inc. (KKR, Financial), a globally renowned investment firm. This move aligns with PayPal's growth strategy in the BNPL market and highlights its commitment to derisking its balance sheet.
The agreement entails KKR purchasing a substantial portion of PayPal's European BNPL loans currently held on its balance sheet, as well as any future loans originated in Europe. PayPal will retain its responsibilities for servicing both existing and new loans, managing loan origination processes and overseeing customer-facing operations.
Under the terms of the agreement, PayPal anticipates receiving $1.8 billion in proceeds from the initial acquisition of the current BNPL loans.
This collaboration offers multiple advantages for PayPal. By offloading the loans, the company can reduce risk exposure and maintain a stronger balance sheet while earning fees from originating and servicing the debt. The freed-up capital will be utilized for share repurchases, with PayPal increasing its planned buybacks from $4 billion to $5 billion for the year.
This strategic move raises the question of whether PayPal will pursue similar deals in other markets. With $7.5 billion in loans and interest receivables on its balance sheet at the end of the first quarter, the company might consider a strategy focused on originating and servicing loans rather than owning a significant portion of the debt.
Taking into account these recent developments, as well as the overall performance of PayPal's business, the stock emerges as a compelling investment opportunity. Despite its slower growth, PayPal's management is dedicated to enhancing shareholder returns and has positioned it for financial stability.
A financially robust enterprise
With an impressive 435 million active accounts, PayPal generated $27.5 billion in revenue in 2022. Despite a lower growth rate attributed to slower total payment volume and active accounts, the company achieved a substantial total payment volume of $1.36 trillion.
Notably, PayPal has consistently exceeded earnings estimates and provided robust guidance. Currently, the stock is trading at an attractive valuation. With analysts' price targets ranging from $60 to $200, there is also significant upside potential.
In its financial report, PayPal announced an 8.5% increase in revenue to reach $27.5 billion and successfully repurchased $4.5 billion shares. The company boasts a strong balance sheet, minimal net debt and a manageable debt-to-equity ratio. In 2022, it recorded a remarkable 12% growth in total payment volume, primarily driven by a notable 30% increase in unbranded volume. Additionally, the operating margin expanded by 200 basis points, earnings per share surged by 33% and the company generated $1 billion in free cash flow.
PayPal foresees approximately 20% earnings per share growth for the year and provided positive guidance for revenue in the upcoming quarter. Despite facing competition from major tech giants, PayPal's strategic focus on margin expansion and bottom-line growth helps mitigate risks. Notably, unbranded processing serves as a key driver for investment.
With a high earnings yield and a track record of share repurchases, analysts view PayPal as a buy with strong potential returns. The company's emphasis on margin expansion and its ability to generate free cash flow contribute to this positive outlook.
Risks
It is evident that replicating the extraordinary growth witnessed by PayPal in 2020 and 2021 may be an unattainable feat in the future. The company's revenue only grew by 8.5% in 2022, while the addition of a mere 8.6 million net new active accounts pales in comparison to previous years. Furthermore, PayPal's user base actually experienced a slight decline in the first three months of this year compared to December 2022. Does this indicate the platform has reached its maximum potential?
This scenario is a distinct possibility. As the world gradually returns to normalcy, the surge in online shopping, which flourished when people were confined to their homes, has begun to wane. Notably, prominent e-commerce companies such as Etsy (ETSY, Financial) and Amazon (AMZN, Financial) have reported a slowdown in sales in recent quarters, suggesting a shift toward in-person retail experiences. As PayPal is the widely accepted digital wallet in North America and Europe, this trend adversely affects its business.
Moreover, inflationary pressures present a significant challenge for PayPal. Consumers are facing tighter budgets and are compelled to spend more on essential items, leaving them with reduced discretionary spending power.
In addition to inflation, PayPal faces intense competition in the payments industry. While companies like Visa (V, Financial) and Mastercard (MA, Financial) have established themselves as leaders, Apple Pay is gaining ground in online checkout services, experiencing a surge in usage during key holiday shopping seasons. This competition extends to in-person transactions as well.
Furthermore, PayPal's ownership of Venmo, a popular peer-to-peer service with 60 million monthly active users, places the company in direct competition with Zelle, which is operated by a consortium of major banking institutions.
Overall, PayPal confronts multiple challenges, including shifting consumer preferences, inflationary pressures and robust competition in both online and in-person transactions. While the company remains a significant player in the payments industry, it must navigate these obstacles to sustain its growth and market position.
Attractively valued
Due to a significant decline in its share price over the past several years, the current price-earnings ratio is 28.36, which is much lower than its average multiple of 49.26 for the past decade. This indicates a shift in investor sentiment from extreme optimism to a more pessimistic outlook. However, considering the Wall Street consensus analyst estimates project 28% annualized net income growth between 2022 and 2027, there is potential for favorable returns, particularly when taking the valuation into account.
The company has been successful in increasing user engagement, as evidenced by a 13% rise in transactions per active account in the latest quarter. CEO Dan Schulman has prioritized this aspect as a key strategic focus.
PayPal benefits from a robust two-sided platform, boasting 35 million merchants and 398 million individuals, which capitalizes on network effects. This essentially means that as more merchants join PayPal, consumers find greater value in using the service and vice versa. This establishes the company's strong competitive position, making it highly challenging for smaller competitors to catch up.
The company's profitability can also be attributed to network effects. In 2022, PayPal achieved a remarkable 19% margin, generating $5.1 billion in free cash flow from $27.5 billion in revenue. Furthermore, PayPal boasts a robust balance sheet, with a net cash position amounting to $4.4 billion. Moreover, the leadership team has implemented cost-cutting measures across the organization, enhancing future operational efficiency.
Takeaway
In conclusion, PayPal's growth trajectory has slowed down as economies reopen and consumer behavior returns to normal. However, the company's strategic measures, such as the partnership with KKR, highlight its commitment to derisking its balance sheet and generating shareholder returns.
Despite the challenges, PayPal's strong financial position, minimal net debt and focus on margin expansion position it for future growth.
