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PayPal is one of the world’s largest internet payment companies. The company allows businesses of all sizes to accept payments from merchant websites, mobile devices and applications, and at offline retail locations, through a range of payment solutions.
Its combined payment solution capabilities, including its PayPal, PayPal Credit, Braintree, Venmo and Xoom products, comprise its payments platform. Their mission is to displace the use of cash with a digital wallet and is therefore a highly disruptive company.
PayPal originally listed in 2002, after which it became a wholly-owned subsidiary of eBay. In July 2015 it was spun off as a separate entity and PayPal listed on 20 July 2015, in what was essentially its second initial public offering (IPO) in 13 years.
One particular part of the business that I would like to highlight is the company’s valuable Venmo application, which PayPal acquired through its Braintree acquisition.
In case you are not familiar, Venmo is one of the leading mobile payment smartphone applications today. Venmo processed over $4bn worth of person-to-person payments, roughly a staggering 140% growth from the second quarter of last year. Venmo added eight additional applications to pay with Venmo, such as Parking Panda, App Market and Pashmark, to name a few. The application makes it very easy to exchange money between friends, family, and strangers.
In its latest quarterly results, the company also highlighted One Touch, the “most rapidly adopted product in PayPal’s history”. With One Touch, PayPal users don’t have to enter login and billing information every time they buy something online, but remain covered by PayPal’s fraud protection. At the end of June, more than 25m consumer accounts have opted in to One Touch and more than 2m merchant accounts have enabled the product, PayPal said.
What we like about PayPal is the fact that it has recently signed large deals with Visa and MasterCard, essentially ending its big “feud” and rivalry with the big card issuers. This aligns with their strategy to become a more universally aligned method of payment. MasterCard and Visa will open up their “doors” to help PayPal enter the physical store payment area (one that PayPal has been struggling with for years). The deals also eliminate the fear that Visa and MasterCard could have sided with a competitor. The mobile wallet and payment industry is undergoing strong growth and PayPal’s established position puts it in the driver’s seat.
Active customer accounts and the number of transactions processed have shown strong annual percentage growth. In the second quarter of the year, active customer accounts totalled 188m, reflecting an increase of 11%, while the company processed 1.4bn transactions, an increase of 25%. Total payment volume was up 28% to $86bn, the group said. The CEO’s compensation consists of 69% performance-based remuneration i.e. management is heavily incentivised to keep the share price ticking up. While free cash flow has been increasing, the company has gotten cheaper on a price-to-free cash-flow ratio.
A few key risks that we have identified:
- Their mobile business is heavily impacted by the physical device manufacturers (Apple, Google etc.), which have the power to hamper their integration into mobile devices.
- The mobile payments industry have relatively low barriers to entry.
- Short-term risks include margin pressures due to higher costs negotiated to facilitate Visa and MasterCard transactions via the PayPal network. We believe the long-term benefits outweigh the short-term drawbacks.
Overall we think the market is underpricing PayPal’s long-term cash flow generating capabilities and are purely looking at short-term margin pressure risks. Our fair value estimate is between $41 to $46 per share with a one-year price target of $44. PayPal was trading at $40 on 26 September.
Iwan Swiegers is a director at Capilis Asset Managers.
This article originally appeared in the 22 September edition of finweek. Buy and download the magazine here.
