[FREE] PayPal (PYPL) Equity Research Report

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Thank you all for the recent support. As part of our ongoing effort to highlight our portfolio, we’re releasing detailed write-ups for each stock we invest in. This approach gives you insight into the companies we believe in and the reasoning behind our investments. This weeks research report is on PayPal (PYPL 0.00%↑) , a technology platform that enables digital payments on behalf of merchants and consumers worldwide.

PayPal operates a vast and multifaceted e-commerce payment network, with a revenue model that is predominantly reliant on transaction fees, commonly referred to as "take-rates." These fees account for approximately 91% of PayPal's total income. While PayPal reports only two primary revenue lines—Transaction Revenues and Other Value-added Services—the company’s operations encompass a diverse range of businesses, each with its own take-rates, costs, and growth dynamics. The key components of PayPal's revenue structure include:

• PayPal's Branded Checkout/Digital Wallet: This service is the cornerstone of PayPal's business, enabling millions of online merchants to accept payments from over 429 million active PayPal users globally. The Branded Checkout service not only facilitates payments but also includes features such as "Buy Now, Pay Later" (BNPL). This segment is estimated to be a significant contributor to PayPal’s gross profit due to its higher take-rate compared to other services. The wide acceptance of PayPal across online retailers makes it a go-to payment method for many consumers, reinforcing its central role in PayPal's revenue generation.

• Braintree/Unbranded Processing: Acquired by PayPal in 2013, Braintree is a payment processing platform that competes directly with industry heavyweights like Adyen and Stripe. Unlike PayPal's branded checkout, Braintree operates behind the scenes, providing end-to-end e-commerce payment processing for businesses without prominently displaying the PayPal brand. Braintree’s competitive rates have made it a popular choice among tech-savvy and large-scale enterprises looking for flexible payment solutions. While Braintree is crucial for expanding PayPal's market reach, it typically operates with lower take-rates, reflecting its role as a high-volume, low-margin business within PayPal's broader portfolio.

• Venmo: Venmo, initially launched as a peer-to-peer (P2P) payment service, has evolved into a broader financial platform under PayPal's ownership. Known for its social feed feature and popularity among younger consumers, Venmo has increasingly focused on monetisation by offering services like debit and credit cards, instant transfers, and even cryptocurrency trading. These services provide new revenue streams and help PayPal capitalise on Venmo's large and engaged user base. Despite its growth, Venmo's revenue contribution is still emerging, with PayPal working to fully integrate and monetise the platform alongside its core services.

• Other Merchant and Value-added Services: PayPal offers a wide array of additional tools and services that contribute to its revenue beyond transaction fees. These include:

  • Merchant Services: PayPal provides merchants with essential tools to enhance their sales and streamline operations, such as invoicing, fraud prevention, payment gateways, and analytics. These services are particularly valuable for small and medium-sized businesses (SMBs) looking to optimise their online sales processes.

  • Value-added Services: This category includes a diverse range of revenue-generating activities such as partnership revenues, interest income from customer deposits, and credit offerings like working capital loans to merchants. With rising interest rates, the interest income from customer deposits has become increasingly significant, adding a stable revenue stream to PayPal's overall financial performance.

Over the past year, PayPal has seen a gradual decline in its total take rate, which has decreased from 1.99% in the same quarter last year to 1.89% in the most recent quarter. This decline reflects a broader trend driven by several factors, including the growing prominence of lower-margin services like unbranded processing through Braintree. As Braintree’s share of PayPal's total payment volume (TPV) has increased, the overall take rate has been pressured downward.

Moreover, PayPal’s branded checkout services, which historically contribute to higher take rates, have faced increased competition, leading to a mix shift toward larger merchants who negotiate lower fees. This shift has further contributed to the decline in the transaction take rate over the past year. Despite these challenges, PayPal has managed to sustain its transaction margins by growing its volumes in other areas, such as Venmo and its international operations, which have shown consistent performance.

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Proprietary Brands

PayPal, Braintree and Venmo, Xoom, Zettle, Paydiant, Hyperwallet, Honey, iZettle, Swift Financial, Simility, Chargehound, Happy Returns, Paidy.

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Moat Analysis

PayPal operates one of the largest payment networks globally, with a two-sided network connecting 35 million merchants and over 400 million consumers. This extensive reach gives PayPal a strong competitive position, but by no means an impenetrable one.

Unlike Visa (V) and Mastercard (MA), which operate a shared payments monopoly by connecting banks, merchants, and consumers, PayPal faces more direct competition across multiple facets of its business:

• Branded Checkout: PayPal competes with Apple Pay, Shop Pay, Google Wallet, and other digital wallets for consumer attention. Additionally, it faces competition from traditional payment methods like manually entered credit/debit card information.

• Payment Processing: Through its Braintree subsidiary, PayPal competes with other e-commerce processors like Adyen and Stripe, as well as the online offerings of brick-and-mortar processors like Chase Paymentech and FIS’s Worldpay.

• Digital Wallets: In the U.S., PayPal’s digital wallet competes with Apple Pay and Square’s Cash App, while internationally, it faces myriad alternative payment methods.

Despite the presence of well-capitalised and formidable competitors, PayPal has somewhat maintained its market position through several key advantages:

• Brand Recognition and Trust: PayPal’s name is synonymous with online payments, offering a level of security and reliability that has been built over two decades. This trust is particularly valuable in the digital payment space, where consumers are cautious about security and privacy.

• Network Effects: PayPal benefits from strong double-sided network effects. The more merchants that accept PayPal, the more attractive it becomes to consumers, and vice versa. This virtuous cycle reinforces PayPal’s market position, even as competition intensifies.

• Captive Capabilities: Any merchant that wants to accept PayPal payments must process those transactions through PayPal’s system. This captive processing capability ensures that PayPal remains integral to the transactions on its platform.

• Scale and Efficiency: PayPal leverages its significant scale and strong balance sheet to operate efficiently, maintaining stable margins despite intense competition.

Comparison with Apple Pay and Similar Services

A common concern among investors is, "Why wouldn't consumers just use Apple Pay instead of PayPal?" To address this, it's first important to understand the fundamental differences between their business models and how they generate revenue.

• Apple Pay earns revenue primarily through a small fee collected from issuing banks for each transaction made using its service. This fee is a portion of the interchange fees that banks pay to card networks. Apple's model is largely dependent on its agreements with banks and is designed to keep costs low for merchants, thereby encouraging widespread adoption.

• PayPal, on the other hand, generates revenue by charging merchants directly for processing transactions. This fee structure typically includes a fixed fee plus a percentage of the transaction amount. This model is applied across PayPal’s suite of services, including online payments, Venmo, and Braintree, giving PayPal more direct control over its revenue streams.

Pros and Cons of Each Model

Apple Pay:

• Pros:

  • Low Merchant Costs: Apple does not charge merchants additional fees, which encourages merchants to adopt Apple Pay as a payment option.

  • Enhanced Security: Apple Pay uses biometric authentication (like Face ID and Touch ID), which increases transaction security for users.

  • User Convenience: Payments are streamlined with a simple tap or device authentication, making the process quick and easy for consumers.

• Cons:

  • Currently Limited to Apple Devices: Apple Pay is only available on Apple products, with iOS currently making up 30% of the mobile phone market. This limits its reach to non-Apple users. (However see Apple’s recent WWDC announcements below and how this might change).

  • Dependence on Banks: Apple’s revenue is tied to agreements with banks, which could potentially change, affecting its revenue model.

PayPal:

• Pros:

  • Widespread Acceptance: PayPal is accepted by a vast number of online merchants globally, making it a versatile payment option for consumers.

  • Revenue Control: PayPal directly earns from merchants, providing a stable and predictable revenue stream.

  • Service Versatility: PayPal offers a broader range of services, such as money transfers, holding balances, and processing payments through Venmo and Braintree.

• Cons:

  • Higher Merchant Costs: PayPal’s fees can be higher for merchants compared to Apple Pay, which might deter some small businesses from using its services.

  • Competition from Banks: PayPal faces competition from direct bank transfers and other payment processors, which could impact its market share.

The Impact of Apple's WWDC Announcements

Apple’s recent WWDC event introduced several new features that could further intensify competition. Notably, Apple expanded the reach of Apple Pay by enabling it to work with web browsers beyond Safari, such as Chrome, Firefox, and Edge. This significantly increases Apple Pay's accessibility in online checkout, challenging PayPal's dominance in this area.

Additionally, Apple's new Tap-To-Cash feature, which allows iPhone users to send money to each other by simply holding their devices together, marks Apple's entry into the peer-to-peer (P2P) transaction market—a space where PayPal's Venmo currently holds significant market share. Although Tap-To-Cash is currently limited to in-person transactions, it could evolve into a more comprehensive P2P solution, which PayPal should monitor closely.

Assessing PayPal's Moat Amid Growing Competition

To better understand the competitive landscape between PayPal and Apple Pay, it's important to start with the overall market distribution:

• Mobile Market Share: 61.79% of users are on mobile devices.

• Desktop Market Share: 36.04% of users are on desktop devices.

• Tablet Market Share: 2.17% of users are on tablets.

(Data from: https://gs.statcounter.com/vendor-market-share/tablet/worldwide)

Within these segments, Apple’s market share is as follows:

• 30% of the Mobile Market

• 20% of the Desktop Market

• 55% of the Tablet Market

Let’s quantify the potential impact on PayPal by considering the maximum market share Apple Pay could theoretically capture:

• Mobile: With 61.79% of users on mobile devices and Apple capturing 30% of that, Apple Pay could potentially target 18.54% of the total market through mobile devices.

• Desktop: With 36.04% of users on desktops and Apple holding 20%, this translates to 7.21% of the total market.

• Tablet: Tablets represent 2.17% of users, and with Apple’s 55% share, Apple Pay could influence 1.19% of the total market.

Total Potential Market Impact: If Apple Pay were to fully capture its market across these segments, it would have the potential to target 26.94% of the total market.

This represents the maximum “damage” Apple Pay could inflict by capturing users who might switch from PayPal. Given this analysis, while Apple Pay has a strong presence in certain device categories, its overall impact on PayPal is limited by its market reach. Even if Apple Pay fully leverages its device ecosystem, PayPal still has a significant market outside of Apple’s influence, where it can continue to compete effectively.

This framing underscores that, while Apple Pay is indeed a significant competitor, its potential to disrupt PayPal’s business is limited by the scope of its device penetration. PayPal’s extensive network effects, platform neutrality, and strong brand trust provide it with a robust competitive moat that spans all types of devices, not just those from Apple. However, PayPal’s ability to innovate and adapt, particularly under new leadership, will be key to maintaining its market position. As the digital payments sector continues to grow globally, PayPal’s established infrastructure and trusted brand should allow it to retain a leading role, even if its a smaller one than current in the face of Apple Pay’s expansion.

Overall, while Apple Pay and other competitors present real challenges, the notion that PayPal is on the brink of obsolescence is overstated. With careful management and continued innovation, PayPal’s competitive advantages should ensure its continued relevance in the digital payments landscape.

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Management and New Initiatives

In response to the increasingly competitive landscape, PayPal has made significant changes to its leadership team over the last year.

Alex Chriss was appointed CEO of PayPal in 2023, bringing with him a wealth of experience in scaling digital businesses and driving product innovation. Before joining PayPal, Chriss was the Executive Vice President and General Manager of Intuit’s Small Business and Self-Employed Group, where he led the company’s efforts to empower small businesses through innovative financial solutions. His leadership at PayPal is focused on steering the company toward sustainable profitable growth through strategic execution and innovation.

Key Leadership Hires from Industry Leaders

Under the new leadership of Alex Chriss, PayPal has also attracted several high-calibre executives, each bringing a wealth of experience and fresh perspectives to the organisation. The following are some of the key hires:

• Rachel Kobetz joined PayPal as Chief Design Officer in September 2023. She previously served as SVP and Global Head of Design at Expedia Group, where she led experience design for all stakeholders. Her background includes leadership roles at Bank of America, Amazon, and Samsung, positioning her to elevate PayPal’s user experience.

• Jaime Miller became CFO in November 2023, bringing experience from her role as Global CFO at EY, where she led a major corporate separation and IPO. Prior to that, she served as CFO at Cargill and GE, playing a key role in financial turnarounds and corporate strategy, making her a valuable asset as PayPal focuses on profitability.

• Geoff Seeley was appointed CMO in February 2024. He comes from Airbnb, where he oversaw brand marketing and partnerships. Geoff’s experience with Unilever, where he transformed legacy brands, will be crucial in strengthening PayPal’s market presence.

• Aaron J. Webster joined as EVP and Chief Enterprise Services Officer in March 2024. He previously held roles at SoFi, where he was Chief Risk Officer and Global Head of Operations, and at Citi and GE Capital. His expertise in risk management and operations will be critical for navigating regulatory challenges and maintaining PayPal’s security.

• Mark Grether joined PayPal in May 2024 to lead its new advertising platform initiative. He brings over 20 years of experience in the advertising industry, most recently serving as Vice President and General Manager of Uber Advertising, where he scaled the business to $1 billion globally. His background includes key leadership roles at Amazon, Sizmek, and WPP’s Xaxis, positioning him to build a dynamic, commerce-driven advertising platform at PayPal.

• Srini Venkatesan was appointed CTO in June 2024. Srini joined from Walmart, where he led U.S. Omni Platforms and Tech. With a background in leading technology at Yahoo, eBay, StubHub, and Marketo, Srini will drive innovation and advance PayPal’s technology infrastructure.

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Focus on Profitable Growth and Strategic Execution

Under the leadership of Alex Chriss, PayPal is intensifying its focus on profitable growth by prioritising strategic initiatives that leverage its existing strengths while exploring new revenue streams. The key areas they are focusing on are:

• Venmo Expansion: Venmo continues to be a critical asset for PayPal, particularly among younger consumers. Under the new leadership, Venmo is expanding its capabilities with features like Pay with Venmo, Venmo debit and credit cards, and cryptocurrency transactions. These enhancements are aimed at increasing user engagement and monetizing Venmo’s large, active user base. Venmo’s integration into PayPal’s broader ecosystem will also be a focus, ensuring that it contributes more significantly to PayPal’s overall revenue.

• Fastlane: Fastlane is a streamlined checkout solution designed to address one of the most common pain points for merchants—lengthy guest checkout experiences. Studies have shown that 43% of consumers prefer guest checkout, yet 66% expect the process to take less than four minutes. Fastlane directly addresses these needs by significantly reducing the time consumers spend in guest checkout, thus improving conversion rates. Fastlane enables merchants to recognize consumers early in the guest checkout process using their email. This allows customers to access their saved information with a one-time passcode, autofill their checkout details, and complete their purchase in as little as one click. For consumers not recognized during checkout, Fastlane offers an easy opt-in process to create a profile for faster future checkouts. Once a Fastlane profile is created, future purchases across any merchant that has enabled Fastlane can be completed swiftly, significantly reducing checkout time. The results from early adopters have been promising. For example, Black Forest Decor, a small business focused on home decor, saw its guest checkout conversion rate increase from 74% to 86% and a reduction in checkout time from 3.9 minutes to as little as two minutes after implementing Fastlane. Similarly, BigCommerce, the first e-commerce platform to integrate Fastlane, reported that guest shoppers using Fastlane converted more than 80% of the time, a 50% improvement over non-Fastlane users. With its simple integration and ability to maintain the uniqueness of a merchant’s checkout process, Fastlane by PayPal is poised to become a game-changer in the online checkout market. Fastlane is now generally available through PayPal Complete Payments and PayPal Braintree, and can be accessed via platforms including Adobe Commerce, BigCommerce, and Salesforce Commerce Cloud, among others. today announced the strengthening of its global strategic partnership with Adyen, the global financial technology platform of choice for leading businesses. Within the expanded partnership, Adyen will offer Fastlane by PayPal to accelerate guest checkout flows for its enterprise and marketplace customers in the U.S., with plans to extend this offering globally in the future.

• Advertising Platform Development: Leveraging its deep relationships with millions of consumers and merchants, PayPal is uniquely positioned to create an advertising platform that is deeply rooted in commerce. This new advertising business, led by Mark Grether, who joined PayPal after successfully scaling Uber Advertising into a $1 billion business, aims to help merchants sell more effectively and enable consumers to discover products and services they love. PayPal’s advertising platform will utilize advanced customer insights to build a dynamic, personalized advertising experience. This platform will not only drive better advertising spend performance for merchants but will also enhance consumer engagement through compelling offers. The platform will include PayPal's advanced offers, integrating marketing and payments to create a seamless experience for both merchants and consumers.

By focusing on these key strategic initiatives, PayPal is positioning itself to continue its trajectory of profitable growth, enhancing both customer satisfaction and merchant success. These efforts, driven by a combination of innovation and operational excellence, are expected to at a base level sustain PayPal’s competitive advantage in the rapidly evolving digital payments landscape.

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Financials and Rough Valuation:

PayPal has good gross profit margins at around 40%, net margins around 15% and FCF margins around 21%. PayPal also boasts a 22% return on equity (ttm).

The company has little debt with a debt / equity ratio of 0.63. The current ratio is also positive at 1.24 showing good financial flexibility if needed. PayPal also has huge amounts of cash with $13.32 per share as of the last report. Retained earnings are piling up nicely and management have been great at buyback shares in recent years when they feel it is undervalued, with $6bn committed this year. Overall PayPal is an extremely healthy company that under new management seems to be well managed.

Below are our back-of-the-napkin intrinsic value estimates based on a 10% discount rate and a 5-year timeframe.

Bull: 15% EPS Growth Rate, 18 PE - $124.5 Per Share

Base: 10% EPS Growth Rate, 16 PE - $88.5 Per Share

Bear: 5% EPS Growth Rate, 14 PE - $61.5 Per Share

The Thesis:

Our thesis on PayPal is straightforward: the market has overreacted to the competitive pressures facing the company, resulting in an attractive buying opportunity with prices in the mid-50s to low-60s range. At these levels, the market is effectively pricing PayPal as a very low-growth, low-quality company, which is a significant misjudgement. With share buybacks amounting to $6 billion annually against a market cap of around $60 billion, much of the anticipated EPS growth is already baked in in a conservative scenario.

While PayPal may experience some market share erosion in the coming years, this doesn’t equate to a decline in revenue. On the contrary, PayPal’s total payment volume (TPV) is likely to continue growing as the market does, and with a focus on more profitable growth and operational efficiency, a 10% EPS growth rate becomes not just possible, but probable. Furthermore, the introduction of the potentially game-changing Fastlane product, which is already showing strong early results, the development of a new advertising platform that leverages PayPal’s vast customer data, and enhanced efforts to monetize Venmo, all present significant upside potential.

In our view, this presents a prime example of an asymmetric opportunity. The downside is mitigated by the current low valuation, a strong balance sheet, and decent future prospects despite the competitive landscape. Meanwhile, the upside is driven by multiple promising catalysts that could transform PayPal’s business under the guidance of a capable new management team.

This is why PayPal is our largest holding. If you’re interested in a detailed portfolio review, please let us know.

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Risks:

• Increasing competition from Apple Pay, Google Pay, and emerging fintechs could erode PayPal’s market share to such an extent it has an impact on top line growth.

• A ‘race to the bottom’ on pricing could ultimately squeeze take rates to the point where profitability declines even if volumes grow.

• Failure to successfully implement new initiatives like Fastlane and the advertising platform could hinder growth potential.

• A recession could reduce consumer spending and transaction volumes, impacting PayPal’s revenue (However this could possibly be an opportunity for a market leader to grab extra market share).

• PayPal fails to get the younger audience to use its products. (Long term risk).

• New management somehow turn out to be completely incompetent and become less capital efficient.

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Disclaimer: The content provided in this newsletter is for informational purposes only and does not constitute financial, investment, or other professional advice. While we believe the information to be reliable, we cannot guarantee its accuracy. The opinions expressed are those of the author and do not necessarily reflect the views of Schwar Capital. Investing involves risk, including the possible loss of principal. Past performance is not indicative of future results. The author may or may not hold positions in the stocks or other financial instruments mentioned. Always do your own research or consult with a qualified financial advisor before making any investment decisions.