PayPal | Undervalued Trade
The ugly duckling.
This won’t be a lengthy investment case detailing the company, all its products, what they do, and why I believe the stock could be a good long-term position. I’m not really sure what PayPal will be over the next decade to be honnest.
But I am convinced that PayPal is better than many think and that the stock has been beaten down excessively, creating a pretty good medium term opportunity.
[Company & Core Business]
PayPal is quite an old company, founded in 1998 by those who are now known as the PayPal Mafia, a group of investors and entrepreneurs who have been very successful over the years, including names like Peter Thiel and Elon Musk. I won’t talk about the dramas & stories but much of it is covered in Elon’s biography written by Walter Isaacson, if you’re ever interested - a great book.
The company’s goal was revolutionary at the time: to process online payments through a much easier system for both end consumers & online merchants. This seems basic nowadays but it sure wasn’t at the time when the internet was just starting and technologies were not as advanced.
PayPal was a revolution.
The paiement system is very complex and I’m pretty sure none of us really know how it all works, with so many companies interacting before payments are confirmed and money is transferred - a real nightmare.
No single company owns the entire chain, and the system relies on dozens of them, each focusing on their specific part and interacting with another to make it all work. Some issue credit & debit cards, others keep the money, others do the interface between them all, while some more will have to deal with physical, online, and other means of payments…
As I said: a nightmare. One PayPal is part of with different roles, but let’s try to keep it as simple as possible. PayPal works as a trusted bridge between financial institutions to transfer money for two very distinct groups: consumers and merchants. This is true for almost every product PayPal offers and through all its applications.
Consumers. This is the easiest part to describe as it is most of us. During the early 2000s, PayPal was the only major online player and most of those who wanted to buy anything from the internet used it. It allowed us to register out credit card or bank account and would allow us to easily buy anything we wanted online.
We just had to click “Pay with PayPal.” The app would automatically take the money from our configured payment system and send it.
Merchants. Send it to those to whom we owe it in exchange for their products: the merchants. This might not be intuitive, but they are the heart of PayPal’s business because the service they propose is actually for them more than for us. So how does it really work?
Merchants go to PayPal with their needs. Some have huge volumes, others are very small businesses, but all of them need an online payment system and PayPal will have a solution for them, be it with their main software or from other ones such as Braintree. The solution will depend on the needs.
Once this is done and everything is set up, clients can buy using the PayPal infrastructure and the company will charge the merchants for the use of their softwares & infrastructures.
Why Do Merchants Need It? Besides the obvious need to sell online, the answer is called the “network effect.” Why do you want your house to be listed on Airbnb? Because every traveler uses Airbnb, and if your house were not listed there, you’d miss bookings.
Everyone used PayPal, and if your clients didn’t have the option to pay with their system, they might be too lazy to pick up their card and cancel their orders. This is why every commerce wanted to deal with PayPal over the years as they were the only serious solution.
And this is how well it worked for them as PayPal is now processing more than $1.5T of value through its apps for more than 425 million users. TPV is one of the most important metric for PayPal as it shows the usage of their services.
The second reason merchants needed PayPal was for its simplicty of use. Nothing came close to it and it allowed consumers to conclude their purchase easily while other systems could have caused them to be annoyed or too complex and give up on their purchase. This is called converstion and we will talk about it again later.
This is what PayPal, the company, does. They process online payments in the simplest way possible for everyone.
How do they make money. As said earlier, PayPal will charge a fee on every transaction going through their infrastructure. This fee will depend on the service the merchant uses, its volume, and many other parameters defined before setting up the service.
It seems like a free service to users because we can send money to friends without fees - except under certain circumstances like currency swaps - or pay online without any charges. The truth is that PayPal gives consumers free services and charges a fee on the merchant side to build loyalty to their app and make it your go-to app to pay.
It’s transparent for consumers, but it isn’t free.
[Market & Risks]
Up to here, we’ve talked about what PayPal is and offers, but we have to discuss what happened since then because PayPal isn’t the monopolistic online payment processor it once was. Lots of things have changed since the early 2000s, and PayPal… didn’t really adapt.
Although to be fair, the payment industry didn’t change much technically, but its landscape was transformed over the years as many companies saw an opportunity to do exactly what PayPal does, just better or cheaper. Competition came, and that was the beginning of tough times for PayPal.
We’re talking about Adyen, Shopify, D-Local, Stripe, and many more, crowding the market. The problem is that there aren’t many ways to distinguish oneself but two.
Have a better technology. Which is of course possible but complicated in a static industry. The payment system hasn’t changed much over the last 20 years, giving competition time to catch up with PayPal which didn’t innovate much during this time nor developed any barriers to keep competitors out of its turf - they kind of slept through the years.
Have cheaper services. Or to offer the same service but cheaper, and that’s what many companies did, forcing PayPal to fight for its market share by doing the same, resulting in this.
The company had no choice but to reduce its margin over its services; otherwise, its merchants were leaving for the competition.
I think this gives a proper picture of the actual situation, and I understand it’s not very appealing: a kind of static sector that hasn’t seen any innovation over the last decades, a company that used to have an almost monopoly but is now crippled by competition with as good products as theirs, and a business that, even though used more and more, generates less and less money over the years.
This is shown clearly here, where we can see that PayPal is growing revenues but kept flat income.
The market is always looking for rapidly growing and cash-generating companies that can either bring back value to shareholders or innovate to grow even faster, and PayPal was not one nor the other kind.
But things are changing lately, and even if the picture of the last years isn’t appealing, the opportunity lies in the transformation PayPal is going through, coupled with its current depressed (and justified) valuation.
[What’s new & PayPal’s advantages]
It all started when management was entirely changed and Alex Chriss took the CEO job less than a year ago now.
I won’t go as far as saying the company was dying before. Revenues were growing, PayPal was the gate to trillions of dollars and was used more and more worldwide… But it lost its touch. Alex’s goal is to bring back PayPal to an innovative mindset and to leverage the advantages the company has built over the years over its competitors.
Userbase & Data. PayPal has been around for years and was (still is) the most used application to transact money online - with more than 425M active accounts today.
This gave PayPal access to tons of personal information, but most importantly, access to users’ consumption habits. Meta knows what you look at. PayPal knows what you buy. Both pieces of information are valuable but you can understand that the latter is much more interesting for companies that try to sell you things.
This means that PayPal has a clear leverage to use for marketing and has never used it. But as you probably guessed, Alex announced some weeks ago that PayPal would open a new business - an advertising business. This comes after they entirely revamped the app, which now looks much more like a marketplace than a bank, as it did some years earlier.
We now have an app that shows content based on the users’ purchase habits. Companies will pay for this service to advertise on an app from which consumers can buy directly, and PayPal will get double revenues for it: to advertise and to process the payment.
And of course, everything is meant to be easy for the consumer as this is the single most important aspect for any payment processor: conversion.
Convertion. This is about making it easy for buyers, not giving them time to overthink, allowing them to do things as fast as they can. Any second, any friction, any annoying detail can change the buyer’s decision, and payment processor companies have to be the best because merchants will of course choose the cheaper option but will also want the highest conversion rate.
Enter Alex Chriss once again and a new solution he called Fastlane.
Two taps are what you will need to buy anything on the internet without being connected, without sharing info, without doing anything special but using PayPal - and this is of course only one click if you are shopping on the PayPal app already. This is what a company can do when it knows its users like PayPal does.
This product has rolled out in January, and the first returns and comments we have seen over the last months tend to show that Alex was conservative in his numbers. This product apparently shows a conversion rate above 80% according to some analysts - which is a very big step forward for any merchant.
Stablecoin. For someone who loves Bitcoin as much as I do, this represents a major step forward for PayPal and the entire payment industry because the new disruption could come from here. The company has developed its own stablecoin using the blockchain to settle international payments. This is finance 2.0.
I won’t go much further here, but if you’re interested, you’ll have a more detailed explanation here.
https://x.com/WealthyReadings/status/1742515265122758969
This is simply a gadget for today, but it shows that the new PayPal under Alex thinks about the next steps.
Others. The advertising business, combined with Fastlane, are the two most crucial updates that could substantially boost PayPal, helping the company regain market share and increase margins. But that’s not all. The company is working on its own credit card, upgrading its apps for easier usage, introducing numerous new functions and monetization systems to Venmo, leveraging its data beyond advertising, developing cashback solutions, boosting its monetization of Braintree and much more.
All of it since Alex assumed leadership less than a year ago. Results will take time to show but something is happening with PayPal and the first signs are pretty positive.
[Valuation]
PayPal’s business has struggled for years but these innovations and products could be the beginning of a new era for both the company and its stock, which currently trades near its lowest valuation ever around $65B despite generating $30B of revenues last year.
The company wasn’t dying; the business was functional at best, profitable with approximately $4B in free cash flow per year and a balance sheet with $4.6B in net debt. With limited R&D expenses, the new management decided that most funds would be used to return value to shareholders through buybacks with a minimum allocation of $5B throughout the year, representing 8% of the company at current prices.
This is a big part of the bull case for PayPal. Not many profitable companies are capable of buying back 8% of themselves in a year because companies who generate enough money to do so usually trade at much higher multiples.
[Technical]
Technical analysis is nothing more than a representation of what price the market buys and what price it sells. And after falling more than -80% over the last years, the market seems to like the actual prices, marking a definite bottom just above $55 and a higher low a few months later around $57.
The stock bounces within a nice range between $57-$70 but has been defending the actual support, which indicates that more people are inclined to buy at those prices than to sell it.
This is how accumulation phases start, and it might continue for months or years, but there are sure signs that PayPal has stopped its downward tendency and is now stabilizing or preparing itself to go much higher.
[Conclusion]
This is my take on PayPal’s actual state, and the thesis is quite simple. The stock has been beaten up beyond reason because the company wasn’t doing anything for years but losing market share to competition without any reactions. But the new management sees things differently and has already set in motion clear plans to bring back growth and value to PayPal’s business, and those actions are already starting to show positive results.
It might take months for the business to recover, but we’re on the right track now, and the current valuation and cash available to the company to bring back value to shareholders are what make PayPal a potentially good opportunity right now, as the stock is tradding at historical lows.
I wouldn’t have touched it if it weren’t for Alex Chriss and the new products, optimizations, and motivation he brought with him, as every stock trading at very low multiples has reasons to do so. But those reasons aren’t really viable anymore to my opinion and the stock market didn’t realise it yet to my opinion.
This investment is to play this lag between the potential and the realisation of this potential by the market which would logically require much higher multiples for PayPal. I intend to hold my shares until this happens and as long as signs stay bullish for the new products & the global business.
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