PayPal: Much More Expensive Than You Think

May 30, 2019 10:02 AM ETPayPal Holdings, Inc. (PYPL)MA45 Comments
Librarian Capital profile picture
Librarian Capital
7.85K Followers

Summary

  • PayPal has grown strongly since its 2015 spin-off, and management's medium-term outlook envisages a further period of strong growth.
  • However, the stock is more expensive than it seems, with high stock-based compensation costs excluded from non-GAAP figures presented.
  • Growth has been capital-intensive, with large spend on acquisitions and loan receivables; the pending loss of eBay business will be a headwind.
  • We prefer Mastercard as a better investment in the payments space, given PayPal has not been disruptive to existing card companies.
  • At $111.74. PayPal shares are on a 46.1x P/E on non-GAAP EPS (65.3x on GAAP EPS) and 1.7% FCF Yield. Our recommendation is Neutral.

Introduction

PayPal (NASDAQ:PYPL) has grown strongly since its 2015 spin-off from eBay (EBAY), with its Total Payment Value ("TPV") growing at a CAGR of +25.3% and its net revenues growing at a CAGR of +17.8% during 2014-18 (as shown in the charts below). Management's medium-term outlook envisages a further period of strong growth, with revenue CAGR of 17-18%, an "expanding" operating margin, and an EPS CAGR of around 20% in the next 3-5 years (see below).

PayPal TPV (2014-18A)

PayPal Net Revenues (2014-18A)

Source: PayPal company filings.

PayPal Medium-Term Outlook

Source: PayPal investor day (May-18).

However, we believe that PayPal stock is more expensive than many investors think and that incumbent payment provider Mastercard (MA) offers a better risk/reward profile (see my article on Mastercard in April). This is due to a number of reasons, which we will explore below.

Non-GAAP Figures Exclude Stock-Based Compensation

One of the key reasons that PayPal stock is more expensive than it seems is that both management and many investors focus on non-GAAP (Generally Accepted Accounting Principles) figures, which do not include the costs of stock-based compensation.

As shown in the example slides below, non-GAAP figures typically form the centrepiece of results and guidance that management present to investors:

PayPal Results Presented by Mgmt. (2018)

Source: PayPal results presentation (18Q4).

However, among the non-GAAP adjustments, the largest one by far is the exclusion of stock-based compensation costs, as shown on the left below. In 2018, stock-based compensation costs were $920m, or 27% of the non-GAAP operating income; and they were similarly significant in preceding years.

We believe the exclusion of stock-based compensation costs gives a misleading impression of earnings, as stock-based compensation dilutes shareholders' ownership of company earnings and, thus, represents a real cost to them.

This article was written by

Librarian Capital profile picture
7.85K Followers
Global, long-term, fundamentally-oriented & concentrated investing. With more than 10 years' buy-side experience, I look at stocks globally and across industries, with a focus on the U.S. and U.K.. My investing style can best be described as "Quality Growth" or "Growth At a Reasonable Price". (previously writing under the name "Blue Sky Capital" until December 2019)

Disclosure: I am/we are long MA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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