PayPal Is An Excellent Company With Excellent Prospects, But It's Overheating

About: PayPal Holdings, Inc. (PYPL)
by: Oleh Kombaiev

There is excessive optimism regarding PayPal.

Even on the basis of the extremely optimistic development scenario of PayPal, the DCF modeling does not justify its current price.

I personally think that a certain bubble is going on here.

Recently, I have been observing excessive optimism about PayPal (PYPL). In any case, at Seeking Alpha, at least 10 recent articles on PayPal describe this company positively (with the exception of my articles). But I personally think that a certain bubble is going on here. To prove it, I propose to estimate the rational price of PayPal using DCF modeling.

The quality of any DCF model is significantly determined by the quality of the revenue forecast included in it. So, let's start with that.

A fundamental indicator of PayPal's future revenue growth is the dynamics of active customer accounts. And here we should admit that it has been growing with acceleration over the last three years. This is a sure guarantee that it is not worth expecting a considerable slowdown in the company's revenue growth rates in the near future.

Against this background, I expect PayPal's revenue growth will continue to accelerate at least until 2021, and the CAGR will amount to 14.75% in the next 10 years:

It is worth noting that my forecast of PayPal's revenue on the horizon for the next five years is higher than the average expectations of analysts:

Source: Seeking Alpha

Moving on to the Weighted Average Cost Of Capital of PayPal:

To calculate the WACC, I used a one-year rolling beta coefficient, which is close to the absolute historical peak now:

I proceed from the assumption that PayPal's beta coefficient will decrease in the long term. Accordingly, this will reduce the WACC.

Over the last five years, the operating margin of PayPal has been 16% on average. There is no reason to believe that this figure will increase in the future. Firstly, speaking about a 10-year perspective, it should be assumed that competition in the digital payments market will inevitably increase. Secondly, PayPal is developing its ecosystem, embedding its services in the ecosystems of other companies. Such a business model does not, in principle, imply high profitability.

Against this background, I assume that the operating margin will remain at the average level of the last five years. This scenario can also be considered an optimistic one.

Further, I assume that CAPEX will remain at the current average level.

And the model assumes only a gradual increase in the relative size of the tax rate to the average worldwide level of 25%.

It must be admitted that all the input parameters of the DCF model correspond to a favorable development scenario of PayPal in the next 10 years.

Here's the model itself:

As you can see, the result is not satisfactory; the reduction potential is 43%.

Bottom Line

DCF modeling is exactly the tool that makes it possible to objectively estimate a company's value solely on the basis of its development trend. You must admit that I have considered a fairly optimistic version of PayPal's future, and even so its fair value within the DCF model has not even approximated to the current level.

I don't want to be a bore at a party and spoil the festive occasion, but let me remind you once again that PayPal is an excellent company with excellent prospects, but it is overheating very much, and everyone who is buying its shares now is most likely to regret it in the near future.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.