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PayPal Is Losing To Competitors, And Partnerships May Not Be Enough

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About: PayPal Holdings, Inc. (PYPL), Includes: ADYEN, EBAY, FB, MA, MELI, UBER, V
by: Zen Analyst
Zen Analyst
Long/short equity, value, growth at reasonable price
Summary

PayPal lagged the S&P 500 by 17% over the past 6 months.

While valuation, technical indicators, and sentiment are all positive, I am concerned with the fundaments.

My biggest concern is that PayPal may not be able to offset its market share loses with new partnerships.

Over the past 6 months, PayPal (PYPL) significantly underperformed the S&P 500 (lagging by ~17%). I took a look thinking there could be value there. However, I will remain on the sideline due to competitive concerns in an increasingly competitive landscape. Despite being relatively cheaper and bouncing off the a bottom, PYPL remains an expensive stock with consensus estimates calling for an acceleration in earnings in 2021, which may be at risk due to rising competition. In this article, I will walk you through my analysis of PayPal's valuation, technical, sentiment, and fundaments.

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Valuation and Technical Analysis

Source: All consensus numbers and forward multiples are from FactSet.

PayPal is trading at 32x NTM EPS, which is around the middle of its 2-year range of between 27x an 36x. The stock is yielding 3.5% FCF, also around the middle of it's 2-year range.

However, relative to the S&P500, which has been on a tear, PYPL is increasingly "cheap". On NTM P/E, PYPL peaked at around 115% premium to the S&P 500 back in June 2019 and then steadily declined to a 75% premium currently. The good news is that the premium erosion appeared to have stopped back in November.

From July through November of 2019, PYPL lagged the benchmark by roughly 18-19% and have since started to keep up. Overall, the stock looks like it has found a bottom back in November 2019.

PYPL has been a massive outperfomer since becoming public back in the middle of 2015 (doubling the S&P 500's performance), so this recent underperformance, erosion in valuation premium, and the bottoming of the stock in in November suggests a buying opportunity.

Mind The GAAP

Before I move on from valuation, I think it is important to point out to investors that PYPL looks substantially more expensive on GAAP EPS. While 32x NTM EPS is not cheap, PYPL is trading 45x on GAAP EPS.

PYPL cannot seem to outgrow its addiction to adjusted numbers as it consistently report Adjusted EPS numbers that are substantially higher than GAAP EPS. For example, consensus expects FY20 GAAP EPS of $2.45 per share vs. Adjusted EPS of $3.49. As a benchmark, leading fintech companies Visa (V) and Mastercard (MA) report adjusted and GAAP EPS are frequently the same number or not not materially different.

However, to be fair to PYPL, their Adjusted EPS appear to track FCF a lot better than GAAP EPS.

As for whether investors should use GAAP or Non-GAAP EPS, this is one of those things with no clear answer -- investors have no choice but to keep all these factors in mind and triangulate at PYPL's correct valuation. My personal bias is to follow the cash flow, so in PYPL's case I'm comfortable using their adjusted EPS number.

Sentiment Analysis

PYPL's 1.4% short interest has been about stable over the past year, so it does not look like the bears are circling the wagon.

Despite its underperformance, PYPL's sell side sentiment has actually improved from July 2019 through now. Back in July, 75% of analysts rated it as a "Buy", 20% "Hold" and 5% "Sell". Currently, sell side sentiment improved to 85% "Buy", 13% "Hold" and 2% "Sell".

Consensus Analysis

Consensus 2020 EPS is $3.39, up 14% y/y. It is a notable slowdown from the 26-28% growth over the past three years, but growth is expected to pick up in 2021. 2021 consensus EPS of $4.23 implies a 21% growth and this growth rate is expected to continue until at least 2023.

Consensus 2020 sales is expected to hit $20.7B, up 17% y/y, which is consistent with the growth rates of previous years (ranging from 15 to 21%). Analyst expect PayPal to grow at this rate through 2023 -- which is remarkably consistent.

Looking at 2020, growth for the core "Transaction" segment (90% of total revenue) is expected to grow 16.6% y/y, while the "Other Value Added Service" segment (10% of total) is expected to grow +20%.

Everything looks good so far, but what about the fundamentals?

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Fundamental Levers

I've identified several idiosyncratic levers that could drive consensus numbers up or down. As a long-term investor, I don't want to spend too much time on short-term "bull vs. bear" debates. However, I do think it is important to at least be aware of them, and to anchor them within my long-term mental model. These factors includes:

  1. Pricing initiatives, which delayed to a later part of last year and so could potentially provide more incremental benefits in 2020. This is a short-term, timing consideration, which I don't think investors should stress over.
  2. Honey acquisition. PayPal paid $4B for Honey, which many considered to be a very rich valuation. Investors also expressed skepticism over if management could integrate Honey within 6-12 month. PYPL's market valuations is around $133B, so a $4B acquisition isn't going to make or break the long-term story.
  3. Venmo monetization. While this is an important topic, it has been debated ad nauseam. Monetization is always difficult to predict, but internet companies have "figured it out" as long as the user base is there. This isn't a topic I am very concerned with as long as Venmo is growing.

There are two idiosyncratic levers I do want to spend more time on: eBay roll off and partnerships.

eBay (EBAY) roll off: EBAY is 9% of PYPL's TPV (total eligible payment volume) but is more profitable than average so I estimate is closer to 18% of earnings (due to PYPL's higher take rate and other factors). Around 28% of this TPV is PYPL's white label checkout service and the rest is branded, and this portion is expected to migrate to Adyen (ADYEN) in mid 2020. In addition, a portion of the branded TPV is expected to be in-housed by EBAY.

I'm not interested in attempting to model the 2020 impact of this given that there are so many uncertain variables, but the EBAY roll off does appear to be multi-year headwind through 2023. Importantly, I get nervous anytime a major customer moves to a rapidly rising competitor like Adyen, a company that is expected to grow 38% in 2020. To me, this share loss and emerging competitive threat alone would justify PYPL's eroding valuation relative to the S&P 500.

Partnerships. PYPL is trying to fend off intensifying competition by partnering with other tech giants. Prominent partners include MercadoLibre (MELI), Uber (UBER), and Facebook (FB).

In April 2019, PYPL agreed to invest $500M in Uber to extend their partnership which ha been in place since 2013. This extension includes PYPL's development of Uber's digital wallet.

The Uber announcement came a month after two significant announcements. First, PYPL's $750M investment in MELI and an agreement to more closely integrate the two platforms. In December 2019, PYPL and MELI announced a significant step forward by integrating Paypal with Mercado Pago. Second, PayPal announced that will power Checkout on Instagram.

Conclusion

The risk-reward looks balanced to me here so I will stay on the sideline. Although PYPL is cheaper than it was a year ago, the stock's underperformance relative to the market and fintech leaders like V and MA is well justified by the increasingly intensive competitive market and share loss to the likes of Adyen. Although PYPL's partnerships shows a valiant effort to fend off the competitors, 2020 EPS growth is expected to decelerated significantly to +14% before accelerating again to 21% a year in 2021. Given how fast the fintech space is evolving and how aggressive its competitors are, I would not feel comfortable underwriting earning acceleration in the out years.

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.