PayPal: Riding The Global Cashless Wave

Summary

• PayPal is a leading digital payments platform that enables digital and mobile payments between consumers and merchants worldwide.
• PayPal has built a complete payment ecosystem through acquisitions of companies involved across the payments stack, allowing it to achieve robust user growth year after year.
• Secular trends towards digital payments globally will benefit PayPal as it takes advantage by forming partnerships with online and physical retailers for point-of-sales solutions.
• We forecast revenue to grow by 17%, based on its share of the projected global transaction volume growth.

Source: PayPal

PayPal Holdings (NASDAQ:PYPL) is undeniably one of the most successful Fintech companies. Initially providing payment gateway services on eBay (EBAY), it has expanded into a complete payment platform through acquisitions over the years. It now offers digital wallet and peer-to-peer (P2P) payment solutions, cross-border funds transfer, and credit lending. Its user base has been steadily growing. With a complete portfolio of payment solutions, it has witnessed strong growth of its user base with a market reach of over 200 countries. As the secular trends towards a global cashless society continues, digital transaction volumes will exhibit robust growth which benefits PayPal.

The company is taking advantage of this by expanding its footprint across e-commerce and in-store point-of-sale (POS) both regionally and in emerging markets. Its partnerships with e-commerce giants and retailers enable users to pay seamlessly with its platform. At the same time, however, the company faces the threat of new entrants from BigTech and rival Fintech companies. Nevertheless, the company offers a competitive edge as a secure end-to-end payment facilitator which is the most trusted platform by customers. As it continues to integrate its platform services to create more value, it is likely to continue adding users and increasing engagement and payment volume growth.

Source: S&P Global

Complete Payment Ecosystem

PayPal has one of the most unique business models within the payment industry. It has established a complete payment ecosystem through e-commerce expansion of its PayPal Checkout and acquisitions of third-party payment solution providers. This strategy has provided PayPal the ability to integrate many services around its gateway to increase its user base. Its most notable acquisition is Venmo, a leader in P2P payments among millennial users, allowing the company to expand into the mobile market. Besides Venmo, the company's other acquisitions include Braintree, Xoom, iZettle, Hyperwallet, Simility, GoPay and Honey.

Source: PayPal

By acquiring companies across the payments value chain as seen in the diagram above, PayPal establishes its position as an end-to-end facilitator of digital payments. For example, as other businesses suffered due to COVID-19, PayPal on the other hand has witnessed a sharp rise in active users to almost 350 mln as consumers opt for contactless payment options.

Source: PayPal, Khaveen Investments

The integration of PayPal's services around its platform across the payments stack is its main competitive edge. It creates value to keep users engaged. Apart from retaining users, it also aligns with its strategy to continuously grow its user base. Though user growth is expected to moderate as things start to return to normal, yet with increasing integration of services, we are confident that the company will continue to see robust user growth into the future of above 15% annually as it targets 1 bln users globally. This would lead to higher user engagement and total payments volumes (TPV), contributing positively to PayPal's transactional revenue stream as it charges a processing fee from TPV.

Long-Term Adoption of Digital Payments

With a complete payments platform, PayPal stands to reap the benefits over the expanding digital payments market as the world moves towards a cashless economy. According to the Federal Reserve Bank of San Francisco, cash still represents a popular payment method accounting for over a quarter of all transactions. We expect its share to continue declining as digital payments gain popularity.

Source: Federal Reserve Bank of San Francisco

The long-term shift towards digital payments is attributable to several factors, which are:

• Rapid rise of e-commerce;
• increased internet usage and smartphone ownership in emerging countries; and
• shifting preference towards contactless payments for in-store retail purchases.

As retailers have been shutting down, e-commerce growth has accelerated, which in turn has benefited digital payment companies. Despite expecting some normalization as economies open up and restrictions start to ease, it remains a key catalyst for digital payment volumes as consumers prefer the convenience of buying online and have little choice than to use digital payment methods. PayPal is looking to benefit by integrating its platform into e-commerce by partnering with Shopify (SHOP), Etsy (ETSY) and Facebook (FB) for Instagram Checkout, allowing customers and small businesses to pay and receive payments using its checkout platform. PayPal's top 20 marketplaces recorded 40% growth in volume which approached $90 billion last year.

In addition to e-commerce, there are huge opportunities that would arise from a PayPal and Venmo integration with for in-store point of sale contactless payments. The platform has recently introduced QR functionality as another touch-free form of payment. With Venmo's rapidly growing user base and shifting preference away from cash for in-store payments, PayPal is creating an omnichannel solution for merchants to accept cashless payments. It has started implementing QR payment for CVS customers in 8,200 stores throughout the US. We see PayPal expanding QR payments across its merchant base in the US, which contactless payments continue gaining popularity. The US has lagged emerging countries especially China in terms of adoption of QR. Super-apps AliPay and WeChat Pay already dominate the half a trillion Chinese digital payments market with over a billion users each, becoming indispensable for the average user to transact for anything.

Besides the US, the shift towards digital payments is also seen in emerging markets, as improving internet connectivity and higher smartphone ownership rates reduce adoption barriers. According to a Visa (V) report, more than two bln people and 200 mln small businesses lack access to financial services, most located in emerging economies. This presents PayPal with tremendous opportunities to tap these markets. In South America, PayPal is partnering with MercadoLibre (MELI) to incorporate its platform on its e-commerce site. Mercado is touted the Amazon (AMZN) of the fast growing LATAM e-commerce market with nearly 20% of share or $14 bln in gross merchant value. This would deepen PayPal's reach in the region where 70% of the population in unbanked. Additionally, it has also partnered with mobile commerce leader Gojek in South East Asia to incorporate its payment platform. Point is PayPal is connecting leading marketplaces and payment networks globally.

Weathering Competition from Fintech rivals and BigTech

The global payments industry is highly competitive with rapid changes from innovative solutions. Not only does PayPal face competition from digital payments companies, but it is also faced with new threats from the entrance of BigTech such as Apple (AAPL) and Google (GOOG) (GOOGL). These companies are leveraging their strong user bases to capture some of the growth opportunities of digital payments by introducing their own digital wallets.

Platform	Estimated User Base ('mln')
Apple Pay	441
PayPal	346
Google Pay	67
Amazon Pay	33
Cash App	30

Click to enlarge

Source: PayPal, Square, Forbes, QZ, MerchantSavvy

Apple is proving a strong competitor to PayPal. Launched in 2014, Apple Pay's user base has grown rapidly. Nearly half of all iPhone users are using Apple Pay, higher than PayPal with 100 mln more users. While Apple currently has a higher user base, the major downside is that it is only compatible within the iOS sphere. This means that only Apple product users are able to use Apple Pay. On the other hand, PayPal is an agnostic service and has no such limitation as it can be installed on any phone.

PayPal has managed to secure a strategic partnership with Google. At first, users could add PayPal on Google Pay to pay for services such as Gmail, YouTube, Google Play and Google Store purchases. It has further integrated with Google Pay to enable contactless NFC payments between customers and merchants. This benefits PayPal as it can be saved on Google's hundreds of mlns of user accounts.

Apart from BigTech, PayPal has to contend with rival Fintech competitors, the largest being Square (SQ). The company is similar to PayPal as its services encompass mobile P2P, digital wallets and retail PoS hardware. Offering a slightly more competitive fee than PayPal, Square has managed to penetrate this highly competitive market targeting smaller merchants. Yet, PayPal offers a superior level of integration as a specialized e-commerce payments provider for online merchants with physical footprints.

In P2P, Square's Cash App is growing rapidly with above 60% user growth year on year, outpacing that of Venmo's growth at 50%. Its strategy targeting specific consumer networks with partnerships with popular brands such as TikTok allowed it to gain popularity among Millennials and Gen Z consumers. While Square was able to scale both processing and P2P payments successfully, Venmo can also capitalize on PayPal's integration to offer additional services. Additionally, PayPal is still the larger platform with a larger reach of more than 200 countries while Square's international operations is still limited.

Overall, despite the entry of new market participants, we remain confident in PayPal's prospects as it has a complete payment platform with extensive market reach after many years of experience in this field.

Valuation

As PayPal's revenue is mainly derived from processing payment transactions, we forecast its revenue growth based on total digital payments volume growth. Due to factors of rising e-commerce adoption, contactless payments at the PoS and internet connectivity and smartphone ownership, our expectations of transaction volume growth of 23% is in line with industry average. Assuming PayPal maintains its share over total transaction volumes, as an integral platform globally, we see its payment volume reaching $2,662 bln in 2025.

Global Transaction Volumes Forecast	2019	2020F	2021F	2022F	2023F	2024F	2025F
Global Digital Payment transaction volume ($bln)	3,859	4,406	5,455	6,753	8,360	10,350	12,813
PayPal share of global volume	18%	21%	21%	21%	21%	21%	21%
PayPal TPV ($bln)	711.9	915.3	1,133	1,403	1,737	2,150	2,662
Yearly Growth Rate	23.1%	28.6%	23.8%	23.8%	23.8%	23.8%	23.8%

Click to enlarge

Source: PayPal, Research and Markets and Statista

Despite the strong growth in the company's payment volumes, it has trouble converting that volume into revenue. As seen below, PayPal's take rate on transactions, which is total revenue divided by total payment volume has been declining since 2012. The reason is because of PayPal's P2P volume growth, which has a lower transaction revenue than its traditional processing fee of 2.9%. In 2019, Venmo had revenues of $450 mln from $102 bln in transaction volumes, representing a take rate of just 0.44%.

Source: PayPal

However, PayPal plans to monetize P2P volumes by launching QR payments and partnering with Synchrony Financial (SYF) to launch Venmo credit cards, this could see an increase in PayPal's take rate. Nevertheless, we believe it will take time to fully monetize its P2P volumes as its competitors might take advantage. We forecast a moderate decline in take rate to project PayPal's revenues.

PayPal Revenue Forecast	2019	2020F	2021F	2022F	2023F	2024F	2025F
Payment Volume ($ bln)	711.92	915.306	1,133	1,403	1,737	2,150	2,662
Transaction Take Rate	2.50%	2.35%	2.22%	2.09%	1.97%	1.86%	1.75%
Total revenue ($ bln)	17.77	21.54	25.14	29.35	34.25	39.98	46.66
Revenue Growth rate	15.02%	21.21%	16.72%	16.72%	16.72%	16.72%	16.72%

Click to enlarge

Source: PayPal, Khaveen Investments

Overall, we see PayPal's revenue growing at an average rate of 16.72% from 2021. Now that we have obtained the revenue growth, we apply a DCF analysis to calculate its intrinsic value.

Source: Khaveen Investments

Based on a DCF analysis, with an EV/EBITDA multiple of 41.43x (digital payments industry average) and a discount rate of 11.7%, our model shows an upside of 10.97% from current market value based on an estimated average revenue growth of 16.72% (before tapering out in 2027).

Verdict

PayPal is an experienced player in digital payments, and the company has made the right moves in expanding its services to support its core value proposition by acquiring emerging payment startups. Its vast ecosystem now encompasses the payments stack with digital wallets, P2P, lending and many more. This represents its strategy to achieve robust user growth which in turn leads to higher user engagement and transaction volume.

As it continues to solidify its position with partnerships across online and in-store commerce, both regionally and in emerging markets, the company is poised to benefit from the growing global digital transaction volumes despite growing competition. While its take rate has been declining, revenues are still expected to grow at an average of 16.72%, not to mention monetization efforts of its fast-growing P2P segment. Overall, we rate PayPal as a Buy with a target price of $217.51.

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in PYPL over 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.