PayPal Holdings, Inc.'s (NASDAQ:PYPL) share price has fallen 28.3% since Tuesday (February 1), when Q4 2021 results were released after markets closed.
We upgraded our rating on PayPal to Buy in May 2020. PYPL stock is now 9.5% down since our upgrade, with a 46.2% decline since the end of 2020:
Librarian Capital PayPal Rating History vs. Share Price (Last 1 Year)
Investors were likely unnerved by a change in strategy, moving away from a focus on Net New Actives ("NNAs"), guiding to a much lower NNA in 2022 and restating some recent NNAs as "illegitimate". These cast doubt on PayPal's recent growth. 2022 financial guidance was also reduced.
However, 2025 revenue, EPS, and cash flow targets were reaffirmed, and our analysis shows PayPal's recent growth acceleration is real. We continue to believe PayPal possesses unique advantages that will enable it to benefit from the continuing shift to electronic payments.
PayPal is now trading on 27.3x non-GAAP 2021 EPS (and 35.5x GAAP EPS). Our reduced forecasts indicate a total return of 157% (27.3% annualized) return by 2025 year-end, and we reiterate our Buy rating.
Our investment case consists of the following:
PayPal Example Innovations in 2020
As of its February 2021 investor day, PayPal is targeting a 2020-25 EPS CAGR of 22%, powered by a 15% CAGR in Active Accounts, a 25% CAGR in Total Payment Volume ("TPV"), and continuing EBIT margin expansion. The 2025 Free Cash Flow ("FCF") target is $10bn+, doubling from $5.0bn in 2020 (FCF as defined by management, which excludes stock-based compensation).
We believe the qualitative reasons in our investment case remain valid, unaffected by anything within PayPal's Q4 2021 results.
We believe the biggest disappointment in Q4 2021 results was the change in strategy, moving away from the focus on NNAs.
PayPal is abandoning its target of 750m Active Accounts by 2025, and now expects only 15-20m NNAs in 2022, far lower than in prior years:
PayPal Net New Actives (2018-22E)
The reason behind the change is that PayPal's much higher NNAs since the pandemic have included accounts that end up generating insufficient returns, due to lower engagement and higher retention costs. Management now intends to let these churn and focus on driving up engagement instead. NNAs are expected to revert to the pre-COVID level of 30-40m a year "over time".
Nonetheless, management reiterated other 2025 financial targets:
We continue to believe that our revenue and earnings growth rates as well as our free cash flow objectives are achievable in the outyears of the period contemplated in our medium-term guidance."
- Dan Schulman, PayPal CEO (Q4 2021 earnings call)
PayPal 2025 Outlook (Updated)
However, management's new 2022 outlook has significantly lower growth than its 2020-25 CAGR targets.
PayPal's new 2022 outlook is below its mid-term target but still solid.
The new outlook includes a 19-22% growth in TPV, a 15-17% growth in revenues, an EBIT margin of 23% (vs. 24.8% in 2021), and an EPS growth of flat to 3% (all figures are non-GAAP):
PayPal 2022 Outlook
The final volume losses from eBay's (EBAY) migration to Adyen (OTCPK:ADYEY) as its payment processor (since July 2020), prior-year credit reserve releases, and currency are all expected to be headwinds in 2022.
Adjusted to exclude these, the outlook would represent solid progress if achieved. Excluding eBay, the expected growth rates are 21-24% in TPV and 19-21% in revenues. Excluding the impact of the prior-year reserve release alone (125 bps), the decline in EBIT margin is expected to be 55 bps, likely largely attributable to the loss of higher-margin eBay volumes. And, excluding reserve release and taxes only, EPS growth is expected to be 12-15%.
We do not believe the 2022 outlook justified the share price collapse.
2021 results were mostly in line with the most recent outlook in November:
|Feb 2021 Outlook||Nov 2021 Outlook||Actual Results|
|Net New Actives (Organic)||50m||52m||46m|
|TPV Growth (ex. FX)||High 20s||31-32%||31%|
|Net Revenue Growth (ex. FX)||17%||17%||17%|
|Non-GAAP EBIT Margin||"modest expansion"||"in-line with prior year"||down 30 bps (24.8%)|
|Non-GAAP EPS Growth||17%||19%||19%|
|FCF (Mgmt. Definition)||~$6.0bn||$5.2bn|| |
The one big miss is organic NNAs, which were 46m instead of the 52m guided. In addition to the strategy shift away from new accounts, PayPal also removed 4.5m existing accounts that were "illegitimately created" to take advantage of its incentive campaigns.
In other parts of the outlook, TPV growth was at the low end of the range (but better than the original outlook in February 2021), revenue growth was in line, EBIT margin was slightly worse, while FCF was slightly better.
We do not believe the 2021 results justified the share price collapse.
We analyze PayPal's financials and key metrics to demonstrate it has achieved significant real growth since COVID-19.
PayPal has certainly gained far more NNAs since COVID-19.
NNAs reached 21.3m in Q2 2020, and remained at or around 15m for 3 more quarters, compared to 2019 levels of 9-10m per quarter:
PayPal Net New Accounts by Quarter (Since 2019)
NB. Assume all of the illegitimate accounts added before Q4 2021 were in Q3.
Even if we attribute all of the non-Q4 "illegitimate" accounts to Q3, that quarter's NNAs still exceeded 10m. However, organic NNAs fell to 6.6m in Q4 2021 and the 2022 outlook implies average NNAs of 3.8-5.0m per quarter.
So 2020-21 may have simply pulled forward growth from future years, and it is unclear if NNAs have genuinely accelerated.
PayPal's TPV has clearly accelerated since the pandemic.
In 2020, when eBay volume migration was less significant, each quarter's TPV grew more year-on-year in dollars than the last. In 2021, excluding eBay, year-on-year TPV growth each quarter was at least twice the 2019 level:
PayPal TPV Excluding eBay By Quarter
NB. Ex-eBay volumes not disclosed before Q3 2019.
Excluding eBay, year-on-year TPV growth was $70bn (23% ex-currency) in Q4 2021, lower than Q4 2020's $77bn (39% ex-currency), but still sizeable.
TPV growth is driven by both new accounts and higher TPV per account, and the "vast majority" of TPV comes from about one-third of the accounts, so TPV growth can remain strong even with lower NNAs.
As an example, Q4 2021's 23% ex-currency year-on-year TPV growth was driven by a 13% increase in accounts (at quarter-end).
PayPal revenue growth has clearly accelerated during the pandemic.
Revenues have grown significantly since COVID-19. While Q3 2021 revenues fell 0.9% sequentially, this was due partly to the loss of eBay volumes and partly to seasonality; Q3 revenues only rose 1.7% sequentially in 2019:
PayPal Net Revenues by Quarter (Since 2019)
TPV and revenue growth have been decelerating, as the COVID boost fades. However, even in Q4, revenues excluding eBay grew 22% ex-currency, higher than pre-COVID full-year growth rates (19% in 2019 and 21% in 2016-18):
PayPal Revenue & TPV Growth Y/Y (Since Q4 2020)
Looking at the figures excluding eBay, the gap between revenue growth and TPV growth has been narrowing, from 16 ppt in Q1 and Q2, to 5 ppt by Q4. This reflects how take rates stabilized in Q3 and actually rose in Q4:
PayPal Take Rates (Since Q4 2020)
Of Q4 2021's 17 bps year-on-year decline in Total Take Rate, "roughly half" was related to eBay, and 4-5 bps was related to lower currency fees on cross-border transactions, which are likely cyclical and one-off. Management indicated on the call that they are seeing pressure on take rates lessens.
Higher take rates indicate a healthier kind of TPV growth.
The picture in EBIT growth is more mixed, but shows PayPal's natural operational leverage, and improvement is expected in the future.
PayPal's EBIT, while significantly higher than pre-pandemic, had limited sequential growth due to increased investments.
In Q2 2020, the first full quarter after COVID-19 hit the U.S., EBIT rose 64% sequentially to $1.49bn, with EBIT growth of $58m on revenue growth of $64m. However, by Q4 2021, even with revenues now $1.66bn higher, EBIT was barely higher at $1.51bn, due to higher expenses:
PayPal Revenues, Costs & EBIT By Quarter (Since Q3 2019)
The lack of operational leverage had been due to increases in Non-Transaction Expenses; Transaction Expenses have remained at 80-90 bps of TPV since 2020. PayPal has been making sizeable investments in Technology & Development and Sales & Marketing, including the drive for more NNAs.
PayPal now expects more operational leverage and EBIT margin to expand:
"There is the opportunity for significant increased operating leverage, utilizing our scale and having our OpEx growth move back more towards normalized growth that we had pre-pandemic, which we think will help expand margins as we go forward".
- Dan Schulman, PayPal CEO (Q4 2021 earnings call)
We believe EBIT margin can expand significantly after 2022, when it will be distorted by the last eBay volume losses and credit costs normalizing.
At $126.08, relative to 2021 financials, PayPal stock is trading at a 27.3x P/E on non-GAAP EPS and 2.0% FCF Yield; P/E is 35.5x on GAAP EPS:
PayPal Valuation & Cash Flows (Since 2018)
NB. Net income includes unrealized gains on equity investments (approx. $70m in 2018 and $160m in 2019).
By comparison, current CY21 P/E multiples are 45.2x for Mastercard (MA) and 36.0x for Visa (V) - both significantly higher than PayPal's, and we believe both Mastercard and Visa are significantly undervalued at present.
PayPal does not pay a dividend.
We consolidate our forecasts into a single scenario. Our assumptions (and how they compare with our old Upside Case) are:
Our forecasts imply a 2020-25 EPS CAGR of 16%, much lower than PayPal's 22% target. Our new 2024 EPS forecast is 20% lower than before ($8.35):
Illustrative PayPal Returns
With shares at $126.08, we expect an exit price of $323 and a total return of 157% (27.3% annualized) by 2025 year-end. The exit price is only slightly higher than PayPal's share price peak of about $310 in July 2021.
We reiterate our Buy rating on PayPal.
This article was written by
Disclosure: I/we have a beneficial long position in the shares of PYPL, MA, V either through stock ownership, options, or other derivatives. 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.