PayPal (NASDAQ:PYPL) is a data-driven company that operates a two-sided network that connects merchants and consumers with 429 million active accounts across more than 200 markets. In particular, the Company offers to merchants an end-to-end payments solution along with other services to manage their business; and to consumers financial services along with shopping tools.
But how does the Company make money? Well, it earns revenues in many different ways, that we can decompose as follows:
- (Merchant & Consumers) - The Company generates revenues from merchants by charging fees for completing payment transactions for customers and other payment-related services that are typically based on the volume of activity processed on the Company’s payment platform (the main source of revenue).
- (Merchant) - It earns revenues from interest and fees earned on the Company’s merchant loans receivables
- (Consumer) – It earns also by charging fees for foreign currency conversion, instant transfers from customers’ PayPal or Venmo accounts to their debit card or bank account, purchase and sale of cryptocurrencies, and credit product programs.
- (Merchant & Consumers) - Finally, the Company also generates revenue through partnerships, referral fees, subscription fees, gateway services, and other services that the Company provides to merchants and consumers.
Total Addressable Market (TAM)
PayPal's TAM is not well defined, and many people tend to have their own version of what they believe to be the Company's total addressable market. Most frequently PayPal's TAM is narrowed to eCommerce, however, there are also other addressable markets that payment platforms such as PayPal can serve. In particular, I believe that the current Company's TAM is close to ~$4T in addressable volumes and it will more than double by 2030. Below, you can see the markets of reference I included within my estimates.
Moreover, it is worth noting that my TAM estimates may be conservative since other markets can be included as addressable (e.g., in-store payments).
To understand how well or bad the Company is doing, we should focus on 4 key metrics:
1 - No. of Active Accounts (NNAs): which states the number of accounts that have completed a transaction on the platform within the past 12 months.
2 - No. of Payment Transactions: which is the total number of successfully completed payments on the platform, net of payment reversals.
3 - Total Payment Volume (TPV): which is the total value of successfully completed payments on the platform, net of payment reversals.
4 - Average Revenue per User - Transaction (ARPU-T): which is the transaction revenues divided by NNAs.
Let's now break down revenue by geographical regions to better understand the company's top-line dynamics.
In 2021, as you can see from the first graph, the U.S. was the biggest contributor to the Company's top line (54%), followed by Other Countries (34%) and the U.K. (9%) with a CAGR over the last 3 years respectively of 4.41%, 3.53%, and 1.63%.
In particular, since Q1'19 we can note a growing revenue concentration toward the domestic market with the U.S. increasing from 53.0% to 56.6% of total revenue in Q1'22. A clear decline can be noticed in the U.K. where the percentage changed from 10.5% to 8.1%, while for the other Countries we can observe a flat to declining dynamics with the percentage changing from 36.5% to 35.3% in Q1'22.
Discounted Cash Flow Model
Let's now understand how much the company is worth according to the assumptions I have made and which you can see represented below.
For the top line, I assume a CAGR of 11.2% over the next 10 years and a growth rate in perpetuity that is equal to the current 10-Y treasury rate of 2.89%. Going forward, I also assume an operating margin for the next year equal to 16.4% (vs 2021'EBIT margin of 17%) and a target operating margin of 25.8%.
The unlevered Free Cash Flow is discounted at a WACC of 8.83%, those computations you can see below.
In particular, the levered beta has been computed using a bottom-up approach, the company's ERP using an implied method approach, and the cost of debt using the synthetic approach. Finally, by putting all of it together, we get the implied value per share, represented below.
As you can see from the above estimates, the implied value per share is equal to $91.64, which means that the company is currently trading at a discount of 4.0% (based on my assumption, you can see that I assume a terminal EV/EBITDA multiple of 9.11x). To better gauge market beliefs, I provide along with the implied value per share, the sensitivity analysis on two key variables: terminal growth rate and WACC.
The implied value per share of $91.64 is based on my "base case" scenario or based on those assumptions that I believe to be more reasonable. However, it is also worth considering the other two scenarios:
- Bull Case Scenario ($122.43 Target Price - 28.2% discount): Under the bull case scenario I assume a revenue CAGR of 12.90% (vs 11.2% base case) over the next 10 years and a target operating margin of 28.9% (vs 25.8% base case). Under this scenario, I am assuming a successful unfolding of the new strategy and a steady NNAs' growth along with other tailwinds (e.g. Venmo - Amazon (AMZN) partnership).
- Bear Case Scenario ($71.32 Target Price - 23.3% premium): Under the bear case scenario I assume a revenue CAGR of 10.11% (vs 11.2% base case) over the next 10 years and a target operating margin of 23.2% (vs 25.8% base case). Under this scenario, I am assuming different long and near-term headwinds (e.g., further weakness in eCommerce activity, elevated user churn, weaker macro-environments).
Risks to my target price include:
- Missing NNAs Estimates: Past misses resulted in severe stock declines, especially if the misses were perceived to be related to tougher competition.
- Competition: The Company faces competition from a wide range of businesses and from all forms of physical and electronic payments that may negatively affect its future performance.
- Strategy: The Company announced the decision to switch its focus from growing its NNAs to growing its ARPU. I believe that it has been a wise decision given the great amount of data PayPal has at its disposal and thus I factor it within my forecast analysis as one of the key drivers. If the company will be unable to grow its ARPU, it will negatively impact my forecast analysis and thus the provided price target.
- Macroeconomic Environment: Inflationary pressure on low-income consumers, weaker e-commerce activity, and other factors may adversely affect the company's operating performance.
I rate shares as BUY with a fair value of $95.13/share (an average value across my 3 scenarios) which implies an 8% discount vs the current price of $87.93. I believe that the company will be able to successfully navigate the near-term headwinds it is facing and prove to investors that the strategic shift, from quantity to quality, will be key to the company's long-term success (especially if we account for the big amount of data the company collects from its customers that will allow it to deliver tailored products and services).
All of that said, I am expecting a further technical correction that I am willing to use as my entry opportunity through a sale of cash-secured puts.