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REPORT SUMMARY

Good Morning Investor! For those of you that haven’t been around long enough to have seen our last “superferformers” research report, today we’re highlighting another business which we believe is a fantastic investment opportunity trading below what it’s worth. At the time of writing, one of our previous selections, Hims & Hers Health ($HIMS) is up over 43% since we first called it out back in March.

REPORT CHAPTERS

• Debut & Performance

• Business Model & Overview

• Financial Analysis

• Opportunities

• Risks & Competition

• Valuation & Investment Outlook

DEBUT & PERFORMANCE

Public Debut: On July 20, 2015, fintech payments firm PayPal (Ticker: PYPL) made its grand entrance on the Nasdaq, having bid adieu to its parent company eBay ($EBAY) in a highly anticipated spinoff.

• PayPal started trading at a $52 billion valuation. Its share price shot up 11% on day one, from a modest $34.69 to a dazzling $42.55. Clearly, Wall Street was more excited than a kid in a candy store.

• Fast forward to today, and PayPal's valuation has soared past $70 billion. That’s a 93% return over nine years. Not too shabby for a company that started by helping you settle eBay auctions without a fistfight.

But wait, there’s more! At its peak in July 2021, PayPal’s stock price hit an astronomical $308 per share. That’s a jaw-dropping 789% return in just six years. If only all investments could defy gravity like that.

BUSINESS MODEL & OVERVIEW

Level of the Onion: PayPal is what would be referred to as an “Acquirer”, which enables merchants to accept electronic payments. They can be financial institutions or independent payment processors. Both PayPal and Block ($SQ) fall into this category.

PayPal: PayPal’s business model might be straightforward, but it's a money-making machine. Offering a suite of payment solutions, PayPal lets customers make purchases using their PayPal balance or PayPal Credit. Plus, with Braintree and Venmo in its arsenal, it's covering all its bases.

• PayPal's revenue streams are as diverse as they are lucrative. These include a 1.75% fee for instant transfers, currency conversion fees, merchant payment processing fees, and even PayPal business loans. It’s like PayPal found a way to turn every financial transaction into a goldmine.

• Recently, PayPal announced its foray into the advertising world, taking a leaf out of Uber’s playbook. This new platform will leverage customer spending habits to help advertisers drive sales, charging only when a shopper actually makes a purchase. Talk about a smart move!

A Serious Buyer: PayPal’s been on a buying spree, snapping up some pretty impressive companies. These acquisitions have transformed PayPal into a fintech powerhouse, each one adding a new layer of strength to its already formidable arsenal.

• 2013: Braintree (mobile payment service) $800 million.

• 2013: Venmo (peer-to-peer payment) $26 million.

• 2015: Xoom (electronic funds transfer service) $890 million.

• 2018: iZettle (payment, point of sales) $2.2 billion.

• 2019: Honey (cashback, online coupons) $4 billion.

• 2021: Paidy (Japanese deferred online payments) $2.7 billion.

Braintree: PayPal’s Braintree business is what would be classified as a “gateway” are essential components in online and in-person financial transactions, acting as intermediaries between merchants and customers. They facilitate the secure transfer of payment information from the customer to the merchant and then from the merchant to the payment processor.

Wizard Moves: Braintree offers a suite of payment processing services designed to make online transactions as smooth as a magician's sleight of hand. Braintree is essentially the digital backbone for businesses looking to handle online and mobile payments with finesse. It provides a robust platform that enables companies to accept, process, and split payments across various channels, including web, mobile apps, and in-store experiences.

• Braintree enables businesses to accept payments in over 130 currencies and offers support for various local payment methods. This global approach helps merchants expand their reach without the hassle of dealing with multiple payment processors, currency exchanges, or international regulations.

• Additionally, the platform offers advanced fraud detection and mitigation tools.

• Braintree also offers subscription management services which includes everything from setting up recurring payments to managing billing cycles and customer subscriptions.

• Braintree’s largest competitors include fintech unicorn Stripe and Dutch payments darling Adyen ($ADYEY).

Money Maker: Braintree makes money in the form of transaction fees, typically a percentage of the transaction amount plus a small fixed fee. In the US, the fee structure might be something like 2.9% + $0.30 per transaction.

Venmo: Venmo isn’t just a mobile payment service; it’s a social experience. Users can send and receive money instantly while sharing their transactions (minus the amounts) on a social feed. It’s like combining financial management with social media, making even bill splitting a fun activity. British fintech firm Monzo have attempted to recreate this functionality.

• Venmo makes money through instant transfer fees (1.75% per transfer with a minimum fee of $0.25 and a maximum fee of $25), merchant transaction fees (around 2.9% + $0.30 per transaction), and interchange fees from Venmo card swipes. Plus, its venture into cryptocurrency transactions adds yet another revenue stream.

In a Nutshell: From transaction fees to merchant partnerships, interchange fees, and innovative financial products, PayPal and its subsidiary Venmo have diversified revenue streams that keep the money flowing. Whether it’s online payments, social transactions, or even crypto trading, PayPal’s ecosystem is not just profitable—it’s practically unstoppable.

IN PARTNERSHIP WITH BEEHIIV

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• Monetization via the beehiiv Ad Network and premium subscriptions (i.e. beehiiv helps you get paid)

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FINANCIAL ANALYSIS

Loan Sharks Can Take a Nap: PayPal’s current financial setup is like a well-balanced seesaw. The fintech titan is lounging comfortably with about $9.6 billion in long-term debt. But wait, it also has a matching $9.6 billion in cash and cash equivalents on its balance sheet.

• On top of this, PayPal is expected to rake in roughly $5.6 billion in free cash flow for both fiscal 2024 and 2025. This isn’t just pocket change—it means PayPal can effortlessly handle its debt and still have plenty left over for new ventures (more on those later). With a free cash flow margin of 16.40%, PayPal is practically printing money.

Growth as Consistent as a British Rainfall: Even though PayPal’s trading valuation might be lower than expected, it’s still pouring down growth like a classic British drizzle. For fiscal 2022 and 2023, PayPal managed to increase sales by more than 8% each year. That’s no small feat, especially compared to the sluggish pace seen by some less sprightly competitors in the financial services sector (cough Fiserv ($FI)).

• Looking ahead, PayPal is expected to boost its net income by a robust 14.49% in 2025, with a further 6% uptick the following year. And let’s be real, if PayPal keeps steering the ship right, it might just blow these expectations out of the water.

OPPORTUNITIES

PayPal’s Bold Move: PayPal is in a unique pickle: it's trading at a valuation that screams "value destruction" despite the company steadily growing sales and profits. With over $10 billion in free cash flow expected over the next 24 months and a hefty $9.6 billion in cash and equivalents, PayPal is sitting pretty.

• Given this unique set of circumstances, I believe the best return management could generate for its shareholders, would be to buy back its own shares hand over fist.

• So, what’s a fintech giant to do? Buy back its own shares, of course! Management seems to be on board with this strategy, having announced a plan in February 2024 to spend up to $5 billion on stock buybacks this year. That’s a jaw-dropping 8% of the current shares outstanding. It’s like PayPal is planning the ultimate shopping spree—for itself.

Follow the Crowd: If PayPal nails its new advertising business, it could morph into a fast-growing, high-margin machine, sparking fresh growth for the company. With over $400 billion in quarterly payment volume and 427 million users, PayPal’s got data gold.

• For a bit of context, Uber’s ad platform hit a $1 billion revenue run rate in 2024. If PayPal can leverage its vast transaction data to deliver personalized ads based on user spending habits, it could connect merchants with the right customers and boost sales in no time.

• PayPal's Advanced Offers platform, already launched, uses AI to analyze transaction data and provide personalized deals, showcasing the potential value for merchants.

RISK & COMPETITION

Fintech Frenemies: PayPal's biggest headache right now? Moat degradation. Yes, the mighty fintech fortress is under siege from a horde of competitors in the payments processing arena. It's a classic tale of incumbents and upstarts jostling for a piece of the pie.

• For years, Braintree has been the scrappy underdog, running at a loss to outprice competitors like Adyen, Stripe, Worldpay, and Square. But the new sheriff in town, CEO Alex Chriss (formerly of tech firm Intuit), has called time on this cutthroat strategy. It's no more Mr. Nice Guy as Braintree stops playing the price-cutting game.

• Venmo, PayPal’s darling, is in the fight of its life. Block’s CashApp, US bank-backed Zelle, and the ever-convenient Apple Pay and Google Pay are all vying for the top spot in North America. It’s a crowded battlefield where only the strongest (or the most innovative) will survive.

• Across the pond, the competition ramps up to fever pitch. Venmo’s European counterparts—Monzo, Starling, Revolut, Wise (formerly TransferWise), and a host of other fintech unicorns—are popping up left, right, and center. It's like a game of Whack-a-Mole, but with digital wallets.

Constantly at War: PayPal’s traditional merchant and consumer business is like a knight constantly fending off dragons. Square is snapping at its heels in the POS systems market, while Amazon Pay and Shopify Pay are heavyweights in the e-commerce payments ring. Add to that the tech titans Apple Pay, Samsung Pay, and Google Pay, and it’s clear PayPal is surrounded. Then there’s the rise of buy-now, pay-later services like Klarna, Affirm, and Clearpay, which are revolutionizing consumer spending habits and tightening the competitive screws on PayPal. It's a brave new world of deferred payments and increased competition.

VALUATION & INVESTMENT OUTLOOK

Cheap as Chips: PayPal is currently trading at its lowest valuation since it made its public markets debut in 2015. As of now, the stock is sporting a price-to-earnings (PE) ratio of 15.45 based on 2024 projections and an 18 times multiple for fiscal 2025’s future earnings. It’s like finding designer clothes at a thrift store price!

• The real magic metric here is the free cash flow (FCF) yield, especially when you kick out the stock-based compensation from the FCF.

• Drumroll, please: PayPal is trading at a FCF yield of 3.73% based on 2023’s financials, but without stock-based comp, that figure jumps to an impressive 5.77%.

• Looking forward, PayPal trades at a 5.67% FCF yield with stock-based compensation factored in. But hold onto your hats—without stock-based comp, this number skyrockets to a staggering 7.71%.

• For context, the company’s five-year average FCF yield has been 4.68%, back when sales growth was running at double today’s pace.

Valuation Model: Now let’s quickly discuss our valuation model, our assumptions and what we believe would be considered fair value for the company given its current circumstances.

Price Target: Now, let’s peer into our valuation crystal ball. With our assumptions and a sprinkle of financial wizardry, we believe that a fair value for PayPal shares right now is around $100 per share. This represents a potential upside of approximately 48.58%, assuming the stock doesn’t skyrocket past fair value once it catches some momentum and positive vibes.

Cautious Optimism: Even with a more cautious approach, the numbers still look promising. Our discounted cash flow analysis, using conservative estimates, points to a potential upside of close to 15% based on the current share price of $16.30 per share. Here’s the breakdown:

• A perpetual sales growth rate of 8% per annum, maintaining the current EBITDA and FCF margins, along with a discount rate of 8%.

• These conservative assumptions give us a price target of $77.18 per share, offering a tidy 14.68% upside. Not too shabby, right?

OUR PICKS

Our selections performance👾

On Monday the 11th of March, we released our “two superperformers” stock picks which we believe will provide significant outperformance compared to the S&P 500. Then on the 10th of June we released our next stock selection.

Here’s how the two stocks have performed since then:

• Evolution AB: 1,130.00 SEK (📉-13.90%)

• Hims & Hers Health: $20.79 (📈+43.68%)

• PayPal: $67.30 (📈+0.00%)

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