Since hitting $44 last month, Paypal Holdings Inc (NASDAQ:PYPL) stock has been on an unrelenting decline. With Monday’s drop, it has now fallen firmly below the $40 mark.
Some of this is probably due to the same market jitters that impacted the market prior to the election. But PayPal stock has failed to show the same recovery that much of the market has enjoyed over the past week.
An apparent reason for this stems from issues brought up in a long and sharply worded blog post criticizing PayPal stock. The blogger claims that PayPal stock should decline 70% to a price target of just $12.50. Do they have a point, or should we dismiss it as scaremongering?
PayPal’s Reliance on eBay
It’s no secret that PayPal’s prospects are tied to those of its former corporate parent, eBay Inc (NASDAQ:EBAY). But it’s unclear just how much PayPal relies on eBay for business. Management discusses eBay as a relatively minor and shrinking channel, accounting for under 20% of PayPal’s business volume.
That 20% figure, however, probably understates things. PayPal earns higher take rates, generally experiences fewer expenses and losses associated with eBay transactions, and spends relatively less to generate eBay volume than through other channels.
The bearish blogger runs through some figures that suggest PayPal earns between 50% and 65% of its actual Ebitda from the eBay relationship. This is a large basis for the $12.50 PayPal stock price target. If eBay reduced or ceased doing business with PayPal, there could be a large impact. While eBay is contractually tied to keep processing payments for several years through PayPal following the spinoff, things could change in the future.
And sure, that is a risk. But is it a showstopper? I’d say no. PayPal and eBay are so integrated, and PayPal’s role is so pivotal in making eBay’s business possible, that it’d be foolhardy for eBay to rework things. If eBay sees its fortunes fade, that would hurt PayPal by association, but eBay has succeeded for many years now. If Amazon.com, Inc. (NASDAQ:AMZN) were going to destroy eBay, it should have happened already.
Visa Competitor or Copycat?
The bearish blogger begins their piece by suggested that PayPal stock represents a “regret trade.” This is, in their view, the sort of trade where we miss one opportunity so we leap on the next one.
Many people failed to capitalize on the huge rallies in Visa Inc (NYSE:V) and Mastercard Inc (NYSE:MA) since their IPOs. Thus, is it possible that we’re gravitating to PayPal stock to make up for that previous error? The blogger claims that PayPal isn’t a significant payment processor apart from eBay. It relies, they would argue, on eBay’s high-margin business to cover up for the low quality/margin of the company’s other transactions.
If you accept that, PayPal seems rather expensive at double the price-earnings ratio of eBay. The new processing agreements with Visa and Mastercard, however, fundamentally alter PayPal’s corporate trajectory. While success isn’t guaranteed, there’s a real possibility that PayPal can become the leading mobile wallet. The company needed more merchant acceptance to make the leap from relatively niche product to a mainstream alternative to existing payment systems. And it has made a bold effort now to get more merchant access.
PayPal Stock’s Subprime Lending Problems
The bearish blogger continues, comparing PayPal’s credit division to other consumer financing operations that have imploded in recent years. PayPal has grown its credit operations by 25% a year recently, and it aggressively markets to customers of a lower credit quality. In fact, the blogger alleges, nearly half of PayPal Credit’s customers are subprime, which puts them in a far riskier bucket than the big banks. The too-big-to-fail players tend to maintain less than 25% of the credit card exposure to subprime clients.
On the plus side, PayPal has found a way to tap into a large and underserved market. The margins are generally much better on subprime than prime lending, and offers a strong revenue stream in addition to payment processing. With PayPal’s purchase of international money transfer service Xoom, it should be clear that the company is diversifying.
It is true that PayPal lends its own money in a way that Visa and Mastercard don’t. This could cause real and meaningful losses, particularly during a recession. However, with financial service companies come such risks.
If you own PayPal stock, you should hold management in decent regard. They believe consumer lending is a good business, and that they can build a strong ecosystem. Paypal isn’t the next Visa or Mastercard exactly, but what they are building could serve to become a powerful player in its own right.
Bottom Line on PayPal Stock
PayPal’s relationship with eBay is pivotal to the company’s success. Regardless of just how much of the company’s profits derive from eBay, losing that business would be a big blow. So yes, shareholders should pay attention to eBay — if they really do migrate away from PayPal stock over time, that’d be a real risk.
PayPal has an agreement with eBay, however, that protects it for the next few years, and by then, the company’s mobile wallet efforts may well overshadow the legacy business.
As for the company’s consumer lending business, it certainly poses a higher risk than the credit card processing model. But with risk comes the potential for reward, and PayPal earns solid margins. Watch this area for potential losses, but nothing indicates it will cause problems for PayPal stock in the near future.
Most fintech companies live in constant fear of revolutionary change making their products obsolete. PayPal is hardly different. However management is being proactive, making acquisitions and signing a transformative agreement with the credit card processors. Let’s see how those moves work out before condemning the company.
As of this writing, Ian Bezek did not hold a position in any aforementioned securities. You can reach him on Twitter @irbezek.
