Back in early June, eBay (EBAY) spun off the PayPal (PYPL) business. Since then, the results have been mixed.
Keep in mind that the return on PayPal stock is about -1% since the transaction.
It certainly did not help that the company posted a lukewarm earnings report. In the latest quarter, PYPL saw its revenues increase by 15% to $2.26 billion and profits come to 31 cents per share. Yet the Street was looking for revenues of $2.27 billion.
PayPal did beat on the earnings by two cents.
OK then, perhaps there is an opportunity here with PayPal stock? Maybe it’s a good value at these levels — especially in light of the potential growth?
Well, to see, here’s a look at the pros and cons:
PayPal Stock Pros
Payments Powerhouse: There continues to be strong momentum in the core payments business. In Q3, volume jumped by 27% to $70 billion. Consider that there has been mid-to-high 20% growth in all quarters for 2015. And in the latest quarter, the company signed up over 4 million new members, for a total of 173 million. PYPL has a robust platform that can efficiently handle massive scale. For example, there are sophisticated algorithms to deal with risks, and there are even 8,000 customer reps who provide value-added services. Oh — and PayPal is a high-margin business. For the current year, the company projects free cash flows of $1.6 billion to $1.8 billion.
Focus: The spin-off of PayPal stock from eBay was the result of the activist pressure from billionaire investor Carl Icahn. His belief was that an independent PayPal would be more nimble, allowing for more success with the enormous opportunity of the payments industry. But PayPal has already been making bold moves, especially with acquisitions. To this end, the company recently purchased Xoom, which operates an online international money transfer service. Keep in mind that the market is about $600 billion per year. Then they acquired Modest, which helps merchants develop mobile apps. All in all, it seems like a good bet that PayPal will remain aggressive with dealmaking — after all, the company has a hefty market cap of $44 billion and $6.7 billion in the bank.
Mobile Megatrend: According to research from eMarketer, the value of mobile payment transactions for 2016 are expected to surge by 210% in the U.S. to $27.05 billion — and the good news is that PayPal is nicely positioned to benefit. For example, the company has a new technology, called One Touch, that allows for quick checkouts. Then there is Venmo, which is a mobile payment app that is focused primarily on the millennials. In Q3, transaction volume came to $2.1 billion, up from $700 million in the same period a year ago, and the app is likely in the top 10 for dollar volume in the U.S. PayPal has essentially transformed all its business towards mobile, and as a result, the transaction activity has been particularly strong. In the latest quarter, the volume jumped by 38% to 345 million transactions.
PayPal Stock Cons
Competition: It’s brutally intense. PayPal must fight against mega operators like Alphabet (GOOG, GOOGL), Amazon.com (AMZN), Microsoft (MSFT) and Apple (AAPL). But there are also the various financial institutions like MasterCard (MA) and American Express (AXP) that are ramping up their efforts. Hey, there are even some unexpected players, such as Starbucks (SBUX), which has been seeing tremendous success with its own payments app. What’s more, with huge amounts of venture capital sloshing around in Silicon Valley, there is also pressure from startups like Stripe. In fact, one of them — Square — is planning to come public within the next few weeks.
Take Rate: This the amount PayPal gets for a transaction. The problem? Well, the take rate has been showing weakness lately. In Q3, it came to 3.24%, down from 3.39% in the same period a year ago. Granted, part of the reason could be that the company is having more success attracting merchants, which often means providing lower fee structures because of the heavy volumes. There may also be issues with the lack of monetization with Venmo (which should change soon!) But given the intense competition, it would be reasonable to assume that this is taking a toll on the take rate. If so, this could make it tougher for PayPal to keep up its growth rate.
Ebay Relationship: As part of the spin-off, eBay has agreed to provide at least 80% of its gross merchandise sales to PayPal for the next five years. Yet the contract still allows eBay to look at alternative providers, although there would be a penalty fee. Now it seems unlikely that there will be some type of termination. After all, eBay and PayPal have had a strong relationship for about 20 years. But then again, in today’s dynamic tech industry, there is always the possibility of abrupt changes, especially if eBay ultimately gets bought by another player that has its own payments platform.
Bottom Line on PayPal Stock
Back in 2002, eBay shelled out about $1.5 billion for PayPal. Yes, it turned out to be a stellar deal. Actually, PayPal is now worth more than eBay!
It’s true that PayPal faces some tough challenges, especially with the many tough competitors. There are also the issues with the take rate.
But then again, the company has a global brand that is trusted and a strong infrastructure. PayPal also has continued to innovate with its mobile initiatives, such as seen with the huge success of Venmo.
And again, the forecasts for mobile payments remain robust – and PayPal should get a nice chunk of the opportunity.
OK, so should you buy PayPal stock?
Yes — in light of the company’s advantages and the growth potential of the mobile payments market, the stock definitely looks attractive right now.
Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.
