“The simple fact is that Square is much less profitable than PYPL. For example, Square’s adjusted EBITDA margin is 10.6% and its FCF margin is 1.6%. But PayPal’s last 12 months’ EBITDA margin is 51% and its FCF margin is 21.7% over the same period. So PYPL’s profitability far exceeds that of Square,” Hake wrote.
Although he might be right based on a valuation basis, it’s helpful if investors make a fair comparison of the two companies’ stocks before rendering a final version.
Yes, it’s hard to argue with numbers. Unless, of course, you study PayPal’s financials at the same point in its evolution. Let me explain.
The Long View on Square Stock
Square got its start in February 2009. This February, it will be 11 years old. Barely a child. The PayPal product, the driver of its growth, has existed since October 1999, or a little more than 20 years. It’s slightly older and more mature, hence the profitability.
So, if we take the current financials of the 11-year-old Square and compare them with the financials of PayPal at the 11-year mark of its 20-year history, around 2010, what do we find?
Well, that’s going to take a little sleuthing. That’s because PayPal was acquired by eBay (NASDAQ:EBAY) for $1.5 billion in August 2002, shortly after it went public. So, I’ve turned to eBay’s 2010 10-K for answers.
Back then, eBay had two operating segments: Marketplaces and Payments. Marketplaces is the company’s current business. Payments was the PayPal business, which was spun-off in July 2015 with each eBay shareholder getting one share of PayPal for every share held in the parent.
Of course, we know in hindsight that PayPal has easily outperformed its former parent in the four years since.
A Deeper Dive on Square Stock
I dig a little deeper and find that in 2010, its payments segment had revenue of $3.4 billion and a direct contribution of $721.6 million. That’s a more flattering version of operating income.
It doesn’t, however, breakout actual margins, etc. It does say its payments business saw revenues increase 23% in 2010 with net total payment volume (TPV) rising by 28% year over year to $92.0 billion.
A Trefis article from January 2011 highlights the fact PayPal’s Bill Me Later (BML) service was directly responsible for improving eBay’s margins in Q4 2010. Specifically, its risk-adjusted margin on credit extended by BML increased 292 basis points to 14.43% in the fourth quarter from 11.51% in Q3 2010.
However, other than improvements in the amount of money it made on BML’s credit products, eBay did little to shine a light on PayPal’s margins.
What we can tell is that Square’s gross payment volume (GPV) in 2018 was $84.7 billion, only a few billion less than PayPal at the same point in their development.
Considering how many other competitors have entered the payments processing arena since then, if you own SQ stock, you ought to feel pretty good about the job Jack Dorsey’s done growing its business in the light of this competition.
PayPal had the arena virtually to itself, and it was growing TMV by 26% year over year. In 2018, Square grew its GPV by 30% year over year, 400 basis points higher than PayPal at the same point in its development.
The Bottom Line on Square Stock
First, let me say that I like PayPal and Square. I’ve recommended both in 2019.
Secondly, although eBay didn’t break out margins for PayPal in 2010, it was making money when eBay acquired it in 2002, with gross margins around 45% or slightly more than half eBay’s. Nine years later, they’re almost identical.
In 2012, the oldest data available, Square, had a gross profit of 32%. In Q3 2019, it was 39%, 700 basis points higher. In another three years, it ought to be very close to PayPal’s and making plenty of money on both a Non-GAAP and GAAP basis.
Is PayPal the more profitable stock? Yes.
Is PayPal cheaper stock by valuation? On paper, yes.
Is PayPal the better stock? In an apple to apple comparison. It’s debatable.
At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.