PayPal Holdings Inc (NASDAQ:PYPL) is on the move. PayPal stock has reached $40 per share Tuesday thanks to Evercore initiating coverage with a buy rating. This move brings PayPal stock to within striking distance of a new all-time high.
This momentum comes just ahead of PayPal’s earnings; they’re set to release those Thursday afternoon. Last earnings season, the company reported strong numbers.
However, the stock slumped following the release as analysts questioned the company’s new deal with Visa Inc (NYSE:V). Will earnings be more favorable for PYPL this time around, or should investors hold off for the time being?
PayPal Stock Pros
Recent Visa/Mastercard Deals: PayPal’s recent deals with Visa And MasterCard Inc (NYSE:MA) transform the company. PayPal previously operated almost entirely online, using the ACH clearing method. ACH allows customers to permit merchants to debit their account directly.
Unlike with credit cards, there are far fewer consumer protections on ACH transactions, making chargebacks less common.
There’s a lot to like about ACH from PayPal’s standpoint. It offers the company high fees and is useful in many transactions that banks or credit card companies don’t want to take credit risk on. However, to become a true mobile wallet, PayPal needed access to many more merchants; it had only one-third as many merchants on board as the major credit card companies prior to the recent deals.
Now, with Visa and MasterCard as partners, rather than opponents, the firms can join forces. A PayPal user can use Visa and MasterCard’s clearing networks for contactless payments that automatically debit out of their PayPal accounts. Now, with access to most global merchants, PayPal’s digital wallet can achieve scale.
Xoom Purchase: Late last year, PYPL acquired the Xoom corporation. It is a leading money transfer service, allowing Americans to send money to more than four dozen countries. Xoom facilitates more than $7 billion annually in money transfers.
It also has other ancillary services that add value to PayPal’s network. Xoom users in many countries can use the service to pay bills. This allows a family member abroad to send money to a Xoom user in a developing country, and then that user can pay their utility bills or whatnot directly out of their account. With large portions of many leading emerging-market societies still not having access to a traditional banking system, Xoom can do a lot in this area. As someone living in Mexico, I can see the great upside that comes from owning such a strong asset; the market for non-bank financial services is vast.
Decent Valuation: Unlike many high-flying tech companies, PayPal stock isn’t trading at an egregious valuation. At 37x earnings, it isn’t cheap, but for a company growing revenues at 20% per year, you could do a lot worse.
If analysts are correct and earnings really surge in 2017, things look even better. PYPL earned $1.40 per share over the past 12 months, and analysts forecast it to earn $1.73 per share next year. If it can hit that mark, the P/E ratio would drop to just 23. That’s a nice figure for a company growing this quickly.
PayPal Stock Cons
Limited Physical Presence: PYPL stock has long struggled with getting access to physical merchants. To make PayPal a universal payment service, the company needed much more access to offline retailers. While the world is rapidly going digital, the vast majority of retail sales still occur physically.
It has managed to find some meaningful brick and mortar partners over the years. Home Depot Inc (NYSE:HD), for example, started allowing in-store PayPal payments several years ago.
It also reached agreements with smaller payment networks, such as Discover Financial Services (NYSE:DFS). But none of these ever reached critical mass. This prevented PayPal from achieving the ubiquity it hoped to achieve. That leads to the next PYPL stock con.
Lower Margins: Due to the issue with physical presence, PayPal decided to make a big move recently. It signed agreements with both Visa and MasterCard to use their in-store payment facilities, as described above. This gives PayPal a far greater presence and allows it to become a true all-purpose digital wallet.
However that scale comes at great cost. PayPal will earn far lower margins on each credit transaction than it earned through ACH. The exact damage to margins remains to be seen. PayPal stock sold off sharply on the announcement, and several analysts downgraded the firm and cut price targets. PayPal gains access through its new arrangements, but it will probably lose a lot of high-margin ACH business to get that access.
Competitive Threats: Financial technology is a competitive arena, and PayPal finds itself in an especially heated category. Apple Inc. (NASDAQ:AAPL) is making a big push this year to roll out Apple Pay far more widely. With Apple Pay now available on traditional browsers, it too can pick up much broader usage outside the direct Apple ecosystem.
Other competitors to PYPL stock, such as Apple and Alphabet Inc (NASDAQ:GOOGL, NASDAQ:GOOG) may be able to take a longer view, but PayPal needs to make profits in the short-run with its mobile wallet, since financial payments are the PayPal business. Apple and Google, don’t rely on FinTech to pay their bills, and as such, can compete aggressively on pricing should they wish.
And PayPal also faces various risks due to the potential f0r security breaches, regulatory changes, and rises in alternative payment technologies such as Bitcoin.
Verdict
PayPal stock has performed fairly well since the IPO. With earnings coming up, it could even hit new all-time highs this month. And the deals with Visa and MasterCard offer it the possibility of grabbing the leading position in the mobile wallet race.
And unlike many rising tech firm, PYPL stock is selling at a decent valuation today.
However we’ll have to see how margins hold up as the Visa and MasterCard deals start impacting PayPal’s financial results. Until then, the stock is unlikely to surge. Analysts likely will remain cautious for few quarters.
At the time of this writing, Ian Bezek had no positions in any of the mentioned stocks. You can reach him on Twitter at @irbezek.
