It’s easy to think of PayPal (PYPL, Financial) as a dinosaur. After all, the company has been around almost as long as Alphabet's (GOOG, Financial)(GOOGL, Financial) Google, and despite being the first fintech business that went global, it is rarely talked about in the same breath. The company’s illustrious founding team went on to do bigger and better things, going on to found companies such as Tesla (TSLA), LinkedIn (LNKD, Financial), Palantir (PLTR, Financial) and more and occupying top positions in venture capital. In all of this, it’s easy to miss the great investment opportunity the company presents now.
The company was founded in 1998 as one of the first payment processors, before going public and getting acquired soon after for $1.5 billion by eBay (EBAY, Financial) in 2002. For the next 13 years, it operated as a subsidiary inside the company, using that time to diversify its product offerings, expand to other merchants and establish the competitive advantages that make it such a compelling investment opportunity today.
To further unlock value from this burgeoning subsidiary, eBay spun out PayPal as an independent company in 2015 at a $47 billion valuation. Since its 2015 IPO, the company has been a serial acquirer of businesses under seasoned executive and CEO Dan Schulman, allowing PayPal to quickly outgrow its parent company. Most prominently, it acquired payment processor Braintree in 2013 (acquiring popular consumer payments service Venmo as a result), money transfer upstart Xoom in 2015, rising payment processor competitor iZettle in 2018 and online coupon specialist Honey in 2020. Most recently, the company acquired BNPL player Paidy in Japan, expanding the company’s distribution and relevance in the third largest e-commerce market in the world.
The company also has a highly active venture arm, investing in top fintech companies across the board, including successes such as Divvy (an expense management company acquired by Bill.com for $2.5 billion) and Acorns (micro-investing and robo-investing), which is expected to IPO at $2.2 billion.
Investors have noticed, and have rewarded management’s M&A playbook as the stock has skyrocketed over 5.5 times to a $215 billion market capitalization. Management plans to continue its M&A strategy over the next five to 10 years, with the dual goals of consolidating the maturing payment processing space while also gaining exposure to new growth categories, such as bill payments, BNPL and in-store retail.
PayPal’s first-mover advantage in the huge and growing market for digital payments has only been further accelerated by the pandemic. The platform is the most accepted digital wallet in the world, with more than 75% of the top 1,500 largest global merchants utilizing PayPal at checkout, including giants such as Walmart (WMT, Financial) and Booking Holdings (BKNG, Financial).
Despite the stock’s meteoric rise since its spinout from eBay in 2015, it’s not too late to get in on this fintech leader, in my view, thanks to management’s proven growth strategy and the massive opportunity remaining in digital payments. In fact, now that the company has lost more than a third of its market value as fintech stocks have tumbled, it now presents an opportunity to get in at an attractive valuation.
What makes PayPal different
As with all great internet businesses, PayPal enjoys strong, sustainable and scalable network effects. The platform also benefits by having information from both sides of the transaction, giving PayPal a meaningful data moat over upstarts and competitors. The company continuously leverages this data to increase conversion rates, average order value and net promoter scores for merchants on its platform. Data and network effects have combined to enable PayPal to ramp up to 416 million active accounts, including 33 million merchant accounts as of Q3 2021, growing 15% year-over-year.
The inherent scalability in the business provides management with solid margin expansion opportunities over time. With this kind of scale, additional transactions only have incremental costs, allowing the company’s margins to continue expanding as it grows.
Recent performance and new initiatives
The company grew its revenue 13% in Q3 2021, most importantly growing its ex-eBay revenue by 25%. The company has gradually been reducing its dependence on its erstwhile parent company from 13% of revenue in Q3 2020, to less than 4% of revenue in the latest results. Full-year 2021 guidance is now estimated at 39% total payment value (TPV) growth and 28% revenue growth, both excluding eBay.
PayPal also increased stickiness among its existing user accounts, growing transactions per active account to 44.2, a 10% increase, and growing overall transactions by over 22%.
Most importantly, PayPal announced it will be teaming up with Amazon (AMZN, Financial), which accounts for more than 41% of the U.S. e-commerce market, estimated to be $538 billion in 2020, to enable customers to pay with Venmo at checkout. Starting in 2022, customers will be able to make purchases on Amazon.com and the Amazon mobile shopping app using their Venmo accounts. Given Venmo has roughly 80 million customers in the U.S., this partnership with Amazon could be a massive revenue driver for the overall business.
Merchants are not being ignored. The platform’s QR code adoption continues to grow (with 1.3 million sellers as of Q2 2021), and Square (from Block (SQ, Financial)) competitor and digital point of sale solution Zettle launched at small businesses across the U.S. According to the company, small businesses expect 43% of their business to be online post-pandemic, versus just 6% pre-pandemic.
The company has also made moves into financial super app territory, by rolling out a digital wallet globally that has seen several early wins, including deal discoverability up by 25 times, cash card enrollments up by 35% and crypto investments up by 15% on the platform. PayPal has made inroads into the growing BNPL segment as well, estimated to be a $680 billion opportunity by 2025, with offerings now available in Australia, France, Germany, Japan (through the Paidy acquisition), the U.K. and the U.S., with Spain and Italy expected to be onboarded in Q4 2021.
A bright future
So how much room does PayPal still have to grow? According to management, the company’s immediate TPV opportunity should reach $2.8 trillion by 2025. In the last 12 months alone, the company’s annual TPV exceeded $1 trillion for the first time, reaching close to $1.2 trillion, growing roughly 30% year over year. Assuming a more conservative compound annual growth rate (CAGR) of 25%, the company could easily reach its target by 2025. If it maintains its current growth rate, its TPV will exceed targets by over half a trillion.
Online payments is only the beginning, however. Beyond the next few years, management expects its bets and acquisitions in other adjacent verticals to pay off in a big way. The company believes its total addressable market (TAM) can get to as big as $110 trillion in TPV, driven by in-store retail, bill pay, emerging markets growth and additional digital services. In other words, despite PayPal already being a large player, it has only scratched the surface of its long-term TAM opportunity.
Although the business is currently valued at 27.4 times its 2023 non-GAAP earnings per share (based on consensus analyst estimates), the full story has not been baked into the current valuation. Between the rapid growth of peer-to-peer transactions, consumer payments service Venmo’s meteoric rise and the evolution into a financial super app, the opportunities for PayPal to further grow from its current base seem almost endless. Efforts to monetize the Venmo platform are still in the early stages, and the value of Venmo has not been fully baked into current analyst models.
In summary, I believe PayPal has a clear path to robust growth over the next five years, and it could continue to generate further growth over the long haul as it rides the pandemic’s need for faster digitalization and the ongoing secular shift towards digital payments. As such, PayPal is a great vehicle for investors to get exposure to the next generation of fintech businesses globally, led by a management team that has perfected the art of successful acquisitions.
This sentiment is echoed by top investors and gurus around the world, including the U.K.’s Lindsell Train with 14.42% of their portfolio in PayPal, Pat Dorsey of Dorsey Asset Management with a 12.92% portfolio allocation, Terry Smith of Fundsmith with 8.8%, David Rolfe (Trades, Portfolio) of Wedgewood Partners with 5.49% and Polen Capital Management with 3.28%.