PayPal After Q4 2017: The Easy Money Has Been Made

Summary

PayPal’s stock price has more than doubled since the IPO.

We identify and assess the drivers of the price appreciation: strategic decisions, strong business performance and a shift in investors’ narrative.

We comment on Q4 2017 results and earnings conference call, including the likely impact of eBay’s transition to in-house payments intermediation.

We dissect the hypotheses backed in the current stock price and conclude that although there may be still some room for further appreciation, the easy money has been made.

PayPal (PYPL) has been in our market-beating portfolio since August 2015, a few months after the separation from eBay (EBAY).

Two and a half years later, the stock is up some 140%. With Q4 2017 earnings just behind us, it is the right time to revisit the original long thesis in the light of substantial business developments and a spectacular stock price appreciation.

The original long thesis

In August 2015, a few months after the separation from eBay, PayPal’s common stock was trading in the low $30s. The business was very profitable, had a cash-rich balance sheet, and mid-term guidance was calling for mid to high teens annual growth for the foreseeable future.

Besides, in 2013, while still an eBay division, PayPal had acquired some assets of extraordinary franchise potential, namely Venmo and Braintree, for a meager $800 million.

After due diligence, we concluded that the stock offered great potential at a large margin of safety to intrinsic value. And we bought aggressively.

The abridged history of PayPal: from IPO to 2018

With the benefit of hindsight, the IPO price seems like a bargain. But why was the stock so modestly priced at the time? Or maybe rather, why is the business so richly priced today? Has the value of the underlying business really increased some 140% in 29 months?

We start by making two observations:

(1) Even though in 2015 we were much more optimistic than the market about PayPal’s prospects, actual business performance has exceeded our expectations.

In a later section, we will estimate intrinsic value following Q4 2017 results to throw some light on whether the stock price appreciation can be explained based on financial outperformance alone.

(2) Investors’ narrative has undergone significant shifts within the span of these two and a half years.

After the IPO, investors’ focus was on the over-reliance on the legacy eBay business and on impending competition from payment products by better capitalized competitors such as Apple Pay (AAPL), Google Wallet/Android Pay – today unified into Google Pay (GOOG/GOOGL), and Samsung Pay (OTC:SSNLF).

Then in 2016, CEO Dan Schulman shocked the markets when he announced a bold bet on customer choice. PayPal balance would no longer be enforced as the preferred payment method. Instead, customers would be given the choice to select one of their credit cards, debit cards or bank accounts as preferred payment method. Agreements with Visa (V), Mastercard (MA), Facebook (FB) and other industry giants promptly followed.

The direct financial impact was an ugly one: higher transaction costs, as PayPal would be sharing payment processing fees with banks and credit card platforms. The promised benefits, namely stable long-term pricing agreements with the credit card companies on terms allegedly beneficial to PayPal, and above all, better customer acquisition and engagement, and lower support costs, as a result of a more flexible service, were much more ethereal. And so the stock price backed that skepticism.