Summary

• The company has 400 million consumer accounts and 35 million merchants.
• It recorded solid growth across sales, profit and book value.
• Venmo continues to grow as a hidden gem.

$PayPal(PYPL)$ is a leading digital payments company that provides a platform for online money transfers and payment processing. Founded in 1998, it became a subsidiary of eBay (EBAY,Financial) in 2002 and then spun off as a separate publicly traded company in 2015.

The company has been a major beneficiary of the growth of e-commerce. Its platform allows consumers to send and receive payments in approximately 200 markets and in approximately 150 currencies, withdraw funds to their bank accounts in 56 currencies and hold balances in their PayPal accounts in 25 currencies. It serves more than 400 million consumer accounts and has a network of 35 million merchants.

A fantastic business

The payment processing industry is known for its scalability, and PayPal is a major player with nearly $1.4 trillion in annual payments processed. This leadership position also gives the company a pretty durable competitive advantage despite the ease of switching from one processor to another.

PayPal's business model is a unique two-sided platform that facilitates relationships with both merchants and consumers. By having access to information from both sides of a transaction, the company has a significant advantage in combating fraud, which continues to be a critical issue across the internet. With the ability to prevent fraud, PayPal has become a valued partner for both merchants and consumers.

More importantly, this, along with PayPal's user-friendly platform, boosts conversion rates for online transactions at a rate of nearly 90%, compared to an industry average of roughly 50%. This is huge. The payment processing industry is pretty crowded and since PayPal's revenue is linked to that of its merchant customers, it is sensitive to macroeconomic conditions.

That said, PayPal has done a great job acquiring other payment businesses. In 2013, it bought Venmo, a peer-to-peer mobile payment service. Venmo is particularly popular among millennials and gen Z users, who use it to split bills, pay rent and send money for things like group dinners and vacations. Venmo currently has over 83 million active users that send around $60 per transfer, but is not yet profitable. Eventually it will be and those users will be worth a lot more to PayPal’s market value.

Financially solid

Since 2013, PayPal has increasedrevenuefrom $6.70 billion to $27.50 billion andoperating incomefrom $1 billion to $4 billion, whileretained earningshave pushed thebook valuefrom $6 to $18 per share.

PayPal reports earnings at the end of April and estimates continue to be for stronger financial growth going forward. For 2023, the company is expected to see significant recovery on the bottom line that should push book value above $20 per share. By the end of 2025,earnings per shareestimates are above $6.25 with revenue in the $35 billion range. It is completely feasible to think PayPal will be able to double revenue by the end of the decade with the same margins, and maybe even do better than that.

If successful, that would put revenue around $55 billion and operating profit in the $8 billion range. However, that brings up the issues with operating costs. Costs related toresearch and developmentandselling, general and administrative expensesare rising faster than PayPal’s gross profit. Even if revenue continues to grow at the same rate, the company’s value will not live up to its potential if these costs are not controlled.

The future looks promising

PayPal still has multiple promising areas for long-term growth, including the development of Venmo, expanding its tap to pay functionality, introducing cryptocurrency offerings and collaborating with Apple Inc. (AAPL,Financial) to enhance its offerings. This strategic approach places the company in a strong position to capture a larger share of the global payment processing market. Even with traditional banks such as Bank of America (BAC,Financial) and JPMorgan Chase (JPM,Financial) starting to show interest in the digital wallet niche, the sector is large enough for PayPal to continue to increase its underlying value. Eventually the market will catch up.

Another approach is to calculate the adjustedfree cash flowyield by deducting thestock-based compensationfrom the company's reported free cash flow, which amounts to nearly $4 billion. This generates a yield of 4.3% based on the current market capitalization.

Investors can reasonably predict that PayPal will be around in 20 years, provided something does not replace the internet. The world should continue to prefer shopping without cash and more importantly, continue to get wealthier as a whole. The stock is off 75% from its July 2021 highs, but I would be shocked if it stayed down at this level for long. In light of the chief financial officer stepping down, unless there is something significantly wrong with the company’s financials, the stock is pretty appealing at this price point.

source:gurufocus