PayPal Holdings, Inc. (PYPL) is a digital payments platform, having a wide range of financial products such as PayPal Credit, Braintree, Venmo, Xoom, iZettle, and Hyperwallet that allow its customers to send and receive payments online.
PayPal has many highly positive financial metrics, such as robust revenue and EPS growth in the past five years, consistent positive free cash flows, and a strong balance sheet.
Shares of PayPal have underperformed year-to-date in 2021, with losses of over 12%. With a current stock price of around $205, I am bearish on PYPL stock; the key factor is its lofty valuation. (See Analysts’ Top Stocks on TipRanks)
I am also bearish because I’m not convinced that the wider adoption of cryptocurrency as a means of digital payment that PayPal supports will support its expansion plans.
Business News: New Partnership, Rumors Of Buying Pinterest
PayPal’s management has been active lately, with a plethora of news released about its business operations and updates on its plans. One very positive piece of information is a new partnership with Amazon (AMZN), allowing Venmo users to use the service and pay on Amazon’s e-commerce platform.
In early September 2021, PayPal announced that it has agreed to acquire Paidy, “a leading two-sided payments platform and provider of buy now, pay later solutions in Japan, for ¥300 billion or approximately US$2.7 billion, principally in cash. The acquisition will expand PayPal’s capabilities, distribution, and relevance in the domestic payments market in Japan, the third-largest e-commerce market in the world, complementing the company’s existing cross-border e-commerce business in the country.”
This is positive news as PayPal has plenty of cash to pursue such strategic business acquisitions. What is interesting news, though, is the announcement PayPal made to put an end to rumors that it was interested in buying Pinterest (PINS). In a very short press release, PayPal stated that “in response to market rumors regarding a potential acquisition of Pinterest by PayPal, PayPal stated that it is not pursuing an acquisition of Pinterest at this time.”
Why not at this time? Why pursue to acquire Pinterest after all? Pinterest is a social media company. Could this be a hint that PayPal is exploring diversified investments? Or, has PayPal identified that Pinterest has a significant user base that seems a good fit to use its digital payment services and support its revenue growth?
We may find out in the next few quarters, although an explanation may be that PayPal could not make this acquisition paying in all cash at this time. It would have to be a combination of cash and stock. This is because in the Q3 2021 results, the cash, cash equivalents, and investments reported on PayPal’s balance sheet were $20 billion, which is far below the $45 billion needed to acquire Pinterest at a rumored price of $70 per share. Even now, Pinterest’s market cap is around $31 billion at $48 per share.
Q3 2021 Results: Strong, but Mixed
The Q3 2021 results were a beat on earnings but a miss on revenue.
PayPal earned an adjusted $1.11 per share on revenue of $6.18 billion. Analysts expected the fintech company to earn $1.07 per share on revenue of $6.23 billion. Some of the financial highlights were net revenue of $6.18 billion, growing 13% on a spot and FX-neutral basis, GAAP EPS of $0.92 compared to $0.86 in Q3 2020, operating cash flow of $1.51 billion, growing 15%, and free cash flow of $1.29 billion, growing 20%.
The business outlook for the Fiscal Year 2021 was also mixed. Revenue is expected to grow about 18%, and PYPL expects to end the year with more than 430 million active accounts.
The most important news is that PayPal estimates that for the Fiscal Year 2021, GAAP EPS is expected to be about $3.62 compared to $3.54 in FY 2020. If this is the actual figure, then there will be an increase of only 2.3% for 2021, a significant decline compared to the diluted EPS growth of 71% for 2020.
Bitcoin Concern: Why Wider Adoption Poses Risks
In late 2020, PayPal launched a cryptocurrency trading service and has also allowed online shopping using cryptocurrencies. In August, it announced that you could trade cryptocurrency in the UK on its platform.
I am not convinced that a switch to broader use of cryptocurrency is positive for PayPal. The cryptocurrency market is highly volatile and subject to risks such as regulation and taxation on a global basis.
Valuation: A Lofty One
On a relative valuation analysis, PYPL stock seems to be overvalued. PYPL has a P/E ratio of 51.3x compared to the U.S. IT industry average of 36.8x. The stock is also overvalued based on its price-to-book ratio of 11.5x compared to the U.S. IT industry average of 5x.
Wall Street’s Take
PayPal has a Strong Buy consensus rating, based on 23 Buys, five Holds, and one Sell rating assigned in the past three months. The average PayPal price target of $276.52 implies 35% upside potential.
Disclosure: At the time of publication, Stavros Georgiadis, CFA did not have a position in any of the securities mentioned in this article.
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