PayPal: still not ready to pay (NASDAQ: PYPL)

Summary

Our initial report on PayPal Holdings, Inc. (NASDAQ:PYPL) has assigned a Hold rating to the shares. Despite the stock’s massive correction following a significant e-commerce-fueled rebound during COVID, we did not find the valuation as attractive given increasing competitive pressures, slowdown growth and uncertainty about recovery. Q1 2024 results surprised on the upside, with strong performance across all key financial metrics, although a significant portion of the outperformance was driven by transitory factors (e.g., interest income). Although the shares are approximately 8% below our initial report price, we remain cautious and maintain our Hold rating on valuation.

Profit Update

PayPal’s new CEO, Alex Chriss, has been appointed to turn around the company by revitalizing growth and disciplining costs. Since he took the reins, we believe early results have been promising, with indications of pricing improvement. in Unbranded, reducing friction in Branded to reverse market share loss and revitalize Venmo.

During the quarter, unbranded volumes increased approximately 26% year-over-year due to recent pricing improvements, with management noting that negotiations with merchants have been positive thus far. Unbranded growth is expected to benefit from the rollout of Fastlane, which is expected to be widely available by the second half of the year (note, management says merchants using Fastlane experience a double-digit increase in checkout conversion rate). Growth in brand volumes also exceeded expectations, driven by large enterprises and international customers. In the short term, PayPal will continue to focus on increasing its SMB penetration and improving its mobile UX.

Venmo volumes were up about 8% year-over-year, roughly flat compared to the previous quarter, although Venmo debit card usage was up about 21% year-over-year. A key management priority in its efforts to reignite Venmo’s growth is maintaining inbound flows within the app (nb, ~80% of flows leave the app within ~10 days).

In our view, the overall transaction margin (“TM”) outperformance was supported by several exceptional items, making it a lower quality result. Interest income was the largest contributor to TM’s growth in the quarter, followed by growth from Branded (which benefited from a +1 point contribution on a leap day), an improvement in losses (partly due to tougher origination standards and portfolio sales) and a lesser drag of underperforming companies. Also on the negative side, subscription rate compression continued, albeit at a slower pace due to the mix change. Management expects TM’s growth to moderate in the second half as interest benefits decline and losses normalize.

Regarding capital allocation, PayPal has repurchased approximately $1.5 billion in shares and plans to repurchase at least $5 billion throughout 2024.

Assessment

We are evolving our PayPal valuation methodology towards a gross profit multiple. Our base price target of ~$67 is based on a 5x EV/GP multiple on our ’25E GP estimate of ~$14.4 billion. We believe this is an appropriate multiple for a company facing TM pressures as it attempts to return to growth profitably.

Our bullish price target of ~$85 assumes greater e-commerce growth, faster acceleration in branded payment volumes, and a 6x GP to GP multiple of ~$15.2 billion.

Our bear price target of approximately $51 is based on deterioration in TMs due to increased competition in branded payment volumes, continued weaker monetization in unbranded volumes and d ‘a 4x GP on GP multiple of approximately $13.8 billion.

Conclusion

Our Hold rating is motivated by the following considerations:

• Uncertainty around how much of branded payment PayPal can sustain and how much sustainable e-commerce growth will be in the future
• The company’s ability to generate sufficient operating leverage to achieve margin expansion
• If the company can improve the unit profitability/acceptance rate of its unbranded payment.

Given these concerns and the modest upside potential we see from our base case target price, we maintain our Hold rating.