PayPal recently announced its best quarter ever, with Total Payment Volume (TPV) and revenue up 36% and 25% respectively YoY. This is not surprising given the increase in online commerce this year. The market has rewarded the company for this performance, with the stock up over 55% from its pre-COVID high. The question investors should now be asking – is future upside fully baked into the current stock price?
Lets dig in.
Revenue
PayPal makes money by charging merchants a fee to accept payments online. This fee is typically 2.9% of the transaction value plus 30 cents. Given PayPal’s revenue is primarily derived from online transactions, the company’s revenue growth is linked to the growth of E-commerce.
PayPal’s revenue growth rate was declining over the last three years until COVID provided a boost in 2020. Given COVID has pulled forward a lot of online spending, I expect revenue growth to revert to normal levels in 2021 and slowly decline from there. Based on these assumptions, revenue in 2030 would be $58B, which is ~3x 2020 revenues.
Let’s sanity check the 10 year revenue forecast. Total retail spending in the US was ~$5T in 2019 (excluding cars). E-commerce sales in 2020 are expected to be $800B, implying E-commerce represents about 15% of total retail. It seems reasonable to me that E-commerce sales will triple in ten years, given that they would then make up 50% of retail sales (assuming no growth in total retail spending).
Note that Amazon is 40% of E-commerce sales and does not accept PayPal, so we’re assuming that as total online sales grow, Amazon’s share of that market remains roughly the same.
About 50% of PayPal’s 2019 revenue was from the U.S, 10% from the U.K and the remainder from other countries. All geographies have grown at about the same rate over the last three years, so I don’t expect a meaningful dispersion going forward.
Margins
As can be seen in the model, PayPal’s operating margins have been quite steady over the last five years – averaging 15%. 2020 is expected to have slightly higher margins at 17% given the sudden jump in revenue, but I expect margins will normalize in 2021 and beyond, so I assume 16% on a go forward basis.
Valuation
Based on these revenue growth and margin assumptions, a terminal value FCF multiplier of 25x and a tax rate of 18%, I arrive at a per share value of $164 for PayPal.
In order to arrive at a price in-line with today’s price, you’d either have to assume faster revenue growth or margins at 20% in 2030. As always, my model is available here for you to input your own assumptions.
Upside Possibilities
New Business Lines
PayPal is working with merchants to accept Venmo at physical stores. If this is a business they scale meaningfully over the next ten years, it could provide a meaningful boost to revenue.
PayPal is exploring ways of extending credit to consumers to compete with firms like Affirm and Afterpay. They recently launched their “Buy Now Pay Later” program which makes 0% loans to consumers that they can repay in four instalments. If they manage the credit risk well, this could lead to merchants favoring PayPal over competitors like Stripe.
Faster E-commerce growth
Online commerce may grow faster than expected because people who’d historically preferred physical retail now appreciate the convenience of online shopping. This could mean that in 10 years, E-commerce represents 60-70% of all retail spending, vs the 50% I’m assuming.
Downside Risks
Competition
PayPal is in a lucrative market, so inevitably there will be competitors. The most promising company competing with PayPal today is Stripe. Stripe is widely regarded as one of the best run companies in Silicon Valley and was valued at $36B earlier this year. As they scale, they could put pressure on PayPal’s margins by cutting fees. They currently charge merchants the exact same fees as PayPal. However, PayPal had about 280mm active user accounts at the end of 2019. Assuming about 100mm of these are in the US, that’s a 50% penetration of the working age population of the country. I don’t have data on how many people with PayPal accounts prefer to use it to make payments, but given they’re approaching close to $1T in payment volume, I’d assume it’s a significant number. This will help PayPal spin the narrative that if you’re a retailer you absolutely need to offer PayPal as a checkout option.
While merchants might prefer to use Stripe, given potentially better service and lower fees, PayPal’s existing user base is going to be hard to compete with.
A Security Breach
While PayPal touts the security of its platform, they are not immune from hackers. Any significant breach that leads to consumers losing funds or having their personally identifiable information exposed, could shake consumer confidence meaningfully and make consumers move away from PayPal.