PayPal: Value Play or Value Trap?

Happy Sunday! (Especially for Google shareholders)

This week we’re talking Big Tech Earnings (Meta, Microsoft, Alphabet, and more) and a breakdown of PayPal’s place in the dynamic world of payments.

Let’s get to it.

Earnings Roundup

Big Tech & More

• Alphabet: The parent company behind the world’s leading search platform crushed expectations after reporting its first quarter earnings on Thursday. Thanks to impressive results from Search, YouTube, and Google Cloud, Alphabet grew its total revenue by 15% and Earnings per share by 62% versus the same period last year. Alphabet’s stock jumped by 10% following the report.

• Meta Platforms: The parent company to popular social network apps like Instagram, Facebook, and WhatsApp delivered better than expected results on Wednesday. However, the company’s weak guidance and increased outlook for capital expenditures left some investors running for the hills. On the company’s conference call, CEO Mark Zuckerberg stated that they intend to increase spending on both their AI and mixed reality initiatives. Meta’s stock dropped 9% this week.

• Microsoft: The cloud computing and business software giant reported quarterly earnings this week and beat on both the top and bottom line. Revenue was $61.9 billion for the quarter, up 17% from a year prior and the company delivered an impressive 44.5% operating margin. With renewed demand for its cloud services, Microsoft’s “Azure and Other Cloud Services” revenue grew by 31% year-over-year. Microsoft’s stock was up just over 1% this week.

• Visa: The leading payments network globally delivered a strong 1st quarter report exceeding expectations for both revenue and earnings. Additionally, Visa’s CEO Ryan McInerney used the conference call as a chance to excite investors about the “$40 trillion” addressable opportunity still ahead of the company. In particular, McInerney called 3 areas where he thinks Visa can still make headway: 1) Cash and check payments, 2) ACH and other electronic transfers, and 3) Cards that run on primarily domestic networks. Visa’s stock was up 1% this week.

• Tesla: The world’s largest automotive company by market cap reported its Q1 earnings on Tuesday and missed Wall Street’s estimates for both revenue and earnings. Tesla generated $1.1 billion in net income for the quarter, which was a 55% drop from the same period last year. However, on the conference call, Elon Musk was able to generate plenty of enthusiasm for shareholders. When discussing Full-Self Driving technology he stated “I think it might be the biggest asset value appreciation in history when that day happens”. Tesla’s stock was up 20% this week.

Company Spotlight

PayPal: Value play or value trap?

Once a market darling, PayPal’s stock is now down 79% from its all-time highs.

To really understand what direction PayPal is heading, we need to look at where they actually sit in the payments ecosystem.

1.) The "PayPal Button" - Often referred to as Branded Checkout, this is their most important business as it accounts for roughly 1/3rd of all transaction volume and ~2/3rds of gross profit.

This segment includes the standard "Pay with PayPal" solution you see at most online checkouts as well as cross-border transfers. In general, the take-rate PayPal generates on these sorts of transactions are higher than anywhere else in its business. Particularly, when payments are made with the cash from a customer's actual PayPal account.

However, due to the rise of mobile wallets like Apple and Google Pay, the PayPal Button is ceding market share within the entire payments space.

2.) Unbranded Checkout - PayPal's 2nd most important business is what it calls "Unbranded Checkout". This refers to its Braintree subsidiary which it acquired in 2013.

Braintree is a “full-stack” payments processor that competes with the likes of Stripe and Adyen, and the segment processes ~$400 billion in annual payment volume. For context, Stripe and Adyen are both at about $1 trillion.

This is PayPal's fastest growing segment, however given the competition among processors, it commands a substantially lower take-rate than PayPal's branded checkout business.

3.) Everything Else - PayPal has been highly acquisitive over the years and today roughly 35% of its total payment volume comes from its collection of other subsidiaries. This includes most notably Venmo (their peer-to-peer payments app), but also Xoom, Hyperwallet, Zettle, Honey, and others.

While each of these businesses could potentially help grow volume and earnings a bit, the vast majority of PayPal's earnings power still comes from its branded checkout business.

Value play or value trap? PayPal currently trades at a price to earnings of ~17x.

Given its total payment volume has grown at 23.5% annually over the last 5 years, it'd be easy to think that the company's valuation looks quite cheap.

However, given that an increasing percentage of that payment volume is coming from its PSP business, which has a lower take-rate, it doesn't directly equate to growth in earnings power for PayPal.

The more important figure to track over the coming years will be the growth in revenue (and ultimately earnings) from its branded checkout business. If the "PayPal Button" can maintain or even grow its market share, PayPal will likely grow earnings fast enough to generate value for shareholders.

Meme of The Week

Google Shareholders Looking at Sundar Pichai After Q1

Alphabet hasn’t had an easy go of it over the last couple of years.

ChatGPT’s launch sparked concern about Google’s search dominance, Google partly fabricated its AI demo, revenue growth slowed, profit margins contracted, and the stock went virtually nowhere for 3 years.

But after Google reported its first quarter earnings on Thursday and delivered better than expected results across the board, it appears shareholder's faith in management has been restored.