Ecommerce, Emerging Markets And Security Will Drive Revenues Higher

Industry

E-commerce growth to continue

E-commerce remains one of the stubbornly optimistic industries, estimated at over $4 trillion in sales in 2023. It is also growing at a double-digit pace, expecting to expand by 10.4% in 2023. This growth supports a strong need for the global digital payment market, which is expected to grow at an even higher pace, exceeding 20% between 2023-2030. For PayPal, it represents a tremendous opportunity to revitalize its status as a growth stock. Based on estimates from Statista, the global e-commerce industry could exceed $7tn by 2028. I believe Paypal can continue to dominate this market through its brand strength, leading to revenue of over $40b by 2028 .

Emerging markets adoption

Emerging markets have been excelling in digital payment adaptation. In those markets, a compound annual growth rate of 25% was double the global average in the last few years. These markets present an opportunity for PayPal, which typically focuses more on developed economies. To take advantage of that trend, PayPal could easily acquire an emerging market brand, or simply provide its existing offerings. 

According to Statista’s data, PayPal has a particularly strong adaptation in Brazil, while it doesn’t do as well in other South American countries. Furthermore, it is widely used in South Africa but less so on the rest of the continent. I believe South America represents an excellent opportunity, especially if PayPal finds ways to serve the needs of the local population that struggles with inflation.

Based on reports from Oxford Business Group digital payments industry in emerging markets has a projected compounded annual growth of 15% until 2028. I believe this represents a growth opportunity for PayPal if it can secure some of that market.

Introduction of Central Bank Digital Currencies 

Central Bank Digital Currencies, often called “CBDC’s” represent the next step in monetary evolution as a new form of money that exists only in digital form. Multiple central banks are currently undergoing trials with CBDCs to experiment with the new technology. There is still so much to figure out in this area, and government agencies are notoriously slow to adopt innovation compared to the private sector. So don’t expect anything to happen too quickly in this area. Industry leaders such as PayPal could end up working with the government and receiving insight and possibly even business by helping to execute such efforts.

Higher need for security

Financial crime continues to grow, with the Federal Trade Commission estimating those losses at almost $400m in 2021. According to Juniper Research, global ecommerce fraud costs $41b in 2022, and might reach $48b in 2023. The report shows that North America accounts for Mitigating those risks requires effort, and online merchants turn to industry leaders as security partners.

So far, PayPal extended a comprehensive Seller Protection Program globally in 2021. Considering there’s no extra cost to merchants to benefit from the Seller Protection program, it seems an enticing offer for these merchants to start to offer PayPal as a payment method on their platforms, which could lead to reduced losses from fraud.

With security issues rising, it is possible they could even expand it abroad and consecutively expand its market share to help other ecommerce platforms reduce fraud, since PayPal’s checkout button represents a standout trademark of its own - merchants who offer it have 33% more completed checkouts.

If this occurs, it could increase the Total Payment Volume (TPV) on PayPal’s network. Considering PayPal’s Total payment volume was $1.36 trillion in 2022, and those estimates for Global ecommerce fraud are for $48bn this year, it wouldn’t move the TPV needle much even if PayPal was used for $48bn more in transactions to prevent fraud. So while I don’t expect TPV to increase meaningfully from merchants wanting fraud prevention alone, I do believe it’s a key selling point to increasing adoption and peace of mind for buyers and sellers.

Company

Improving Profitability 

PayPal has beaten both revenue and EPS consensus, showing a 2% improvement in operating margin Y/Y. While the growth is slowing, it is unreasonable to expect a company of this size to continue to expand at high rates indefinitely. The management is now focused on improving profitability, driving engagement and controlling costs, which should have a positive influence on the company’s bottom line. Given this profitability focus, I believe the company will increase profit margins to 15% by 2028, and reach profits of $6bn, which the market is currently under appreciating.

Excellent free cash flow yield 

Free cash flow yield is a metric describing how much free cash flow is available in relation to a company’s market capitalization (or current price). A rule of thumb I use is to consider yields above 4% to be good and those above 7% exceptional. PayPal has a free cash flow of $5b and a market cap of $69b, giving it an FCF yield of 7.2% - one of the best in the industry. Given I believe cash flows are likely to continue growing, and could reach $10bn by 2028, today’s share price would put it on a 2028 forward FCF yield of 14%, which I find very appealing. Additionally, if it trades at a similar Price/FCF multiple to what it is at today (14.4x), then that provides plenty of upside from today’s prices given the possible doubling of FCF.

Timely Buybacks

In 2022, PayPal announced a $15b buyback program. By estimates, it used about $4b that year, leaving the most available to purchase shares at current multi-year lows. With diminishing stock-based compensation, these buybacks are expected to have a better effect going forward. If we assume that the remaining $11bn (or so) is used to buy the stock at prices around today's share price for the next 2 years, that could reduce shares outstanding by 6.5%, dropping them from 1.12bn to 1.05bn. 

The management will turn to international markets for growth

PayPal gets the bulk of its revenue from the domestic and UK markets. I expect the management to use their cash reserves to expand international business, shifting focus to emerging markets that are growing fast. In turn, PayPal can retain the growth rates in the high teens over the next several years.

SBC will shrink further, making the buybacks more effective

I expect the management to continue trimming the expenses, making further cuts of stock-based compensation, and pursuing timely buybacks as the stock stands at multi-year lows.

Company will start paying dividends 

I expect the free cash flow to remain strong and for the stock to start paying dividends eventually. I believe the company could easily sustain an industry average yield of 1.4%, which at the current price of $62 comes up to a quarterly payment of $0.22 per share – an earnings payout ratio of approx. 31% per latest earnings.

Citizens will continue using third-party P2P payment processors over government-sponsored programs

I expect the government-sponsored payment P2P infrastructure to not achieve significant adaptability due to security concerns and privacy backlash from citizens. With this in mind, I assume the likes of PayPal and others will benefit from their established networks, and citizens will revert to these platforms for P2P transactions. 

Increased competition

PayPal's success is often attributed to its timing. As an industry pioneer, the company became a generic trademark for online money transfers. Since then, the industry has drastically changed with numerous competitors like Wise, Stripe, Payoneer and Shopify, generally charging lower fees than PayPal.

Furthermore, large operators like Apple and Amazon are pursuing in-house solutions and moving away from reliance on third parties.

Public sector involvement

Federal Reserve just launched FedNow Program, which they deem “the first step in a multi-year journey to build an instant payment network that is accessible to all Americans.“

Although they stated this program is not intended to replace online payment platforms, it certainly threatens the existence of third-party payment processors, as it could reduce their Total Payment Volume. 

Crisis of Management

PayPal's long-standing CEO, Dan Schulman, is set to retire by the end of 2023, and the successor hasn't been announced. Schulman had a successful career as a CEO, although he failed to meet the latest financial targets, resulting in a 32% cut in his compensation.

Despite announcing his retirement in February, Schulman has not yet proposed a successor, causing frustration among the investors. The absence of a CEO is likely causing issues in finding the permanent CFO – the second most important position, arguably causing a management crisis within the firm.