PayPal scooped up assets that will help it better compete against Square, and we think both entities have a bright future regardless of the increased competition.
Brian Nelson, CFA
It’s no secret that PayPal (PYPL) generates a considerable amount of free cash flow and boasts a very strong net cash position that allows it to scoop up assets that it deems worthy of the long-term picture. Many have been concerned about PayPal’s expected loss of its contract with eBay (EBAY) in 2023, and it was quite the blow, but the entire relationship merely amounts to a few months of organic growth at the payment-processing giant.
We also view Bitcoin and other cryptocurrencies as more of an opportunity than a threat for PayPal, as most banking transactions remain of the cash or check variety, a difficult-to-believe reality in the age of digital money transfer. Amazon (AMZN) is reported to be interested in the digital payments space, and Facebook (FB) is reported to be working to develop its own cryptocurrency, perhaps paving the way for it to become an e-commerce giant, but we continue to believe the payment-processing industry is large enough for a great many players.
In addition to the operational funding mechanism via considerable free cash flow generation and one of the best balance sheets around, PayPal benefits from something called the “network effect.” As with our favorite credit-card network providers, Visa (V) and MasterCard (MA), as more and more consumers use its service, more and more merchants accept the platform and so on. The credit card networks have benefited from this dynamic for as long as one can remember, but eBay may have brought the concept front and center during the dot-com bubble era. Facebook benefits from a network effect, too.
On May 18, PayPal announced that it would buy Sweden’s iZettle, a provider of credit card readers to small businesses, much like Square, in an all-cash deal of $2.2 billion. The deal will open up the huge European and Latin American markets for PayPal, while augmenting its existing technology and bring on board a talented team that only further accelerates the curve of payment innovation. The price tag for the transaction is considerably higher than iZettle’s expected valuation at its proposed IPO this year and rather hefty, too, given that iZettle is not yet profitable. PayPal, however, held ~$7.5 billion in cash and cash equivalents at the end of 2017 against just $1 billion in notes payable on the books, so it can absorb iZettle without skipping a beat.
The simulated Best Ideas Newsletter portfolio inherited the position in PayPal as a result of the split with eBay, and shares of PayPal have surged since. Now trading at north of $80, it has been a fantastic ride for those paying close attention to our favorite ideas in the simulated Best Ideas Newsletter portfolio. As is customary, we wait until a stock is both overpriced by our discounted cash flow process and its technical/momentum indicators weakening before we’d consider removing it. PayPal remains a key idea in the newsletter portfolio.
Related: AXP, DFS
Financial Tech Services: ACIW, EPAY, FDC, FIS, FISV, FLT, GPN, MA, MELI, PAY, PYPL, V, VRSK, WEX, WU
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Brian Nelson does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.