Those who bought shares of PayPal Holdings Inc. (PYPL, Financial) after the stock began its downward spiral in the second half of 2021 are likely ruing the day. PayPal is down 49% year to date, 68% from all-time highs and 65% over the past year.
It is not just because of the post-pandemic selloff and worsening macroeconomic conditions; PayPal’s woes are also due to strategic factors such as the ending of its partnership with parent company eBay Inc. (EBAY, Financial) and lack of enthusiasm for its “super app” strategy.
When we combine macroeconomic and strategic issues with PayPal’s down-trending bottom line, it seems possible that the stock might deserve its lower valuation. The question is, has PayPal entered permanent decline, or does it still have an opportunity to regain its former glory?
PayPal’s decline
PayPal saw its net income begin to decline slightly in the quarters leading up to the beginning of the pandemic. Its bottom line was bolstered by the pandemic and the resulting dramatic increase in online sales, but by the fourth quarter of 2021, net income had fallen below pre-pandemic highs. In the second quarter of 2022, the company posted a net loss of $341 million.
At the same time, revenue has continued its uptrend, but top-line growth has been slowing down. If these conditions continue, a slowdown in top-line growth and issues with bottom-line profitability could both keep the stock’s valuation at lower levels compared to history.
Let’s take a closer look at the second-quarter net loss. On a per-share basis, the loss was 29 cents per share, but there were several metrics skewing this number, including an 11 cents per share benefit from the release of credit reserves, a 37 cents per share charge related to a markdown of intellectual property value and a 45 cents per share loss from the equity investment portfolio. Without these confounding factors, earnings per share were still less than half of the prior-year quarter’s $1.
Can we expect PayPal’s bottom-line decline to continue? If the economy continues to worsen, it seems like PayPal’s short-term results could suffer unless it manages to make significant gains in market share.
In addition to the general economic outlook, investors worry that parent company eBay’s long-anticipated transition away from PayPal to its own payment system could hurt revenue, but it is important to note that by the time the partnership ended, eBay contributed a meagre 4% of PayPal’s revenue.
PayPal’s partnership with Amazon.com Inc. (AMZN, Financial) could very well make up for the loss of eBay. Through the deal, Amazon shoppers will be able to use PayPal’s Venmo as a checkout option. The deal is only possible due to the termination of the remaining contractual obligations to eBay.
Back to the basics
Perhaps the most underrated reason why investors have been selling PayPal shares is the company’s “super app” strategy.
For those who are not familiar with super apps, these are apps that consolidate the services of multiple different apps into one convenient place for users to access, which eliminates the need to sign into multiple apps, keep track of different accounts, add card info to dozens of different places, etc. The most prominent example of a super app is Tencent’s (HKSE:00700, Financial) WeChat.
The main problem with the super app business model is that it just does not seem to be resonating with PayPal’s home market in the U.S. Even as news outlets have been hyping up the idea, it has thus far failed to impress consumers, perhaps in part due to the risks of having everything in the same place – a cyberattack would be much more devastating, and if the app goes down or is under maintenance, suddenly you cannot use any of its services.
In its latest earnings report for the second quarter of 2022, PayPal seems to have taken a step back toward the basic components of its business rather than focusing on the super app strategy, which could bring it back to its existing niche and thus back into investors’ good graces. “We have narrowed our focus,” CEO Dan Schulman said.
In the second-quarter earnings call, PayPal pledged financial discipline and a focus on core brands for growth. Notably absent was talk of expanding its fintech reach to super app status. There was also no further mention of adding stocks or more cryptocurrencies (aside from the existing crypto options on Venmo and other PayPal apps, such as Bitcoin).
The core businesses that the company will be refocusing on are PayPal and Venmo digital wallets, online checkout and the Braintree platform for merchants.
Cooling its heels from the overly ambitious growth plans of last year, PayPal also announced a $15 billion share buyback program as well as plans to return as much as 75% of free cash flow to investors.
Valuation
It might be more beneficial for PayPal to refocus on its core businesses rather than keep pursuing the super app strategy, but that does not necessarily mean it can recover its previous valuation levels. This latest strategy shift seems more defensive than growth investors would like, which could shift the stock more firmly into the value category going forward.
The GF Value chart currently rates PayPal as significantly undervalued based on historical price multiples, past stock price gains and analysts’ estimates of future business performance.
The price-earnings ratio of 55.67 is quite high, but the forward price-earnings ratio is 24.79 based on analysts’ earnings estimates of $2.19 for full-year 2022. For full fiscal 2022, PayPal guides for revenue growth of 10% compared to 2021. Earnings per share are expected to fall in the range of $1.52 to $1.62 on a GAAP basis and $3.87 to $3.97 on a non-GAAP basis.
If PayPal can meet analysts’ expectations and continue growing, it does look undervalued at the moment even when we consider the hit to valuation caused by being moved out of the growth stock category. It is not in permanent decline yet, as evidenced by the 9% year-over-year increase in total payment volume as of the second quarter. However, more short-term volatility could still be in store, and PayPal’s future will hinge on whether it solidifies its core businesses or pursues a course of diversification.
