PayPal Holdings (NASDAQ:PYPL) was a top contributor to relative performance during the third quarter. The Company’s constant currency revenue growth, operating earnings and earnings per share continue to grow at high-teens rates as their core payment services gain relevance with a growing base of more than 15 million merchants and over 200 million users. We think PayPal’s large-scale, two-sided platform is a unique value proposition to the payments industry where competitors typically focus on either merchants or customers, but rarely integrate both at scale. PayPal’s traction with users and merchants proliferated during its decade-and-a-half tenure under the eBay umbrella, concomitant to the rise of the e-commerce sales channel. The core value proposition of PayPal – then and now – is its ability to offer a turn-key payments platform that includes payment acceptance, processing, fraud detection, and an increasing array of financial services traditionally offered by banks, to merchants of any size, particularly small and mid-sized merchants.
Although we consider PayPal to be in competition with traditional banks, the nature of their competition is a rare partnership, where both create value beyond what either could achieve by themselves. Of course, if they both fail to create value, then their competitive dynamic will turn into winner-take-all, but we think PayPal is in the very early stages of adding substantial value to banks, via their recently signed partnership agreements with Visa and MasterCard. For years, traditional banks have been trying in vain to construct widely accepted mobile payment platforms, beyond what Visa and MasterCard offer, while PayPal has succeeded through its one-click checkout on mobile, Braintree mobile payment solutions, and more recently Venmo P2P money transfer application (among others). In exchange for capturing some of the economics from this mobile volume, banks have become a new source of distribution for PayPal, both on the user and merchant end.
In addition, PayPal has a disciplined value chain that is focused on procuring the natural operating leverage inherent to payments and prudently reinvesting it into large and growing addressable markets. We think PayPal is capable of further leveraging its fixed cost base as the aforementioned partnerships will reduce customer acquisition and support costs.
Over the next few years, we expect PayPal to monetize their credit receivables portfolio, which should free up a substantial amount of capital for reinvestment. Also, we think the Company will begin to specify their strategy around their exclusivity agreement with eBay, which expires in a few years. We believe a substantial portion PayPal’s small and mid-sized merchants will continue to do business via the eBay marketplace. Considering that PayPal’s most valuable offerings are to its small and mid-sized customers; we would expect the Company to take the appropriate measures to maintain these lucrative relationships.
While PayPal sports one of the richest earnings multiples in the portfolio, we think the Company has a multi-year potential for double-digit revenue and profit growth, which is rare for a business of PayPal’s size. If they continue to execute on this growth strategy, leveraging their unique, dual -sided platform in addition to optimizing their capital structure and maintaining their relationship with small and mid-sized merchants, we think the Company will continue to be a core holding for many years.
From David Rolfe (Trades, Portfolio)'s Wedgewood Partners 3rd quarter shareholder letter.
