Sunday, 12 July 2015

Paying with Paypal

The upcoming spin off of Paypal (PYPL) means the company is single once again splitting up with Ebay on the 20th of July. Being independent will allow PYPL to truly partner with retailers in digital commerce. PYPL is uniquely positioned in digital payments handling one in every six dollars spent in e-commerce. Separated from Ebay PYPL will be able to do more business with other retailers that have been concerned that PYPL is owned by a retail competitor in Ebay. PYPL is highly trusted by consumers over 50% of their transactions involve bank or PYPL balances the rest are credit cards. PYPL is a high growth yet highly profitable technology company with a decent 5% free cash flow yield. Spin-offs are always interesting as unlike IPOs sellers are not maximising the price. It's a rare site a technology company that actually throws off a lot of cash that is growing at a decent price. I doubt we would have this pricing if it was an IPO.

Source: Paypal roadshow

Spin-off pluses
The promise of a separate company has helped attract Dan Schulman ex-Amex, Virgin Money and Priceline as the new CEO. In Silicon Valley the share price is all important employees and management prefer equity in a focused growth entity like PYPL rather than Ebay. The separate listing will give PYPL a more attractive acquisition currency. In PYPL's case there is another reason for the spin-off Ebay was beginning to hold back their business.

Independence for Paypal
Retailers have always been cautious about doing business with PYPL because it is owned by a retail competitor in Ebay. The spin off allows PYPL to revisit relationships with retailers that were concerned with funding a competitor and disclosing retail data to Ebay. In Q1 management commented that PYPL is accepted at only 74 of the top 100 internet retailers in the US. The spin off could serve as a catalyst to sign up companies that don't accept PYPL like Amazon, Alibaba, Staples and Macy's. They have also structured the spin-off to keep as many synergies as possible. PYPL and Ebay have a 5 year operating agreement for data sharing and Ebay will be incentivised to grow users and keep their PYPL penetration rates at 80%.

Part of the sharing economy
PYPL strengthened their mobile position acquiring Braintree in 2013. It was great timing as their technology enables commerce apps like Uber and Airbnb helping them to accept multiple types of currencies and different payments such as credit cards, Paypal, Apple pay and even Bitcoin. Braintree also brought in Venmo a peer to peer transaction service useful in splitting bills.

There are plenty of other opportunities PYPL just bought Xoom which competes with Western Union in the remittance market. There is also the opportunity to lend to customers and merchants. PYPL has a tremendous amount of data on their platform yet they only have $3.8 billion in credit receivables a small % of the $238 billion they transact on their platform. Their $6 billion in cash can be used to help fund loans.

Competition is fierce
PYPL's competitors are well known. The entrance of Apple Pay was covered all over the media. Fortunately Apple pay competes at the point of sale not online. Offline or point of sale transactions are only 2% of PYPL's payments PYPL is still mostly an online service. Stripe is more of a competitor online its hard to get information on how they're doing but fraud losses have been an issue. Fraud prevention is what PYPL excels at their loss rate is 0.31%.The average credit card loss rate is 2.98%. This is the key to their business anyone can accept money but having low fraud is what differentiates PYPL for its customers.

Paying with Paypal
I personally like to think about companies in terms of their market cap (see above). In this case PYPL is interesting as the valuation of competitors is high. PYPL's enterprise value is attractive deducting the cash balance of $6 billion (not including Xoom transaction) gets a value of $36 billion with free cash flow generation of $1.8 billion. A 5% free cash flow yield compares favourably to other payment processors like Visa and Mastercard. PYPL also has a real scarcity factor there are plenty of marketplaces Amazon, Alibaba and Mercadolibre but there is no other pure play investment in digital payments.


Decisive has a postion in Paypal (PYPL) and Ebay (EBAY) stock.The material in this article is for informational purposes only and in no way constitutes a solicitation of business or investment advice. The material has been prepared without regard to any client's or other person's investment objectives. Before making an investment decision you should consider the assistance of a financial adviser and whether any investment or service is appropriate in light of your particular investment needs.