PayPal: Follow the Money

09/10/2018 5:00 am EST

Focus: TECHNOLOGY

Todd Shaver

Founder and Editor-in-Chief, BullMarket.com

PayPal (PYPL) has come a long way from simply giving early online shoppers a way to pay for purchases without presenting a physical credit card, notes Todd Shaver, editor of BullMarket.

This is now one of the strongest technology companies in the world, with a dominant core business and exciting future prospects as management continues to invest in both R&D and M&A. And at $109 billion in market capitalization, this “niche” stock is now one of the biggest in its sector.

We’ve written extensively on this gem in the past, but you can’t say enough good things about PayPal, so it’s time for a refresher course.

The 2Q18 numbers were electric. With the top line expanding 22% and earnings up 27%, management has once again found the operational keys that unlock that rarest of gifts in the Transaction Services industry: margins improving faster than scale.

Granted, PayPal has a lot of room to keep capturing both efficiency and scale, which means shareholders can still look forward to good things ahead. A true giant like Visa books more than half of its revenue as profit. PayPal still looks heroic when it can get its margin above 15%.

And with total payment volume up 30% from last year, growth continues apace. PayPal ran $140 billion in transactions across its network in the recent quarter, keeping 3% of it (a staggering cut in this business), before ending up with a $700 million profit. In credit card land these are tiny numbers. For Technology investors, they’re huge.

Growth continues thanks to new acquisitions that take the core PayPal offering wherever money goes, whether that’s fraud protection (Simility), payroll (Hyperwallet) and spending pattern data (Jetlore). A less ambitious company would return profits to shareholders in the form of dividends. PayPal keeps putting that cash to work.

Paying on your phone? PayPal now moves $17 billion a year across its mobile Venmo solution. Want to accept credit cards offline? PayPal spent $2.2 billion in cash to buy iZettle and ensure that they can help it happen.
But the beauty of investing in PayPal is the company’s core business model. The company has close to 250 million active accounts — adding 30 million in the previous year alone.

That successful market penetration creates a “virtuous cycle” in which customers demand PayPal functionality, forcing merchants to become part of the network, which in turn feeds additional penetration in a self-sustaining adoption loop. We saw this in the early days of credit card payment and we’re watching something similar play out now.

And management isn’t asleep. Over the past year, earnings are up 46% while expense growth has been relatively restrained at 12%. A similar pattern applies over the last five years, with earnings up 465% and expenses up a mere 75%. That’s the most direct expression of efficient growth we can offer. This company is literally a cash machine.

PayPal is that rare bird: a fundamentally strong blue chip that also happens to be a growth play. Strong earnings coupled with relatively low expense growth illustrates how adept management is at creating value for investors.

Acquisitions make the company even stronger and more competitive. Based on all of this, there’s every reason to believe PayPal will be a dominant force in the economic landscape for decades to come. We just raised our target to $106. We’ll raise it again.

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