The adoption of electronic forms of payment, especially in mobile payments, is one of the biggest megatrends in the global economy. PayPal Holdings (PYPL -1.97%) and Mastercard (MA -0.11%) are at the center of this trend. But today, only one can be the better buy.
Let's find out which one it's going to be.
Image source: PayPal.
The investment case for PayPal
Since the spinoff from eBay (NASDAQ: EBAY) two years ago, PayPal has pursued a strategy of offering customers more choices in how they pay for things with their account. PayPal has formed several partnerships with card issuers, big banks, and other technology companies including Facebook, Apple, and Alphabet, which has driven growth in key operating metrics, as shown in this table.
| Metric | 2017 | YoY Change |
|---|---|---|
| Revenue | $13.09 billion | 22% (excluding currency) |
| Earnings per share | $1.90 | 27% |
| Total payment volume | $451 billion | 27% |
| Customer accounts | 227 million | 15% |
| Transactions per customer account | 33.6 | 8% |
Data source: PayPal Holdings. YoY = Year over year. Earnings per share data is non-GAAP.
This open-platform strategy has clearly been paying off with the number of customer accounts accelerating to a growth rate of 15% in 2017, compared to 10% in 2016. What's particularly encouraging for PayPal's growth is that new customers who have joined PayPal over the last year are using their accounts more frequently than older customers, which implies newer customers are signing up with PayPal because they like the flexible options when transacting. It also implies that as more customers sign up, the growth in transactions per account may accelerate.
Right now, PayPal's customers use their account on average about once every two weeks, but there's potential to drive that even higher. For example, customers of PayPal's Venmo -- a popular peer-to-peer payment app -- use their account four to five times per week. New features have been added to improve ease of use. One such feature, One Touch, which allows users to more quickly access their account without entering login information, has been adopted by 80 million PayPal users and is helping increase engagement.
One Touch has been absolutely huge for PayPal in building relationships with merchants. Merchants love PayPal for two very important reasons. First, PayPal users complete transactions at checkout with their mobile phone at twice the rate (87%) of the industry average (44%). Second, One Touch allows merchants to offer customers a one-click checkout when they use PayPal, which enables those merchants to better compete with Amazon.com's popular one-click buy button.
In 2017, strong growth in customer accounts and engagement drove total payment volume growth of 29% (excluding currency). This growth is happening as big banks and major credit card brands are incentivizing their customers to use PayPal, which cements the PayPal brand as a payments leader in the global economy.
Image source: Mastercard.
The investment case for Mastercard
Cash, checks, and legacy Automated Clearing House transactions represent 90% of the total $225 trillion commerce market. This means Mastercard and PayPal should be able to grow for decades, as more consumers gradually migrate to electronic forms of payment.
| Metric | 2017 | YoY Change |
|---|---|---|
| Revenue | $12.5 billion | 15% (excluding currency) |
| Earnings per share | $4.58 | 21% |
| Gross dollar volume | $5.242 trillion | 10% |
| Cards | 2.429 billion | 5% |
Data source: Mastercard. YoY = Year over year. Earnings-per-share data is non-GAAP.
A key difference between the two companies is Mastercard's extremely high operating margin of 53%, while PayPal earned an operating margin of 16.2% in 2017. This reflects Mastercard's capital-light operating structure as a pure transaction processor, whereas PayPal is an intermediary between users and their credit card issuers.
Unlike Mastercard, PayPal incurs a transaction expense, which it pays to banks and credit card issuers when users pay with their PayPal account. Excluding transaction expense, PayPal would have an operating margin of 50%, similar to Mastercard.
Mastercard is in a powerful position as a de facto tollbooth operator in the global economy, collecting a fee whenever someone swipes a credit card at a store. And with 1.8 billion branded cards around the world, Mastercard has built a trusted brand for decades that cannot be easily duplicated.
And the better buy is ...
Both companies perform consistently well. Mastercard has grown revenue at an average of 10.7% per year over the last four years. This serves as a good guide for what to expect over the long term. As for earnings, analysts currently expect Mastercard's growth rate over the next five years to be 20% per year.
PayPal has been growing faster. In 2017, PayPal's non-GAAP revenue grew 24%, and management expects the top line to grow approximately 20% in 2018. Analysts currently expect PayPal to grow earnings per share 18% over the next five years, somewhat lower than Mastercard.
Overall, I wouldn't give either company the advantage in terms of expected future growth. Given the huge market opportunity, investors should expect Mastercard and PayPal to continue posting double-digit growth rates in both revenue and earnings for several years.
Turning to valuation, Mastercard currently trades for a slightly lower P/E ratio on both a trailing and forward basis, as shown in the table.
| Metric | Mastercard | PayPal |
|---|---|---|
| Market cap | $186.74 billion | $94.2 billion |
| Trailing P/E | 38.9 | 41.1 |
| Forward P/E | 25.2 | 28.3 |
| Dividend yield | 0.57% | NA |
Data source: Yahoo Finance. Trailing P/E calculated using non-GAAP earnings per share.
Mastercard also pays a small dividend yield of 0.57% at the time of this writing, whereas PayPal has yet to initiate a dividend. However, the recent deal with Synchrony Financial, where PayPal sold $6.8 billion of credit receivables on its balance sheet, may give management the extra cash to begin paying a dividend in the near future.
Additionally, Mastercard CEO Ajay Banga is viewed favorably by 94% of employees, according to the management-review website Glassdoor. This is higher than PayPal CEO Dan Schulman's rating of 85%. This may seem minor, but these approval ratings reflect overall employee satisfaction, which can contribute to company performance over the long term.
Both companies should be good investments over the long term. But right now, Mastercard has the edge in valuation and CEO approval, which, for me, makes it the better buy.
