Of all the companies that could make a bid for Pinterest (PINS 0.43%), Paypal (PYPL -1.83%) was one of the least likely.
The fintech giant's business is only tangentially related to the social media company's, and Paypal seems mostly interested in Pinterest's potential as an e-commerce platform that can be tucked into its "super app."
However, the logic behind a potential deal, which was first reported by Bloomberg, isn't really important to Pinterest shareholders. What matters is the price -- and $70/share is a head-scratcher for a stock that was one of the breakout stories of the pandemic, and was trading above that level for much of this year.
Image source: Pinterest.
While the offer represents a 26% premium over Pinterest's closing price on Tuesday before the news broke, the stock was trading near a 52-week-low at the time, and $70 a share would still be 22% below its peak in February. In other words, anchoring to its price before the news broke seems to be a mistake here, especially for a high-growth, volatile stock. That's the biggest reason why a buyout for $70 a share isn't in the best interest of Pinterest investors. As a stand-alone company, Pinterest has the ability to greatly exceed that value.
A brief refresher
The stock price tumbled when the company released its second-quarter earnings report, which showed that its domestic user base shrunk unexpectedly. Management also said that revenue growth would decelerate significantly in the third quarter after the top line more than doubled in the second quarter. However, there were good explanations for both of those potential warnings signs.
First, monthly active users (MAUs) surged in Q2 2020 as the pandemic lockdown drove millions of people to check out Pinterest for the first time, looking for recipes, children's activities, are other ideas to stave off boredom. However, many of those lockdown visitors were low-value users, who just came to the platform under unique circumstances. Even though Pinterest lost domestic MAUs over the past year, that number is misleading because the value of its user base still increased. In its shareholder letter, management explained, "Virtually all of the difference between our Q2 MAU guidance and our actual Q2 MAUs is attributable to a decline in MAUs who use Pinterest on the web. These users have tended to be less engaged and generate less revenue than Pinners who visited our mobile apps directly." Domestic mobile users actually increased year over year and were up by more than 20% internationally. Domestic MAUs under 25 increased by double-digit percentages, showing that the company is gaining traction with the youngest generation of consumers, which is a valuable demographic for advertisers.
Meanwhile, the company called for revenue growth in the low-40% range for the third quarter, a strong clip that only seemed disappointing because the top line soared 125% in the second quarter.
Pinterest's profit potential is clear
When Pinterest had its IPO in 2019 at a valuation of around $10 billion, it was still unprofitable, but its scalability and profit potential are evident after the pandemic-driven surge. In its second-quarter report, the company posted an adjusted EBITDA margin of 29%, or $178 million in EBITDA, on $613 million in revenue. That surge has come not just from growth in its user base, but as the company has improved its advertising products and built out its advertiser ranks. Pinterest has only just started monetizing its platform, especially in international markets, and the business has plenty of potential -- not least because many of its users come to it for specific use cases and are receptive to ads.
Don't take the money
Selling out to PayPal for a price that's 22% below its February peak would be a disservice to investors. Pinterest has significant revenue growth momentum from large advertisers and international markets, and a business model that is just starting to demonstrate its scalability. The company has a bright future ahead of it, in spite of the stock's weak performance this year.
At best, there's a weak business case for merging with PayPal, and at worst, management would be depriving shareholders of significant upside potential as a stand-alone company. Management and shareholders are better off remaining independent and allowing the company's growth to play out.
