Editor's note: This podcast talking about PayPal's (PYPL 0.59%) rumored interest in acquiring Pinterest (PINS 0.02%) was recorded before PayPal's Oct. 24 announcement that "it is not pursuing an acquisition of Pinterest at this time."

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This video was recorded on Oct. 22, 2021.

Dylan Lewis: It's Friday, October 22nd, and we're talking Pinterest and PayPal. I'm your host, Dylan Lewis and I'm joined by fool.com's absurd appraiser of accidental acquisitions, Brian Feroldi. Brian, what is going on?

Brian Feroldi: Dylan, we got visited by not the news fairy this week, but by the rumor fairy this week [laughs] and that's what this shows about.

Dylan Lewis: I like to think of them as cousins, the news fairy and the rumor fairy. One slightly more reputable than the other.

Brian Feroldi: That's right. In some cases, given the size of the deal that we're about to discuss, more often than not, I found these rumors tend to be true.

Dylan Lewis: Usually don't get any movement on a company that big, unless there's some pretty solid reasons to back up the rumor. Of course, we are talking about the interest that PayPal has, the rumored late-stage talks that they have to acquire Pinterest. Brian, you were one of the first Fools to really put Pinterest on, I think the community's radar, as an interesting investment. It has proven to be a multi-bagger for people who followed some of those early looks that you gave. I know there are also some people like myself who have some positions that are currently down on the stock, you were the person I wanted to bring on to talk about this.

Brian Feroldi: Pinterest was my wife's, and still is, favorite business on Earth. She has been a user of this platform for years and knowing how often she used it and how often I've seen it in my daily life, I knew that there was a lot of value to this platform. The company has been a roller-coaster up and down. The long-term trajectory has been positive and the interest by PayPal at this stage of the game isn't all that shocking.

Dylan Lewis: We're going to get into strategically why this might be a good fit. The pros and cons of a deal like this and then also a little bit of just how investors should think about the stocks they own in their portfolio when they get acquired. But first, I think we need to just give a run down, Brian, on what we know so far. We are talking about rumors, there's a little bit of speculation here, so we have to give that caveat, but there have been some details that have leaked out.

Brian Feroldi: Yes. Earlier in the week, both Bloomberg and CNBC reported that PayPal was in late-stage talks to acquire Pinterest. While again, it's unconfirmed by either company at this stage of the grain, given the size of this potential deal, I would lean toward this being more true than not true. The deal terms that we know, "know so far", is that PayPal is roughly willing to pay $45 billion to acquire Pinterest, that values the company somewhere around $70 per share. This news broke on Wednesday, and that price represents a 27 percent premium to Tuesday's closing price. No surprise, Pinterest stock shot up the day that this deal was announced, about 13 percent, PayPal stock actually went down. As of the time of this taping, Pinterest market cap is about 39 billion. It's currently trading in the low 60s, so there is still a discount to the "take-out price".

Dylan Lewis: People will always look at that first-day movement after the announcement as an indication of the market's perception of a deal like this. I will say, before we even get too far down into the details, there's been a lot of times that acquirers have sold off on the news that they are buying somebody new, and they've turned out to be wonderful acquisitions. There are times where acquires have popped on news of acquisitions and they've proven to be terrible acquisition. You can only really read so much into the immediate reaction in the first-day news. I imagine, Brian, that most folks that have listened to the show for a while are probably fairly familiar with Pinterest, but I do want to bring people up to speed a little bit on what the most recent quarters looked like, particularly as we start to talk about how this strategically might fit in for PayPal.

Brian Feroldi: 2020 was a fabulous year for Pinterest with everybody in the globe stuck in their houses, demand absolutely skyrocketed. While initially Pinterest's results lagged because of the slowdown in marketing spend, the company really came back with a vengeance in the third and fourth quarter. As a result, its stock just went straight up and to the right. More recently we've seen a slowdown in the company's user base. In the second quarter, which is the most recent quarter, we have financials on. Top-line growth was still outstanding, 125 percent revenue growth showing that advertisers are still choosing this platform more often. However, the stock actually sold off when the earnings were announced. Reason for that is because of the monthly active users. While the total monthly active users were up about nine percent to 454 million, in the United States, monthly active users actually declined by about five percent to 291 million. Wall Street is a forward-looking machine, so the fact that monthly active users were declining really spooked some investors.

Dylan Lewis: I think it's helpful to lay in a little context, Brian, just on the lifeblood of a social media company, is going to be the users long-term just because that's the monetizable activity. There's a perfectly viable business, at least for the next couple of years, for a social media company, that is where Pinterest is, where they are bringing a lot of ad inventory onto the platform. But what Wall Street and what investors want to see is that they have the growth lever of bringing those ads on, and also a growing user base, particularly in the US and in North America, which is the most important ad market out there.

Brian Feroldi: Yeah, that's the one-two punch for this company. One of the reasons why I was so bullish on Pinterest and still I'm, it's just the fact that they are so under-monetized when compared to many of the other social platforms. In the most recent quarter, the average Pinterest user in United States generated about five dollars in revenue, compare that to a company like Facebook, which is in the 40s. More importantly, the international numbers are very under-monetized. The average user in international markets only generated 36 cents in revenue, again, if you look at a company like Facebook, it's many multiples higher than that. A big bull case for the company was that there was going to be modest growth in total users, however, there was so much room to grow on the monetization side that that was going to power the company's revenue.

Dylan Lewis: Let's talk a little bit just about how this fits into the strategic direction for a company like PayPal. Because similar to Pinterest, I think PayPal is one of those companies, we get lucky Brian, we don't have to give too much of an introduction on what they do, people are pretty familiar with it. You're going to be thinking about this primarily with online payments, peer-to-peer payments, they've increasingly made investments in the buy-now-pay-later space. But the constant thread with all of those is generally we're talking FinTech and we're talking payments is what this company owns.

Brian Feroldi: PayPal is on a mission to make itself into a super finance app, and essentially, anything that has to do with money and finance, PayPal wants to do. The company does have a history of throwing money around to make acquisitions. Just some recent, in the last couple of years, that it's made would be Braintree, Venmo, Xoom, iZettle, Honey, which was its biggest acquisition at four billion dollars, and more recently Paidy which was roughly three billion dollars. That's a lot of money that this company has thrown around. The idea behind tying up with Pinterest is an order of magnitude bigger than its biggest acquisition. This would be a super bet for the company. But you can understand some of the rationale. The CEO of PayPal has gone on record saying they want to essentially double the number of active users that the company has in its platform by 2025 to 750 million. Buying Pinterest would help them get there. There's also an argument made that there will be some tie-ins for the merchant side where you could say, "Hey, you're already accepting our payments, have you thought about advertising to your customers? We can do so on one of the most popular social media platforms that also, by the way, has no negativity associated with it." I think that's a big part of the rationale.

Dylan Lewis: You also see some strategic fit here with payments being the focus for a company like PayPal and Knowing that Pinterest is really the starting point for a lot of people making purchase decisions. Very often the inspiration moment or the vision board moment for people, whether it's a project in the home DIY space, recipes, anything like that, it starts with Pinterest and then they are taken elsewhere to transact. We think of Pinterest primarily as an ad play, it would not be far-fetched to think that under PayPal, there could be some merchant and more e-commerce functionality built into what that company does.

Brian Feroldi: Yeah, that's a great point, that's one of the primary reasons why I've been so bullish on Pinterest. People go to Pinterest because they want inspiration so they can take action in the real life. When we were redoing our kitchen two years ago, we were on Pinterest almost every day trying to find ideas, it's a very natural extension from going from, here's this idea that I have to, how can I buy that thing? That makes, to me, Pinterest an incredibly monetizable platform.

Dylan Lewis: One of the other things that I think is kind of interesting too, is you gave that rundown of some of the acquisitions that they've made recently. Some of those names are probably not super familiar to folks in the United States and that's because a lot of them operate or are based elsewhere. iZettle is a Swedish company, Xoom helps people send money, reload phones, and pay bills around the world, Paidy is buy-now-pay-later in Japan. One of the things that we have noticed looking at the user transfer for Pinterest is, international is one of the better performing segments for them, that's where a lot of the growth is happening, and the US is seen as a more mature market. You see PayPal making these international investments and you know that that's where the excitement is with user growth in Pinterest. I think there's probably something there too.

Brian Feroldi: That's worth double-clicking on. As of the most recent quarter, there were 91 million monthly active users in United States, but there were 363 million in international markets. While the growth in users was declining in United States, it was up double-digits in international markets. Management also did give some forward guidance for the third quarter on monthly active users, and they basically we're expecting more of the same, a decline in monthly active users in United States, but growth in international markets. That tie-in for international reach definitely makes sense.

Dylan Lewis: Brian, I am a shareholder of both of these companies. Are you a shareholder of both these companies?

Brian Feroldi: I am a shareholder of both of these companies, Dylan.

Dylan Lewis: [laughs] I think it is only healthy for us to also make the case here against this deal, and take a little bit of a critical view and just try to understand what could go wrong with something like this. I think the most obvious thing to me, Brian, with something like this is we know what PayPal does, PayPal knows what it does, and it does it really well; it is pretty specialized, pretty focused in the payment space. This is something that looks like a TAM expansion opportunity, it also means that they'd be moving further and further away from what their core competency is.

Brian Feroldi: They don't really have any experience running a company like Pinterest. All the other acquisitions that they've done have been small relative to their absolute size, which is absolutely gargantuan. I mentioned PayPal is currently a $285 billion company; it's huge. They don't necessarily have working knowledge of how to run a company like Pinterest. It also matters on how they would actually do it. We've seen time and time again, history clearly shows that most acquisition especially big ones do not work out, the companies fail to realize the "synergies that are promised". How PayPal and Pinterest would integrate with each other would really matter.

Dylan Lewis: I like that operational point that you mentioned with just running that type of business because while Pinterest is, what we think of as probably in the best light social media company out there right now, it's at least controversial, I think, of any of them, it is generally seen as a relatively safe space on the Internet. It is still a treasure trove of user-generated content, that means moderation. Who knows where the winds go with that kind of thing. That is just a little different than the monster that PayPal is used to managing.

Brian Feroldi: It certainly is. The other thing worth noting is one of the big reasons that I was so bullish on Pinterest is it was still founder-led. Ben Silbermann founded this company but was still running it. If indeed this acquisition goes through, would he want to stay on and essentially become an employee of PayPal? That's something that is not really attractive to a lot of founders. If he was to exit, stage left, that would certainly be culturally changing at Pinterest.

Dylan Lewis: One other thing I saw out there that I thought was interesting, Brian, I'd love for your take on this is PayPal for all intents and purposes right now, is relatively neutral in the online shopping space. They operate in this space where they're helping everyone facilitate transactions, they exist in competition with other payment facilitators, but they don't own any turf that they are trying to point people to. We've talked about this with the likes of Roku in the past. That can sometimes be a super advantageous position to be in.

Brian Feroldi: It really can. That is one of the major reasons that PayPal was spun off of eBay. That direct tie-in with eBay was keeping PayPal from winning business. After the split happened and it was truly a neutral party, that's one of the reasons that PayPal has seen such phenomenal adoption and growth. There is an argument to be made that tying in with one social media platform so directly could inhibit adoption.

Dylan Lewis: Just as an aside, Brian, the PayPal-eBay spinout is one of the classic, sometimes it's better to own the other one things, right? When you roll a company out from underneath another one, sometimes you're able to materialize value that you can't recognize when they're owned by that parent company. That is like the poster child for that. PayPal has been far and away the better business to own of those two.

Brian Feroldi: Yes, it's not even close and it just shows you how much value can be unlocked sometimes for spinouts.

Dylan Lewis: Yeah, you mentioned before 285 billion in value to be exact. PayPal is, I think one of those sneaky big companies. I think it's easy to be like, there's relatively young, how big they be? Hundreds of billions of dollars in market cap big, and so I think in the context of a company that size $45 billion acquisition, Brian, it's a sizable one. It is not necessarily a course altering one if you're looking at the overall value business. But I think if you start digging into the top-line for these companies to cash available on hand, it's a different story. It is a pretty impactful acquisition, if it goes through.

Brian Feroldi: PayPal would be paying a pretty healthy premium if the pricing is indeed real. Again, Pinterest is doing about two billion dollars in trailing 12-month revenue. That is about one-tenth of PayPal, which did about 24 billion, so a $45 billion take-out price would be a price-to-sales ratio of about 22. Again, it's really the comparison to the market caps of the two businesses that I always look at. At $45 billion acquisition, that would be about 15 percent of PayPal's current market cap. That is a huge number.

Dylan Lewis: Yeah. If you look at the balance sheet, PayPal currently has 12 billion in cash and equivalences, 9 billion in long-term debt, so you got to pay for an acquisition somehow. It's either going to be cash, it's going to be debt, or it's going to be shares. I think we can figure out which of the two it's most likely to be based on those numbers?

Brian Feroldi: Yes. It would almost have to be equity, or at least involve a sizable amount of equity. I can't imagine that the company would want to go and settle it's balance sheet with 30 or $40 billion in additional debt. That would make it look upside down. I'm guessing that equity would be a major part of that consideration.

Dylan Lewis: Brian, before we move onto the broader view on this and just how investors should be thinking about businesses that they own when they get acquired, and really what the to-do list is. I want to take a second and pause and say, we own both of these businesses. How are you looking at this acquisition? I guess we own either of them and both of them either way, are you rooting for this to go through?

Brian Feroldi: I'm of two minds about it, to be honest. In general, I don't like it when the companies that I own get bought out. A lot of people do because it's fun to see that one day pop when the share price goes up by a whole bunch. But I put so much time and effort into finding these companies research thing then doing everything upfront. When I finally bring a company into my portfolio, I essentially wanted to do all the growing and all the compounding for me. If the company comes in and swoops that away for me, that stealing away a major opportunity from me. So in this case, while I understand the rationale for the deal, I'm not exactly for rooting for it to go through.

Dylan Lewis: I think that's one of the tough parts about being a long-term investor sometimes, is the short-term pops can be exciting negative on news, but if you buy a business, and you're planning on holding it for 3, 5,10 years, you're probably looking at far bigger upside on your thesis than whatever that one day pop is going to be. You're hoping maybe for multi-bagger returns depending on the type of investor you are and types of businesses you own. That's certainly the case I have with Pinterest, where I have some positions on Pinterest that are actually down. I'm in the red on some of those. I will probably get close to breakeven with this take-out price, but I see this being a potentially much bigger company in five-years than this takeout prices can be giving me right now.

Brian Feroldi: That's a particularly precarious situation when you buy a stock, it gets bought out and you end up losing money on the deal, and that's worth noting here. Pinterest traded at almost $90 per share earlier in the year, so if that $70 ticket price, again does materialize, that means there's going to be a bunch of shareholders there that are going to see this company taken away from them at a loss.

Dylan Lewis: Yeah. You hate to see it. In this case, I'll be able to enjoy the upside because I'll be a PayPal shareholder. Whatever the terms of the deal, maybe I'll be paying attention to that. But I do think there is something to be said for a stand-alone Pinterest in the future, being a business that maybe gets to the size of some of the other social media giants out there. We do that ARPU comparison almost every single time we talked about them, Brian, and it seems like there's so much upside. The investor in me wants to be able to see that materialize.

Brian Feroldi: I'm right there with you. Now, on the scoop side, the news flow out of Pinterest recently has not been exactly positive. Not only that they report the slowdown in user growth as we saw, but more recently, Evan Sharp, one of the companies co-founders, decided to step away from the business and leave. That's not something that I like to see, and another news and other companies also been dealing with some acquisitions by former employees that the company was discriminating against female workers. When you combine all that together with the fact that the stock price has been weak recently, it's possible that Pinterest management team has just decided running a public company is not as much fun as it is to run a private one and they are looking for an exit.

Dylan Lewis: We talked about how these are rumors at this point, it's speculation at this point. There are instances of these types of talks materializing into something that seemed like it was going to happen. You don't have to look too far in the past, Zoom and Five9, I think, are a great example of this Brian, where it seems like a deal is going to happen, it got to the vote, and that didn't come through, it didn't happen. Even though the companies could be interested in, you have to have the investor's interest as well.

Brian Feroldi: There's still a lot of hurdles that a couple of I'd have to go through in order for this to actually happen, so both companies have to acknowledge it publicly, the official terms of the deals would have to go through, then there would be a shareholder vote that would have to go through. In this case, it would really boil down to what does Ben Silbermann want because he is the co-founder, he owns a sizable amount of stocks, so he could probably push the deal through on his own if he wanted to. But to your point, there are instances, recent instances when deals were announced, shareholders were onboard and yet it failed through because of either a vote or the company later changed it's mind. That's exactly what we saw happen with Zoom and Five9. Both companies agreed to it, both companies, boards agreed to it and yet shareholders of Five9 ended up voting it down. There's plenty of land mines ahead for the still to go through.

Dylan Lewis: Brian, our listeners know that you are a very checklist oriented person. You're very structured thinker when it comes to your investing framework. I know that you have a couple of different things that you look at when you're considering an acquisition, and whether it's ultimately good and also how to think about it as an investor. What are some of those questions, so we can pass those along to our listeners.

Brian Feroldi: This is a common question that people get when they own a company and the stock is going to get bought out. There are a number of questions, and I'd like to go through to say, should I sell now, should I wait, what are the odds of this happening? One question to ask is, can the acquirer afford the deal? In this case, we've been through the market caps of the two businesses and PayPal clearly could access to finance, it needs to make a deal happen. Another question I'd like to think about is, could there be any regulatory hurdles that could prevent this deal from going through? In this case, I doubt it, I doubt that there'll be any government blocking for saying PayPal can't acquire Pinterest. But if these two businesses are both huge giants in the payment industry, that would be a different story. For example, we're making this up, but if MasterCard and Visa were going to acquire each other, that would be a completely different regulatory headache. Another question I like to ask is, do I want to be an investor in the combined company if the deal goes through? I'm already investor in PayPal, I'm already an investor in Pinterest in this case, if the deal was made in stock, for example, my Pinterest stock will just get converted into PayPal stock, assuming it was an equity transaction. I will be more than OK with that because I'm still very bullish on PayPal's business. In other cases, if the acquirer is taking over a company, and you are not at all interested in the acquirer, then it can make sense to close out early. The final thing is just you really need to make sure that you understand the terms of the deal, is it going to be paid in all-cash? Is it going to be paid in all stock? Is it going to be a combination of the two? That is something that you have to think about.

Dylan Lewis: One thing I'll throw out there just for people that keep in mind for their own portfolio, and usually what will happen is we'll see the rumor mill run, we'll see the details get firmed up over the course of weeks or months, and then we if there's actually a deal, we'll know when that transaction date is going to be, and people wind up in the spot where they're saying, I could wait for this deal to close and enjoy the full acquisition price, or I can sell or move out of the position at a slight discount right now because they always have the pricing a little bit of risk just in case, and move on with my life, and what should I do here? I think if you're in the mindset of I don't want to be a shareholder in the acquiring company, one thing that often gets overlooked when people are looking at the stuff is just check your holding period for the company that you own. You want to make sure that you're not accidentally setting yourself up for short-term gains, if you are selling before the transaction period actually finishes, and it's just an easy box to check. Keep that in mind, we're generally thinking 3, 5,10 years, but you happen to have a position in a company that's a relatively short-term position, and they have to get bought. Just add that to the checklist, make sure it's on.

Brian Feroldi: Certainly. You do have to think about the taxes now if you own either of these stocks in an IRA or Roth IRA or 401(k), obviously, you don't have to really consider the tax situation, but if you want to in a taxable brokerage account, that is completely something that you need to think about. In this case, the deal, it hasn't been announced yet, but if the deal does get announced in the next couple of days, there's no way that it was going to be closing in 2021, it would easily close in 2022. In some cases, even if you want to sell and there will be a tax to doing so, it can make sense to wait to January to do so, so that where you're delaying those long-term taxes out until the following tax year. Taxes are definitely part of the equation.

Dylan Lewis: Brian, I think that's all I got on this one. I am glad that we were able to get together and talk about it. I'm bummed that this company that has been a great performer for a lot of Fools could possibly be taken out of the market because in part, I enjoy talking about it so much with you. It's a fun one to talk about, and I think the show is probably one of the first opportunities that it's really gone on Fools radar. Hopefully there will be more Pinterest shows to come. But either way, we will be talking PayPal. [laughs]

Brian Feroldi: Pinterest is definitely a fun one to talk about and I'm really glad we got this opportunity to talk about when acquisitions happen because it's happened to me many times in the past where companies that I've hold, have just gotten bought out, even though I didn't want them to and I guarantee it's going to happen in the future.

Dylan Lewis: It's a constant truth of the market. That's just the reality of it. It's validating in a way. It's Paypal saying, "Hey, I like that thing that's in your portfolio. I think I might want it myself." [laughs]

Brian Feroldi: It does suggest that you're onto something that you're stock-picking.

Dylan Lewis: Let's hope so. Brian, thank you as always for joining me.

Brian Feroldi: Thank you, Dylan.

Dylan Lewis: Listeners, that's going to do it for this episode of Industry Focus. If you have any questions you want to reach out and say, "Hey." shoot us an email, [email protected], or tweet us @MFIndustryFocus. If you're looking for more of our stuff, subscribe on iTunes, Spotify, or wherever you get your podcasts. As always, people on the program may own companies discussed on the show and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Tim Sparks for the work behind the glass today, and thank you for listening. Until next time, Fool on!