Shares of PayPal (PYPL -1.91%) fell 25% the day after it reported fourth-quarter and full-year earnings results on Tuesday, Feb. 1. In this report, the company posted worse-than-expected net income and forecast underwhelming first-quarter revenue.
This has been a tough few months for PayPal. The company cited supply chain issues and inflation as reasons growth slowed, and the fact that it is cutting ties with eBay (EBAY 0.53%) doesn't help the situation. However, PayPal still has a rock-solid foundation, and its shift to a new business strategy could pay dividends in the future. Here's why I am less worried than many other investors.
Image source: Getty Images.
Why shares slumped
The macroeconomic environment hurt many businesses in the fourth quarter, and PayPal was no exception. Inflation crimped spending on its platform, and supply chain constraints reduced the company's cross-border volume rates. As a result, revenue grew just 13%, posting $6.9 billion for Q4, and net income was $801 million -- down from $1.5 billion in the year-ago quarter.
The company was also affected by its separation from eBay. PayPal used to be owned by the e-commerce company, but since they split, PayPal had been the partner and primary payments platform. However, eBay announced a new partner in 2018, Adyen (ADYE.Y 2.64%), to replace PayPal. This is expected to be finalized in the first half of 2022.
eBay -- while a small fish compared to e-commerce platforms like Amazon (AMZN 0.81%) -- is still expected to take $600 million off PayPal's top line: $400 million in the first quarter and $200 million in the second. Consequently, PayPal is anticipating revenue growth of just 6% year over year for Q1 -- much lower than the company's traditional 20% growth rates.
A miss on the bottom line and lowered forecasts were enough to hurt the stock, but the company continued to hand out what seemed like bad news to investors. The company reported 9.8 million net new active accounts (NNAs), which was lower than expected and 3.5 million fewer than third-quarter 2021.
This was primarily driven by a 4.5 million reduction in NNAs, which management cited as "illegitimate accounts." The company also announced that it will not hit its goal of 750 million accounts in the future. Instead, management said, it will shift its focus to increasing user engagement and lowering churn.
The road ahead
PayPal's growth strategy has historically been to expand its user base, and it has done that well. Today, it has more than 426 million users on its platform. However, PayPal is going to start focusing on increasing user engagement rather than expanding its user base. Chief Executive Officer Dan Schulman noted in the Q4 earnings call that PayPal sees lots of users added in any given quarter, but many of them are not engaged or only do one transaction, then they go dormant. When the company spends money to reengage these users, they engage once, then are inactive again. With this, a lot of capital that PayPal spends on these users goes to waste and typically results in a high-churn environment.
What PayPal wants to do is increase engagement among its active and loyal users, and focus less on attracting NNAs and inactive past users. This, Schulman claims, will be more capital-efficient, increase the company's return on investment, and result in stronger revenue and profit growth. This will, however, damp the company's NNA growth, and the company now projects 35 million to 40 million NNAs this year, lower than the 122 million it had in the past two years combined.
Despite this weaker growth and expected weakness in the first half of 2022, PayPal is still a financial machine, and that should not be underrated. Last year, the company brought in more than $5.4 billion in free cash flow, resulting in a 21% free cash flow margin. The company's net income was similar: It brought in almost $4.2 billion in 2021.
While the loss of eBay is going to hurt the business, it has already been developing even better partnerships with other companies to replace it. PayPal announced deals with Amazon, DoorDash (DASH -0.44%), and Instacart, just to name a few. As a result of these strong partnerships, Chief Financial Officer John Rainey said he expects that revenue growth will rebound to its normal 20% range by year end.
Why I am still optimistic
PayPal is a market leader in payments, with more than 75% acceptance among the 1,500 largest retailers in North America. This beats out other fintech platforms like Apple (AAPL 5.98%) and Affirm (AFRM 1.42%). This is not to mention that its user count is larger than the entire U.S. population, and represents over 6% of the entire world's population.
This industry leader might be weaker in the short term as it faces a strategy shift and headwinds, but PayPal's long-term prospects look strong. Its shift to engagement might temporarily hurt its bottom line, but this more profitable strategy will likely benefit the company -- and shareholders -- over the next five years, which is why I think PayPal is still a robust company today.
