Is This a Disaster or an Opportunity for Fintech Giant PayPal?

The number of new users coming onto the PayPal (PYPL 2.90%) platform is beginning to slow, and management is now shifting its business strategy to focus on monetizing its current user base. In this segment from "The Future of Fintech," recorded on Feb. 3, Motley Fool contributors Matt Frankel, Jason Hall, and Danny Vena examine what could be ahead for the fintech giant in this new environment. 

Matt Frankel: This is a five-day chart of PayPal. Look at how it fell off a cliff after earnings, it had been up for the three days before, about 10 percent and now is down 20 percent.

Jason Hall: You go to bed with a great view of the ocean from the top of the cliff and you wake up and you are in a cave.

Matt Frankel: That's what happened with PayPal. If we zoom out a little bit, let's say a three-month chart, PayPal is now down 45 percent over the past three months. The latest decline wasn't even the worst, [laughs] it was already down pretty far. If I give you some of these numbers, let's try to dig into why this happened. The headline numbers look pretty strong. Total payment volume is up 23 percent year over year and is now over $1.3 trillion on an annualized basis, 1.3 trillion. PayPal's revenue was up 13 percent year over year. It earned four dollars and 60 cents per share on adjusted earnings, it was GAAP profitable on an adjusted basis, its earnings were up 19 percent year over year, so that means it now trades for 30 times trailing earnings. It added 9.8 million net new accounts, to be fair, 3.2 million of those came from the Paidy acquisition. PayPal is very free cash flow positive. There is Jason putting some of the numbers on this screen right now.

PayPal generated $5.4 billion in free cash flow in 2021, that's a pretty impressive number, especially in the context of some of these fintech companies, a lot of which aren't profitable at all yet. PayPal is very profitable, so they can make theoretically, a five-billion dollar acquisition this year and fund it just from the money it made. Those might sound like numbers that would make a 20 percent increase, not a 20 percent drop. What went wrong? As Jason and Danny both know, there's one sure-fire way for a company to tank its stock after earnings, and that's the issue of a weak forecast, right, guys?

Jason Hall: That's right. Yeah, guidance.

Matt Frankel: PayPal did just that. There were a few problems. One was a weak revenue growth forecast. Analysts were expecting about 18 percent revenue growth in the first quarter, they guided for a range of 15-17 percent. Earnings are essentially expected to be flat, I mentioned they were 4.60 a share in 2021. They're expecting not much more than that in 2022 and they're only expecting, and here's, I think the big problem, they're only expecting 15-20 million net new accounts.

They reported they found 4.8 million illegitimate accounts on the platform that were essentially opened up to get incentives, but not really doing anything for the company. It had previously said that it was expecting about 750 million users on the platform within a few years, it's up 426 million now, it completely walked back that comment and now says it's shifting its focus to monetizing its current user base essentially and maximizing the value of that.

Jason Hall: Probably just the guidance, it's like this midstream shift in strategy that I think as playing a part of this too.

Matt Frankel: Yeah, the shift from all our user growth to improving monetization because that's proven difficult so far. Venmo has proven very tough to monetize especially. Guys any thoughts on whether this might be an opportunity now, whether you're staying away from it, what do you think?

Danny Vena: Well, I wanted to add a little bit of color here. I think that this was a perfect storm when it came to things that Wall Street could view as uncertainty with PayPal's earnings. If you look at some of the statements that were made by John Rainey, the Chief Financial Officer, he talked about a decline in seasonally adjusted retail sales, he talked about a decline in consumer spending and how they ended up with a softer end of the quarter, talked about the impact of inflation, a lack of stimulus and he said that these things, changes in personnel consumption, labor shortages, supply chain issues, weaker customer sentiment all played into lower spending by PayPal users with lower incomes. That was one thing that Wall Street just freaked out completely about. Essentially, they were saying people are spending less money and that continued into the first quarter.

I think the second thing that really, and Jason mentioned this already, this midstream change in strategy. You can look at that as a glass-half-full or glass-half-empty. If PayPal sees as their management sees that the number of users coming onto the platform is slowing, and I'm not surprised by this because, we saw that with Netflix, particularly where after a huge bump in users last year it slowed down, PayPal may be seeing the same thing. It makes sense to me from a management standpoint that they would shift their focus and say, "Okay, if we are going to be growing users slower over the coming year, maybe we should focus on better monetizing the users that we have while still trying to grow our user base."

Jason Hall: I think that's the thing because if you look at the growth rates, they are certainly slower, and I imagine that's probably going to continue. But I think if you look at the number of users that it's adding, that's still a positive thing, it's still adding a lot of users. But I do think, and I'm not going to say I'm a PayPal bear because I like the business, I think it's very well-run. I think, Matt, you were talking about it when you were going through the earnings, this is not just a profitable business on a GAAP basis, but also a cash cow business, it generates massive amounts of operating cash flow that it can use, and massive amounts of free cash. Even after investing back in the business, there's a tremendous amount of cash that's leftover.

I guess, for me what I get hung up on and this is maybe Matt, Danny where you guys can weigh in, is thinking about what you are looking for as an investor, where does PayPal fit? I think it's probably going to generate above-average growth and should be able to over the next five-plus years, generate steady double-digit earnings-per-share growth, I think that's a reasonable expectation. But to me, it seems like in this space, if you're looking at fintech, if you're looking at payments, if you're looking in this area, it just seems like there's better opportunities to invest in growthier companies. Is this at a point now where you have to start really looking at it as more of a value play? Not a traditional value play, but a great growth at a really good value.