Shares of digital payments leader PayPal (PYPL 2.90%) are down mightily over the last nine months, now more than 60% below the all-time high reached last summer.
Of course, there are valid reasons for the decline, including losing a major exclusive contract with a large customer, pandemic-era tailwinds fading, and the threat of higher interest rates pulling down the value of growth stocks.
On the other hand, with the stock and valuation down so much, others may see a big opportunity in this former fintech darling. So which side will prevail?
What the bears will say about PayPal
Not much has gone right for PayPal in recent months, and bears will be quick to tell you that. Most notably, the stock took a plunge after its recent conference call, in which management revised down net new active members (NNAs) and revenue projections for the year. Notably, the company abandoned several growth targets outlined just one quarter before. Not only was that disappointing, but it also dinged management's credibility, making even the more modest projections dubious.
Management guided for just 15 million to 20 million net new actives this year, after amassing 120 million new active members over the past two. That's a significant deceleration, and below prior guidance of 30 million to 40 million NNAs. Additionally, management abandoned its medium-term target of 750 million active members altogether. Currently, the company has 426 million active accounts. Management said it was having more success converting regular users to frequent users, but marketing aimed at infrequent or new customers wasn't effective, so it's pulling back.
Management also gave somewhat lackluster revenue guidance of 15% to 17% growth for 2022, below the 18% growth projection given as recently as November.
Furthermore, PayPal's margins seem to be on a downtrend, with adjusted (non-GAAP) operating margins falling from 24.7% in the fourth quarter of 2020 to just 21.8% last quarter, as average take rates continue to tick down. Management also projects just 0% to 3% earnings-per-share growth in 2022, despite higher revenue growth and share buybacks. That could suggest PayPal may be feeling some heat on competitive or regulatory fronts, or both.
In any case, it's clear PayPal's business is slowing down in 2022. Digital payments and e-commerce received huge adoption increases during the pandemic, but now that the pandemic tailwinds are fading, business appears to be slowing.
Image source: Getty Images.
What the bulls say about PayPal
All of those bearish points look valid and concerning for PayPal. But PayPal bulls would probably point to not one but several one-time elements that will weigh on the first half of 2022, but should fade later on in the year. That could lead to growth accelerating in the second half and into 2023. Off a multi-year low valuation, accelerating revenue could lead to better things for the stock.
PYPL PE Ratio data by YCharts
What are these one-time elements holding back 2022 results? First, PayPal's revenue from former parent and large customer eBay (EBAY 1.32%) will decline for the first half of the year. PayPal used to be the exclusive payment option on eBay, but eBay didn't extend its agreement with PayPal, instead choosing European processor Adyen (ADYE.Y -1.57%).
PayPal will still be a payment option on eBay, as it is on other sites, but the loss of the exclusivity is causing revenue from its largest customer to decline. The transition just began over the past couple of years, but management expects a "new normal" in eBay baseline volume will be reached by mid-2022.
While revenue came in at 18% last year, PayPal's revenue outside of eBay grew 29%, which is magnitudes better. In the fourth quarter, eBay's payments volume was less than 3% of total payments volume, down from 6% for all of 2021 and 13% in 2020. So PayPal's growth should accelerate after eBay revenue reaches a steady state. The eBay contract is also higher-margin, which is why PayPal's overall operating margin has been sliding over the past several quarters as eBay revenue declined. But that should stop too, and perhaps move in the other direction, once the eBay decline is over.
Second, PayPal's earnings benefited strongly from reserve releases it took in 2021 on its loan portfolio. Though it shares the economics with partners, PayPal does have credit exposure. In 2020, the company took reserves on expected losses as COVID-19 broke out. But as the economy bounced back strongly, those extra reserves were released in 2021, benefiting margins by 125 basis points.
As the economy has now swung back to concern over inflation and recession fears, PayPal is reserving normally once again. So going from reserve releases to a reserve build will affect its bottom line -- but again, this appears to be a one-time phenomenon due to the extraordinary bounce-back of the economy from COVID-19.
Finally, the delta and omicron variants and associated supply chain issues hurt PayPal's cross-border revenue, which also carries a higher fee and margins than the average PayPal application. But as the world hopefully emerges from COVID-19 and supply chains improve, that high-margin revenue should come back as well this year.
Oh, 2022 will also see Amazon adopt a "Pay with Venmo" button on its site, which could certainly lead to increased volumes throughout the year.
The verdict
PayPal has been punished severely, down as much as many profit-less growth stocks amid the rise in interest rates. But PayPal generates a healthy amount of free cash flow, with management projecting $6 billion this year, which would be an 11% increase over 2021.
At 20 times this year's cash flow estimates, and with financials potentially accelerating through 2022, shares seem reasonably priced here. PayPal is still a leader in digital payments, which are taking market share from traditional methods. With a first-mover position, PayPal also has the resources to buy back stock and make acquisitions to bolster growth in the years ahead.
I don't own the stock yet, but I'd lean toward the bulls at these levels.
