No matter how good a company appears on paper or its market opportunity, consistent missteps from management are a red flag for investors. Unfortunately, that's exactly what many investors are encountering with PayPal (PYPL 2.90%).
PayPal has had its fair share of hiccups over the past two years. First, it was rumored to be buying Pinterest. Then, it scrapped aggressive growth projections just one quarter after they were released. And recently, it committed perhaps its biggest blunder yet -- the $2,500 misinformation fine.
Even unintended actions have consequences
On Oct. 8, PayPal released an update to its user agreement that included a clause allowing PayPal to fine its users $2,500 for using the service to spread "misinformation." However, PayPal quickly retracted the update and said the misinformation clause had been included in error.
Regardless of whether the policy was published in error or dumped because of the public blowback, the damage is already done. According to Google Trends, the phrase "delete PayPal" is about 10 times more popular in searches now than it has been over the past five years. Additionally, many members of the so-called "PayPal mafia" -- founders and early employees of the fintech who have since gone on to found numerous other companies -- have spoken out against the policy.
For example, one-time company President David Marcus tweeted in part: "PayPal's new AUP goes against everything I believe in." Elon Musk (another PayPal mafia member) replied in agreement with Marcus.
It remains to be seen how this stunt impacts the business, but PayPal was already on a downward slide before this story broke.
Investors will have to wait to see what the damage is
Regardless of whether or not management ever actually intended to enact this policy, it has now been definitively dropped. However, since news of it broke on Oct. 8, PayPal stock is down about 6% versus the broad market's 1% rise. From a bigger picture perspective, though, the stock is now down more than 70% from its all-time high.
A 6% drop is significant, but it also indicates investors don't view this event as a thesis-buster. Management will likely face questions about it during PayPal's upcoming third-quarter earnings call on Nov. 3. But until its next report arrives, investors can only evaluate the company based on the most recent data they have -- its second-quarter results.
In that quarter, PayPal's active accounts rose 6% year over year to about 429 million. However, because the third quarter ended Sept. 30 -- before the user agreement furor erupted -- investors won't actually get a clear picture of its impact (if any) until the year-end results come out.
While PayPal grew its revenue 9% year over year in the second quarter, its adjusted earnings per share decreased 19% to $0.93, but free cash flow still rose 22%. To improve its bottom line, PayPal announced cost-cutting initiatives that management expects will save the company around $900 million in 2022 and $1.3 billion in 2023. These plans contributed to management raising its full-year outlook. As for valuation, PayPal currently trades at 19 times free cash flow -- not expensive but not cheap either.
The "misinformation" fine has spooked some investors and users (as it should have), but until we know what actual effect it has had on the business, I won't be buying PayPal stock. Even then, the incident is making me rethink my PayPal position. It's not about the intentions or thoughts behind the user agreement blunder. It's more about a company that can't seem to get out of its own way.
Depending on how these next few quarters shape up, I may sell my shares -- even at a loss. There are many fantastic businesses out there, and I'm not going to waste my time owning shares of one that isn't executing well.
