PayPal (PYPL 1.96%) investors were seeing huge gains after the digital payments giant spun off from eBay in July 2015. Shares were up 741% in roughly the first six months of trading, only to come crashing down 79% since then. The most recent earnings report also disappointed shareholders.
Nonetheless, this might still be a company that's on your radar, so it's a good idea to have a solid understanding of its operations. Here are three important things about PayPal that the smartest investors know.
Facing a notable slowdown
PayPal's business was firing on all cylinders during the depths of the coronavirus pandemic. The company added 73 million net new active accounts in 2020, with another 49 million in 2021. And in each of these years, revenue soared by greater than 18%. Consumers were spending more time at home, which led to more online shopping on discretionary items. This was a clear boon for PayPal, as it is the most popular checkout option at the top 1,500 retailers in North America and Europe.
This monster success led CEO Dan Schulman, who is retiring at the end of 2023, to set an extremely ambitious goal of PayPal amassing 750 million users and $50 billion in revenue by 2025. In 2021, the company generated $25 billion in sales and ended the year with 426 million active accounts, so he certainly was aiming high.
But as the economy and consumer behavior have normalized, PayPal has been dealing with a major slowdown. In 2022, the company added only 8.6 million net new active accounts. And during the first three months of 2023, active accounts decreased sequentially.
The post-emergengy phase of the pandemic, an environment where PayPal's growth will be more subdued, has forced Schulman to abandon his lofty targets. And with the payments space known for its fierce competition, particularly from the likes of Block and Apple Pay, it might be a good idea for shareholders to temper growth expectations.
Operating a transaction-based model
Unlike Spotify or Netflix, which make their money mainly from monthly subscriptions, PayPal operates a business model that benefits from greater usage. Anytime someone uses PayPal at checkout, the business collects a fee, called a take rate. In the most recent quarter, this take rate was 1.99%. And in 2022, 90% of PayPal's overall revenue was derived from transactions. In other words, the more activity occurring on the platform, the better the business performs.
PayPal processed a whopping $1.36 trillion in total payment volume in 2022, a figure that has a direct impact on the company's revenue numbers. By making PayPal available as a checkout option at more places and introducing new features like Venmo's partnership with Amazon or buy now, pay later functionality, the hope is that PayPal usage rises.
What's interesting about this business model is that it can act like a natural inflation hedge. If the prices that merchants charge for items go up, the amount PayPal counts as revenue should increase as well. But because the purchases occurring on PayPal's network lean toward discretionary items, activity can take a hit in tougher economic times. It's obvious this business is exposed to macroeconomic trends and changes in consumer sentiment.
Outstanding financial profile
Another critical and must-know attribute about PayPal is just how strong its financials are. The payments space can have very lucrative business models at scale, and PayPal demonstrates this. Once the technological infrastructure is developed, handling additional transactions should carry high margins.
And this business produces free cash flow (FCF) like there's no tomorrow. In 2022, PayPal generated $5.1 billion of FCF, or 19% of revenue. This has allowed management to conduct sizable share repurchases. Over the past year, the outstanding share count has been reduced by more than 3%.
What's more, PayPal has a strong balance sheet, which has made it much easier to weather the recent slowdown. As of March 31, the company had $15.3 billion of cash, cash equivalents, and investments compared to debt of $10.9 billion. Coupled with PayPal's ability to consistently generate positive FCF, this is a solid position that many businesses would love to be in.
By now, investors should be well informed about some of the most important aspects of PayPal's business. Hopefully, you'll be able to make better investment decisions about the stock.
