Online payments pioneer PayPal (PYPL 2.90%) has seen significant growth over the last decade, but you wouldn't know it simply by looking at the stock price. Investors who purchased shares when eBay (EBAY 1.32%) spun off PayPal back in 2015 have received a 73% return compared to the 143% they could have had with an S&P 500 Index fund.
But the underwhelming stock performance hasn't necessarily been from lackluster financial results; the stock has also seen significant valuation compression.
Today, PayPal trades at a 13 times multiple of enterprise value to EBITDA (earnings before interest, taxes, depreciation, and amortization), which is far cheaper than at any other point in the company's public history and well below its average valuation over the years.
PYPL EV to EBITDA, data by YCharts.
Let's see whether or not this valuation presents a good opportunity to pick up some shares.
The PayPal business
Before diving into any sort of outlook on the stock, it's probably best to explain what PayPal actually does. While it has acquired many different payments-related businesses over the years, there are three segments that drive the bulk of its revenue.
The most important is PayPal-branded checkout. This refers to the actual PayPal button that customers see during the online checkout process. Last year, branded checkout accounted for 30% of PayPal's total payment volume (TPV). But it accounts for a much larger chunk of the company's gross profit thanks to the greater take-rate it brings in.
The second most important segment is what the company calls "unbranded processing." This is driven primarily by Braintree, which PayPal acquired for $800 million in 2013. Braintree, which competes with companies like Adyen (ADYE.Y -1.57%) and Stripe, is an unbranded payments processor that merchants can easily embed into their online checkout process. It has grown at 40% annually over the last three years and now processes more than $400 billion a year, or 30% of PayPal's TPV. But the company collects a smaller take-rate on these transactions.
Lastly, Venmo is a peer-to-peer payments app that PayPal also received in its 2013 acquisition of Braintree. It still accounts for a much smaller percentage of PayPal's overall revenue pie, but it has grown its TPV by 55% annually over the last three years and has the potential to offer lots of new features to customers of its sticky ecosystem.
In total, these three segments have helped PayPal drive substantial growth since 2015. Active accounts have grown at 14% annually, while revenue and free cash flow have increased by 16% and 22% a year, respectively.
What has gone wrong?
While PayPal's financial growth has no doubt been impressive, it is quickly beginning to slow. In the most recent quarter, PayPal's active accounts grew by just 1% compared to the same quarter a year prior, and management expects second-quarter revenue to grow by just 6.5% to 7%, a steep decline from the company's 16% annual increase over the last seven years.
Slowing growth isn't all that surprising for a massive company like PayPal, which already says it has more than 430 million annual active accounts, but the more concerning part is that the slowdown could be attributable to the recent success of Apple's (AAPL -0.35%) Apple Pay and Alphabet's (GOOG 9.96%) (GOOGL 10.22%) Google Pay.
Last November, Apple Pay was reportedly growing its adoption at 52% a year, which was substantially higher than any user numbers PayPal has been putting up, albeit from a lower base. The daunting thought of competing against Apple and Google on their own operating systems seems to have pushed many investors to the sidelines.
Is it time to buy?
Though the competition from big tech warrants concern, PayPal's current valuation doesn't require very lofty estimates to assume a good return. The company expects to generate $5 billion in free cash flow (FCF) this year, and it has a current market cap of $71 billion with very little debt. With shares trading at a market-cap-to-FCF ratio of 14, the company is eager to buy back its own stock and has publicly stated that it will spend $4 billion on repurchases this year alone.
At that kind of valuation, even a little bit of growth can go a long way. And I think it's reasonable to assume that PayPal can still grow in spite of the competition thanks to the ongoing increase in online payments as a whole. If you're a long-term investor looking for a steady business with consistent cash flows, I think PayPal deserves a place in your portfolio.
