Payments giant PayPal (PYPL 2.90%) has a new, and very big, partner in its buy now, pay later (BNPL) business. In a press release, it announced that KKR (KKR 0.71%), a global investment firm managing more than $500 billion in assets, had signed on to buy up to EUR 40 billion -- about $44 billion at recent exchange rates -- of "current and future" PayPal Later loans originated in Europe.
So what exactly does this deal mean for PayPal going forward? Is PayPal stock a buy? Let's break down the specifics and see.
What we know about the deal
At this point, there's not a significant amount of detail, and it's likely that both KKR and PayPal intend to keep the specifics confidential. So we don't know if KKR negotiated a significant discount to the book value of these loans, or if PayPal was able to toe the line on market value. According to the terms of the deal that were disclosed, KKR will buy "substantially all" of PayPal's European BNPL loans held on its balance sheet, as well as future European BNPL loans PayPal originates, with the deal capped at the EUR 40 billion mentioned earlier. PayPal, a leader in digital payments, will continue to service existing and new loans, originate new ones, and operate all aspects of the customer-facing side.
PayPal also disclosed that it expects to get $1.8 billion of proceeds from the initial purchase of the existing BNPL loans KKR is acquiring, and said that it also has already included the impact of this deal in its full-year earnings guidance, announced back in May. In other words, this deal -- or a deal with someone to buy these assets -- has been in the works for some time now.
For KKR, which has a very long history as an acquirer of debt both for its own balance sheet and for client funds, the move is a way to tap into the increasingly popular BNPL space with a large, trusted partner that can handle the customer-facing aspects. In other words, earn the higher yield these more risky loans can pay while working with one of the better operators in the space.
Why this makes sense for PayPal
In short, this is all about maintaining a strong balance sheet and freeing up capital. By working with KKR to offload those loans from its own balance sheet, and have a partner lined up to acquire future European BNPL loans, PayPal can be more asset-light, and earn fees originating and servicing the debt while KKR and its investors take on the risk of loan losses.
We also know exactly what PayPal plans to do with the freed-up cash, too. In the release, the company said that it would increase its planned share repurchases this year from $4 billion to $5 billion. At recent prices, that's almost 7% of the company's market cap it will buy back this year.
The question is whether this portends similar deals in other markets in the future. It ended the first quarter with $7.5 billion in loans and interest receivables on its balance sheet, and it's possible PayPal changes its BNPL strategy to owning less of the debt and focusing on originations and servicing.
Is PayPal a buy now?
On the premise of this deal alone, PayPal isn't a buy. But taken in total with the rest of its business, a move that is clearly a de-risking of its balance sheet, management's intense focus on shareholder returns, and the current valuation, PayPal is very attractive. It may look pricey at 29 times last year's earnings, but it's below 16 times free cash flow and about 14 times operating cash flow. That's cheap, and neither fully reflects the cash from investing/finance benefits of this deal.
PayPal's fastest development may be in the rearview mirror, but its growth is far from over. Investors can look squarely ahead and see a future of continued per-share cash flow growth, and trading for low-teens multiples, it's absolutely a buy in my book.
