Shares of PayPal (NASDAQ:PYPL) started trading on the Nasdaq last week after eBay spun off the payments company. The newly independent company received a higher valuation than its former parent company post-spinoff, trading for around a $45 billion market cap compared with eBay's $34 billion. Several analysts have already stamped a buy rating on PayPal.
Indeed, PayPal's recent revenue growth compared with eBay's Marketplaces business justifies its higher valuation, given that it accounted for about half of eBay's revenue in the second quarter. But PayPal faces tough competition in the digital-payments market, with Apple and Google making big pushes into the market over the past year. So what has investors so optimistic about PayPal?
A leader in the growing digital-payments market
Despite the increasing competition from companies big (Apple, Google) and small (Stripe, Shopify), PayPal remains the leader in the digital-payments space. The company has over 165 million users, including 10 million merchants. It's accepted by 74% of the top U.S. online retailers, 70% of the top online retailers in the rest of the world, and 67% of mobile apps.
It operates across borders in 200 countries, whereas newer services have yet to reach as far internationally. Apple Pay, for example, is available only in the U.S. and U.K. Google Wallet is available in nearly as many countries, but it never caught on because of PayPal's established presence. The company will relaunch its payments platform with Android Pay later this year, but it will again be limited geographically.
PayPal's global scale has a significant impact on its business. Nearly half of PayPal's revenue comes from international markets, and the ability to send money across borders accounts for about one-fourth of its business.
While growth in mobile-first payments solutions such as Apple Pay and Android Pay represent significant threats to the platform built on desktop computers, PayPal is nimble enough to navigate the mobile world. As I mentioned, it's already enabling payments in 67% of mobile commerce apps, and it continues to acquire technology and companies to support its growth on mobile.
Capable of defending its territory
In terms of the spinoff, PayPal is left with about $6 billion in net cash. That's important for the company, which is expected to produce less free cash flow than eBay in 2015. As a pure-play digital-payments company, it will be willing to spend wherever necessary to fend off competition from more diverse businesses and less established players.
The acquisition of Braintree (and Venmo, which it had acquired) for $800 million in 2013 is a prime example of PayPal's willingness to spend. Braintree provided PayPal with a stronger foothold in mobile payments, supporting back-end payments processing for app developers. At the same time, PayPal was able to snatch up a growing competitor in the peer-to-peer mobile-payments market in Venmo.
Earlier this month, PayPal agreed to buy Xoom for $890 million. The acquisition will boost its cross-border money transfers and establish a larger presence for PayPal in the growing markets of India and Latin America. Additionally, it increases the company's presence on mobile devices, which outnumber desktop computers in those developing markets.
With $6 billion in net cash, and the ability to raise a similar amount of debt at investment-grade rates, PayPal should have plenty of cash at its disposal. As an independent company, PayPal will also be able to use its stock for future acquisitions as well, if need be.
Management will be key
PayPal is operating from a position of strength right now, and its balance sheet, strong brand, and global scale give it the heft to maintain that strength for some time. In the long run, however, PayPal will need excellent management to fend off competitive threats from larger companies and make key acquisitions of smaller companies before they become significant. CEO Dan Schulman has experience in both payments and mobile phones. Let's see if he can combine those experiences to maintain PayPal's course.