PayPal After Q4 2017: The Easy Money Has Been Made

Finally, we note that although PayPal's take-rate has decreased every single quarter since the IPO, the company has so far managed to retain its high margins through operating leverage.

The value of current earnings and return on capital

With a discount rate of 6% (selected in light of the low level of interest rates and the recurrent and relatively safe nature of PayPal's CF), the value of 2017 FCF comes in at $39.2 billion ($2.35 billion / 0.06). We can see this number as the Earnings Power Value (EPV), or the value of a constant stream of FCF.

The company has some $7.7 billion in excess cash and cash equivalents, which brings the value of equity, assuming no future growth, to $46.9 billion.

In using a 6% discount rate, we have applied a 16.7 multiplier to 2017 adjusted FCF. We believe PayPal deserves a much higher multiple of current distributable CFs, given its sustainable competitive advantages (as the dominant digital payments platform) and immense growth potential (the continuing shift from cash to digital payments is all but certain, and the cash payments TAM is enormous). But how much larger?

The book value of equity in Q4 2017 balance sheet was $16 billion. $7.7 billion of those assets are cash and cash equivalents that played no role in the generation of cash flows. But we believe that they are approximately offset by the investments required by a new entrant to reproduce PayPal's payment platform, brand reputation and number users and merchants, which we estimate somewhat above 3x annual S&M and product development expenses of some $2 billion a year. So both things considered, we estimate the real value of PayPal's productive net assets at about $16 billion.

The fact that EPV ($39.2 billion) handily exceeds net asset value ($16 billion) confirms our observation that PayPal has powerful competitive advantages (companies without competitive moats cannot sustain EPV above net asset value).

Correspondingly, PayPal's ROC (return on capital) comes in at 14.7% ($2.35 billion/$16 billion), well above the assumed 6% cost of capital. This again speaks to powerful competitive advantages.

Nb.: If any of these financial concepts is unknown to you, or you want to learn more about the underlying logic, we recommend you pay a visit to the Investment Works Academy.

Discounted cash flow analysis

We are not big fans of discounted cash flow analysis, for it places the same weight on metrics that are known today with relative certainty (such as balance sheet on current earnings items) as on uncertain forecasts of the far future.

Nevertheless, given that PayPal is growing at rates much larger than its current cost of capital, there is no way around it. (Constant growth models require growth rates below cost of capital, for a company able to sustain growth equal or larger than its cost of capital would be worth the entire universe).

Rather than coming up with a concrete estimation of intrinsic value, which would be very uncertain given the uncertain nature of forecasts of the future, we reverse-engineer the current market cap of $94.1 billion (1,228 million diluted shares at $76.6/share).

Intrinsic value matches current stock price under the following assumptions:

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Disclosure: I am/we are long PYPL, AAPL.

Additional disclosure: I/we may reduce the PYPL long position over the coming months.

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Alpha Stockman 3 years ago Member's comment

This is a highly competitive space. I wouldn't have bet on PayPal years back but they proved me wrong and continue to impress.

Investment Works 3 years ago Author's comment

If you have enjoy the read >> FOLLOW US << on TalkMarkets so that you don’t miss any future research on $PYPL.

Joe Black 3 years ago Member's comment

Why did #Ebay abandon #PayPal and who the heck is #Ayden? I never heard of them but would love to know the story of what the catalyst for such a monumental change was.

Paul McGee 3 years ago Member's comment

This is a solid company which still has a promising future. Buy the dips.

Barry Hochhauser 3 years ago Member's comment

Plenty of opportunities left for PayPal's international growth.

Currency Trader 3 years ago Member's comment

As I wrote earlier today here:

"PayPal Stock Crashes: Buying Opportunity Or Time To Panic? "

While I agree that $PYPL will likely rebound in the short-term, in the long-term old-school companies like PYPL will go the way of the dinosaurs and be completely replaced with true digital currencies.

Investment Works 3 years ago Author's comment

As a payment system, what practical advantages do cryptocurrencies have over PayPal? The only one we're aware of: payment anonymity, which is only of use in connection to illegal activities and therefore has no impact on $PYPL market.

Michele Grant 3 years ago Member's comment

I disagree, as I've argued many times in the past (check my hashtags for #bitcoin and #crptocurrency), the digital currencies you are referring to are incredibly volatile, completely unregulated, uninsured, are a haven for criminals and are an increasingly tantalizing target for hackers.

A proven and trustworthy company like #PayPal is the perfect middle grown for investors who want to follow the future of payments, but want safety and stability as well. Very bullish on $PYPL.

Flat Broke 3 years ago Member's comment

#eBay dropped #PayPal for #Ayden. That's going to severaly hurt PayPal. Who knows how much longer they'll be around? Between the disolution of their longstanding partnership with ebay, and increased competition from traditional credit cards and the new wave of cryptocurrencies, I'd say $PYPL's days are numbered.

Harry Goldstein 3 years ago Member's comment

That's not quite correct @[Flat Broke](user:29387), the two companies will remain partners through July 2020. It won't hurt PayPal anytime soon and gives them plenty of time to recoup those losses.

Not to mention it's been quite a long time since Ebay was their primary revenue source.

Michele Grant 3 years ago Member's comment

Actually, if you read the article, you'll see that credit cards are partnered with PayPal, not just competing with them. And I've already explained why I think #cryptos are not a threat. They will fail long before $PYPL.

Charles Howard 3 years ago Member's comment

Good stuff.