Investment Thesis
PayPal (NASDAQ:PYPL) goes through a tough period, as its Q4 guidance is woefully shy of its own estimates. Also, management discusses its move away from the acquisition of Pinterest (PINS).
Furthermore, lest we forget, PayPal is a free cash flow machine like few other businesses. It already has $10 billion of net cash on its balance sheet and makes more than $5 billion of free cash flow already this year.
PayPal reminds investors of its path to grow to $50 billion in revenues by 2025.
Hence, at 8x next year's revenues, PayPal is becoming increasingly attractive. Investors would do well to consider putting this stock on their watchlist.
Investor Sentiment Facing PYPL
There are certain blue-chip companies that simply don't have misfires. I always presumed PayPal was one such company. However, the past several months have been incredibly tough for shareholders.
Since PayPal's Q2 results, the stock has slowly given back much of its gains. Then, the negative selling pressure picked up momentum with the announcement of the most absurd acquisition of Pinterest (PINS) that nearly went through. I can only say, good riddance that it didn't!
PayPal had absolutely no business in acquiring a social media company. It was nothing short of hubris to assume that PayPal had the magic dust necessary to revitalize Pinterest. Yet, to be clear, I'm a fan of Pinterest at this valuation but simply could not see how PayPal would improve Pinterest's user engagement by layering on commerce through Pinterest's platform.
For their part, PayPal notes that it was their plan to get closer to consumers, being a super app, for ''consumers engaging at the beginning of their shopping journey to purchase and post-purchase''.
PayPal's Revenue Growth Rates Fizzle Out, But!
Source: author's calculations; **company guidance
The graph above points out the obvious problem for PayPal, its growth rates are pointing noticeably in the wrong direction, as eBay (EBAY) migrates away from PayPal.
Pertinently, what's more, not only did PayPal's guidance come meaningfully shy of its own guidance for Q4, but investors are also now starting to think about 2022, and how PayPal will come up against its super-strong H1 2021?
PayPal notes that eBay's payments migration, as well as stimulus earlier this year, are making for a very challenging period for PayPal's 2022. Most noticeably being Q1 2022, where PayPal comes up against an incredibly strong quarter with this year's Q1.
Looking out to 2022 as a whole, PayPal guides for approximately 18% CAGR.
Moreover, PayPal notes that once it laps Q1 2021, the remainder of the year should be picking up its pace of growth, so that its exit from 2022, should be close to mid 20s% revenue growth rates.
(Source)
Further, PayPal reminds investors that despite this near-term turbulence, that PayPal is still on target to grow its top line by 20% CAGR all the way into 2025.
Near-Term Prospects Discussed
If you've read my work before, you'll have heard me say the following. Nobody asks difficult questions about their investment while the stock is going up. It's only when things go down, that people start to bring up tough questions. Or in other words, ''buy-and-hold for as long as the share price is going up''.
But when things go slightly sour, investors are quick to ''react''. However, asides from eBay leaving PayPal, PayPal's underlying fundamentals remain strong.
(Source)
In fact, as you can see above, despite raising prices in the US, merchant adoption hasn't slowed down and was up 13% y/y, with healthy engagement too, that was up 10% y/y.
Pinterest or Not, PayPal is a Free Cash Flow Machine
In 2021, PayPal is expected to make $5.2 billion of free cash flow. As PayPal reminded investors during the call, PayPal makes 21 cents for every dollar of revenue. Few businesses are as cash flow generative as PayPal.
In an attempt to enlighten investors, PayPal notes that its balance sheet carries $10 billion of net cash and that its responsibility is to seek out ''opportunities that are out there that create even more value creation''.
That although Pinterest will not be pursued, PayPal may look for other ways to broaden its reach with consumers.
PYPL Stock Valuation - One of the Cheapest Blue Chips
As noted already, PayPal makes meaningful amounts of free cash flow. If we presume that its top-line grows by 18% into next year and that its transaction-based costs grow proportionally, it's likely that PayPal will make approximately $6.1 billion of free cash flow next year.
This puts the stock trading at approximately 42x next year's free cash flow. This may not seem eye-popping cheap, but remember, PayPal rarely trades cheaply. What's more, you are still getting about 18% to 20% long-term growth thrown in too.
In the present market, paying 42x free cash flow is a lot cheaper than it seems.
The Bottom Line
Investing is not supposed to be easy. PayPal has lost momentum and is now starting to become too cheap to be ignored. Its stock is priced at 42x next year's free cash flows. Not sales or non-GAAP earnings, but actual free cash flows!
This investment certainly belongs on my watchlist. That being said, I'm still finding better opportunities to deploy my own capital. Good luck and happy investing!
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