Be PayPal, Be Visa, or Be Square!

Buying a turkey fryer on Amazon- $100

Buying a new TV on BestBuy.com- $1,000.

PayPal handling all of these transactions- priceless.

This is not another credit card commercial.  In fact, PayPal Inc. (NASD: PYPL) is the largest online payment platform in the world. They give customers choice and flexibility in the way that they send, spend, and receive money. The company operates in 202 countries and supports 25 different currencies.

Now, it is important to distinguish the difference between online payment platforms and debit/credit cards.

Your debit/credit card that is issued by, let’s say Visa, enables you to access funds directly from your bank account or credit provider. Most of the time, this card is limited to making purchases in the country it was issued in. And, as we know, credit cards incur interest on any funds used.

PayPal is essentially an online account. You transfer funds from your bank account into your PayPal account. Acting as an intermediary, when you make a purchase using PayPal, funds are transferred from your PayPal account to the merchant. The merchant never sees your card number or payment information. This acts as a safety net, especially since PayPal guarantees payments and safeguards your information.

You might be tempted to throw your hands in the air and yell “what about Visa’s online payment platform?”

Well, PayPal controls over 80% of the online payment market share. Visa’s online payment platform, Visa Checkout, holds less than 1%. It’s the same story for Amazon Payment and MasterPass.

There are undeniable advantages to being the first successful mover in any industry.

Online payments have exploded thanks to the growth of e-commerce. E-commerce transactions have nearly doubled over the past 4 years. They are expected to hit nearly $2 trillion this year. Online payment platforms, like PayPal, are projected to account for half of that by 2019. That’s over $1 trillion in transactions!

PayPal saw where e-commerce was heading and acted to get ahead of it.

After spinning off from eBay, they acquired Modest, a mobile payment company that allows businesses to create customized mobile apps for their stores. This gives smaller businesses the same resources and exposure to e-commerce that only large corporations had. Their apps offer consumers coupons, news and alerts on upcoming events, and any other unique features the creator desires.

Moves like this have helped ensure PayPal’s dominance. Along with Modest, they’ve acquired companies like Bill Me Later, Braintree, and Xoom. These acquisitions have expanded PayPal’s sphere of service to retailers like Walmart, Home Depot, and Overstock.com.

Besides basic transactions, PayPal offers credit services as well under PayPal Credit. As opposed to a simple credit card, which would compete directly with major credit card providers, PayPal Credit operates as a revolving credit facility for consumers and merchant businesses. At the same time, it has built partnerships with the likes of Visa and Mastercard to help facilitate transactions between institutions and consumers.

These partnerships, unfortunately, come with a cost. The average margins for the industry hover around 20%. Partnerships with Visa and Mastercard will cut into those margins for PayPal. Specifically, the company will most likely lose out on high-margin ACH transactions.

It’s not all doom and gloom, though.

The partnerships the company has formed has drastically expanded its user base. In 2010, the company reported just over 83 million registered accounts. Now, they have over 192 million. That’s a jump of 128%. The company expects to have over 211 million by mid-2017.

More users is all fine and dandy, but transactions are a two-way street. To continue to grow, the company must continue to grow its user base as well as recruit more merchants into its network.

International operations are helping to beef up this user growth.

Once PayPal acquired Xoom, a money transfer corporation that facilitates over $7 billion in transfers annually, it expanded its international presence. It now offers money transfer services in over 50 countries. As of 3Q16, 46% of its revenue was derived from overseas operations. However, its revenue is derived from the transaction fees, not payment volume, which should shield the company from drastic currency swings.

Seeing as how most of the company’s revenue comes from transaction fees, 87% to be exact, how do they “encourage” their customers to initiate more transactions (a.k.a. fork out more dough)?

Well, the answer is simple. They make the act of spending money easier. PayPal One Touch is a service that makes online checkouts a breeze. It remembers customers’ payment preferences and shipping addresses, enabling purchases by a touch of the finger, literally. This prevents customers from having to re-enter sensitive financial information.

To encourage more activity from its merchant customers, the company rolled out PayPal Working Capital. This service offers financing to select customers based on their sales history. Sales history is taken into account as opposed to undergoing credit checks. The merchant can then choose the exact loan amount it needs for a fixed, one-time fee.

Repayment of the loan comes from portions of future sales through the PayPal platform. This eliminates administrative costs and helps businesses grow without worrying about periodic loan repayments. More importantly, it opens PayPal up to customers that cannot obtain financing from major institutions.

Though this could potentially facilitate growth, it also opens the company up to moderate amounts of default risk. PayPal has also struggled to connect to physical merchants. Though e-commerce is on the rise, the majority of transactions take place physically.

Another issue is that of cyber security. Obviously nothing is invulnerable to breaches. Though PayPal hasn’t reported a serious breach yet, it’s not out of the realm of possibility. A serious breach would do some real damage to the company’s impeccable reputation.

Regardless, we are still bullish on PayPal.

Now, because of the phenomenal growth the company has shown, we used a growth duration model to estimate its fair value. The growth duration model is appropriate for companies that show significant growth potential compared to its industry peers. Our model showed a fair value of $50 per share, an upside potential of 25%.

Everything has a determinable value.

A Yeti 10 oz. Rambler- $25.

PayPal’s stock price in the next year- $50.

Monetizing the act of spending money- priceless.

This is not another credit card commercial.

 

 

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