1. PayPal Holdings (PYPL) — New Position
a) Brief PayPal Summary
I started a position in PayPal Holdings this week. I plan to publish a full Deep Dive into the company and my investment thesis in February (after I publish the Upstart Deep Dive this month) but I wanted to provide a brief synopsis of the investment rationale today.
In a nutshell, PayPal plays a ubiquitous role in integrating payment processors and digital payment flows for both consumers and merchants. It connects, transacts, verifies, and fulfills to enable the digital transformation of payments all without the inherently rising costs of fraud that typically coincide. Just like every other company in the financial technology space, it prides itself on a drive to democratize access to services — and it has a long, long track record of doing so successfully.
PayPal is the most accepted digital wallet in the world today with over 75% of the largest global merchants integrating with it at checkout. The company boasts an astonishing 416 million active consumer and merchant accounts thanks to seamless facilitation, authorization and settlement.
This last quarter, PayPal deepened its already extensive merchant network via new programs launched with Walmart, Booking.com, Fanatics, GoFundMe, Valero and Phillips 66. Interestingly, this strong momentum could be culminating from the end of a restrictive operating agreement with eBay (the parent company that spun PayPal off) which prevented PayPal from working with a large portion of merchants. Those cuffs are now off which is freeing PayPal to grow its network that much more freely.
Conversely, the cuffs are also off for eBay which is prompting it to shift to its own managed payments system to replace some of the same functionality PayPal has provided it in the past. As a result, total payment volume (TPV) from eBay tanked 45% year over year for PayPal this last quarter. Luckily, this business accounts for just 3% of PayPal’s volume and the freedom to pursue new contracts should be a stronger long term tailwind than this has been a short term headwind. Still, the turbulence — and also tough pandemic comps due to accelerating adoption and usage of digital payments — led to “muted” growth of 13% in the company’s last report. This is set to re-accelerate going forward.
b) Venmo and Other Growth Engines
My favorite piece of the business is Venmo — the peer to peer payment app that has achieved verb status. The platform boasts over 80 million users and did $60 billion in TPV last quarter at an annual growth rate of 36%. The massive, established user base is ripe for up-selling. Why? PayPal intends to transform the platform into a “super app” or a centralized location for all digital banking services. This ambition is no different than Block’s Cash App (or SoFi & countless others) but PayPal is behind this formidable competitor in seasoning Venmo’s product suite. While this is somewhat of a concern, it also leaves significant low hanging fruit to enhance the lifetime value (LTV) for each of its 80+ million customers. I like that.
This thesis — like all of my others — relies on a management team capable of executing and fortunately, PayPal’s leadership is impressive.
The current President and CEO is Dan Schulman — a former AT&T, AmEx and Sprint President, Virgin Module and Priceline.com CEO and a current Verizon Board Member. He sports a 93% Glassdoor rating with a significant sample size of 5600+ reviews. The CFO — John Rainey — has been with the company since 2015 in that role and previously served as the Executive Vice President (EVP) and CFO at United Airlines. He’s also a Nasdaq Board Member.
For the sake of brevity I won’t go into the rest of the team — but it’s highly capable and makes me comfortable with betting on the potential success of a Venmo super app transformation.
In recent months, Venmo launched a credit card (with the ability to directly buy crypto) and will launch Venmo Pay for Amazon this year. PayPal’s own digital wallet platform has already added more crypto features, a high yield savings account and finance management capabilities — I think it’s only a matter of time for Venmo to inevitably catch up.
Speaking of this new digital PayPal Wallet, the company has merged some of the key competencies of Honey — a $4 billion acquisition within deal and product discovery — into this new offering. Early results are promising with deal discoverability already growing 25X vs. the previous platform version. A deeper, Honey-powered presence within deal discovery pushes PayPal further up the shopping value chain and enables it to demand a larger piece of the overall margin.
PayPal also has a Buy Now Pay Later (BNPL) branch already posting an $8 billion TPV run rate. To extend its capabilities within the payment niche, PayPal bought Paidy — a Japanese BNPL player — for a more modest $2.7 billion. My BNPL bias leans negative — so to me the smaller the investment in the space, the better. This was certainly much smaller than some other BNPL M&A. PayPal expects to deepen its cross-border commerce presence — another key focus for the company — in Japan and Asia with the help of this purchase.
c) Quantitative
PayPal is expected to compound at a roughly 19% clip for the next few years. Its most recent free cash flow margin of 20.9% and net income margin of 21.3% did both fall YoY as the company sinks its teeth into Venmo, the new PayPal Digital Wallet and other growth engines. It also experienced slightly falling sequential TPV due to stimulus wearing off and slightly rising transaction costs. While margin compression is never ideal, it’s somewhat warranted in this environment of countless hyper-growth fintech disruptors spending like madmen to claim market share.
PayPal already has that market share, so I wholeheartedly believe that aggressive spending to round out the product suite makes all the sense in the world for preserving its competitive edge. A solid balance sheet also helps make that more doable. PayPal has $20 billion in cash and equivalents as opposed to $8.9 billion in total debt with modest rates ranging from 1.78% to 3.33%.
Despite all of this, the company trades for roughly 20X 2022 EBITDA and 30X 2022 earnings (a significant discount to Block despite loftier 2022 and 2023 PayPal growth expectations per KoyFin). To me, the growth prospects are bright, the team is highly capable, liquidity is healthy, the track record of success is established and the entry point is too good to pass up.
d) Plan
I originally planned on investing 3.0% of my overall capital into the company. I decided to invest 2.5% instead to give myself more accumulation flexibility amid the volatile macroeconomic backdrop. Considering the company relies on payment flow for transaction revenue, less liquidity sloshing around globally will be somewhat of a headwind for it going forward. A full position will be 4.0% of capital and I plan to inch the rest in over time.
I’ll go into much more detail on everything PayPal — including some of its other brands and products like Zettle and Hyperwallet — in the Deep Dive. With that still weeks away from being ready to publish, I thought this would give a good taste on the source of my bullishness.
2. SoFi Technologies (SOFI) — Banking Charter
The Office of the Comptroller of the Currency (OCC) and the Federal Reserve conditionally approved SoFi’s national bank charter application to form SoFi Bank; it also officially approved of SoFi Bank purchasing Golden Pacific Bank. One of the conditions requires SoFi Bank to avoid offering any crypto-currency related products. Importantly, SoFi Money will be able to continue offering whichever crypto products that it wishes according to my chat with CEO Anthony Noto.
Interestingly, the OCC’s press release calls it a “conditional approval” while SoFi’s calls it an “approval.” Regardless of which is more accurate (probably the OCC), this long process is now fully expected to be wrapped up in February.
“With a national bank charter, not only will we be able to lend at even more competitive interest rates and provide our members with high-yielding interest in checking and savings, it will also enhance our financial products and services to ensure they efficiently meet the needs of our members, business partners, and communities across the country, while continuing to uphold a high bar of regulatory standards and compliance.” — Anthony Noto
SoFi is expected to generate roughly $1.46 billion in revenue for 2022. Without the charter — according to its investor presentation — that revenue would have coincided with a 17.4% EBITDA margin. With it — that margin expands to 30.6%. These projections assume a full year’s benefit of having the charter which SoFi won’t enjoy. Still, the company’s EBITDA margin should be between 17.4% and 30.6% for 2022 vs. just 3.7% this last quarter. Expectations are certainly lofty here.
Here’s a list of the benefits that SoFi will enjoy from the charter: