PayPal Holdings Inc. (PYPL, Financial) is an intriguing company. It was once a darling of the payments industry that traded at very high multiples, pricing in both high expectations for the company and a moment of euphoria.

Over the last few years, market sentiment has turned more pessimistic, reflecting slower growth and increased competition in PayPal’s sector. This shift has driven the company from high-growth and premium valuation metrics to a slower growth trajectory with lower multiples.

My takeaway is that PayPal is a good company and can be a value move, and this is illustrated by its good figures, such as strong cash generation. On the other hand, I consider its market to be quite complex, with many players and an environment that is evolving rapidly.

PayPal built a solid business model

Looking at operational indicators, PayPal is a good company. The company has managed to build a payment ecosystem and achieve excellent numbers in a complex market. It has already reached millions of merchant accounts, around 430 million customer accounts, more than 2,400 strategic commerce partners, and an astonishing $422 million in volume just in 3Q24. It's worth mentioning that the company continues to adopt strategies to make its products and services (such as PayPal and Venmo) more attractive to users. One example of this is the debit cards that also offer cashback rewards.

Source: PayPal IR

In the last few quarters, around the beginning of 2023, the company has started to show slightly weirder figures, such as active accounts declining from ~435 million in Q4 2022 to 430 million in Q3 2024, and this in itself gives a sense of stagnation and raises uncertainty about the continued growth of this indicator.

Despite this, when we look at the financials, they were positive and continued to grow, as despite a stagnation/decline in active accounts, there were more transactions per active account. The long-term revenue shows this, with a consistent advance. More specifically, Q3 was a very solid quarter, in which the company posted YOY growth of 9% in payment volume, 6% in revenue, and 31% in free cash flow. Despite this, the company announced weaker-than-expected guidance for Q4, anticipating “low single-digit growth” for revenue.

This constant pace of revenue was what sustained a significant part of the value generation for the shareholder, since the operating margin even improved in relation to other quarters, but did not show a clear trend of expansion. Even so, it was possible for PayPal to improve its EPS and reach ~$4.19 in the last 12 months, also driven by some buybacks.

Source: GuruFocus

This illustrates PayPal's good work in building a robust platform and a profitable business model that is capable of growing (steadily and slowly), generates plenty of cash can distribute some of it to shareholders, and still has some (not so wide) moats. Even so, PayPal has not been able to generate shareholder value over time if we look at the total return of recent years, as the stock was trading at $300 in mid-2021 and today it is at almost $90 even with recent advances.

There are two main reasons for this. The first is its market, and the second is its valuation.

PayPal built some moats but faces a crowded market

As for the PayPal market, at first, it may seem like a promising market. Digital payments are something that has grown a lot and should continue to do so as people switch to secure convenient, digital, and even more automatic payment methods.

As PayPal is a large company in this segment and can be considered a pioneer, it is possible that it could benefit from this and create some moats, but it turns out that these moats are not so obvious. Some that are easier to see are the creation of a strong brand that is accepted in various parts of the world, the gain from a large network of users and the like that builds a certain network effect.

The problem is that over time this has become almost a commodity. PayPal is certainly one of the big players in this segment, but this depends on the region. China, for example, has several other means of payment, Latin America too, such as Pix in Brazil or Mercado Pago from Mercado Libre Inc. (MELI, Financial), which is widely used in some countries, not to mention the banking systems themselves, credit cards and so on.

All these big players like Mercado Libre and big banks entering a similar market and being direct competitors illustrate how difficult this market is becoming. I don't think this will disrupt PayPal in the short to medium term, i.e. make people stop using it, but it is something that could hinder growth prospects, as we are already seeing with stagnant accounts. It will be very difficult for PayPal to increase its penetration in regions where there are already well-established players that charge very low fees or even free ones.

If the market starts perceiving PayPal as a mature, competitive player rather than a high-growth leader, its valuation multiples and analyst confidence are likely to face further downward pressure—a trend already unfolding and potentially exacerbated in more challenging scenarios.

PayPal is a value play, but risks remain

Currently, PayPal's forward price-to-earnings is ~17.7x, a level that can be considered reasonable and possibly undervalued in some scenarios, even with the challenges of its market and a certain stagnation of new users, since we must consider that PayPal still has a high-quality, manages to be profitable and generate a lot of cash.

However, it is necessary to pay attention when analyzing the multiple. The chart below shows us that in mid-2021 this same indicator was more than 60x, which can cause a distortion and impression that eventually, PayPal may present an expansion of multiples that generates a large upside for the stock. It's not my base scenario, in 2021 the multiple portrayed a completely different scenario, and that's why I think it's very unlikely that the stock will ever trade at that same level again.

In addition to another macroeconomic scenario, an interest rate, as mentioned, PayPal had other expectations, so perhaps it made a bit of sense for the company to be trading at such a premium. This is not the current scenario.

Source: GuruFocus

When we look at the forecast for PayPal's financials, they are still very compelling figures, but they are already showing less accelerated growth, reflecting a more mature company and more conservative expectations, which in my opinion makes sense if we think about the uncertainty of this market and the slowdown in new accounts. For net income, the expectation is that it will grow by around 5.9% per year over the next 3 years, while EPS will grow by around 11% due to buybacks. If this happens, in 2026 we'll have a P/E of ~17x, equivalent to an earnings yield of 6.8%. This level is already appealing, but considering the risk of the thesis, which is definitely not zero, I don't think it's a huge bargain either.

In a scenario where the company manages to maintain a certain sustainability, it can be attractive from the point of view of shareholder remuneration. For example, if we consider a 6% annual expansion in revenue and a net income margin that advances at a slow pace until it reaches 15.9% (from the consensus of 2024 and 2025), we would have an earnings yield of almost 8%.

Source: Author (Kênio Fontes)

In other words, PayPal isn’t a bad company, and its valuation is also attractive for investors seeking high shareholder yield, so it should be able to generate good returns with share repurchases since its market cap isn't that high. The problem is that it's a slightly risky thesis, where eventually its growth could be even more threatened, and therefore a high premium on its valuation wouldn't be appropriate and consequently, it's not prudent to count on a multiple expansion.

The Bottom Line

In conclusion, PayPal remains a solid company with a solid presence in some regions around the world, having already built a profitable, efficient business model with some moats. On the other hand, we can't overlook the important risks that are present in this market, which in my view, is becoming less and less trivial to operate and consequently to make forecasts, making future financials a little more uncertain.

Despite this, its valuation appears to be attractive and should be able to generate good returns, even considering gradual advances in free cash flow and consequently in EPS.