Paypal Holdings Inc (PYPL): Wedgewood Capital Sees Multi-Year Potential for Double-Digit Revenue, Profit Growth

Paypal Holdings Inc (NASDAQ:PYPL) is one the most favorite stocks among hedge funds tracked by Insider Monkey. There are 68 funds in our database with bullish positions in the digital payments giant. One of them is Wedgewood Capital which recently released its 2017 Q3 investor letter (you can download a copy here). Wedgewood Capital believes that PayPal’s two-sided platform is “a unique value proposition to the payments industry.”

Here is what Wedgewood Capital said about Paypal Holdings Inc (NASDAQ:PYPL) in the letter:

PayPal Holdings was a top contributor to relative performance during the third quarter. The Company’s constant currency revenue growth, operating earnings and earnings per share continue to grow at high-teens rates as their core payment services gain relevance with a growing base of more than 15 million merchants and over 200 million users. We think PayPal’s large-scale, two-sided platform is a unique value proposition to the payments industry, where competitors typically focus on either merchants or customers, but rarely integrate both at scale. PayPal’s traction with users and merchants proliferated during its decade-and-a-half tenure under the eBay umbrella, concomitant to the rise of the ecommerce sales channel. The core value proposition of PayPal – then and now – is its ability to offer a turn-key payments platform that includes payment acceptance, processing, fraud detection, and an increasing array of financial services traditionally offered by banks, to merchants of any size, particularly small and mid-sized merchants.

Although we consider PayPal to be in competition with traditional banks, the nature of their competition is a rare partnership, where both create value beyond what either could achieve by themselves. Of course, if they both fail to create value, then their competitive dynamic will turn into winner-take-all, but we think PayPal is in the very early stages of adding substantial value to banks, via their recently signed partnership agreements with Visa and MasterCard. For years, traditional banks have been trying in vain to construct widely accepted mobile payment platforms, beyond what Visa and MasterCard offer, while PayPal has succeeded through its one-click checkout on mobile, Braintree mobile payment solutions, and more recently Venmo P2P money transfer application (among others). In exchange for capturing some of the economics from this mobile volume, banks have become a new source of distribution for PayPal, both on the user and merchant end.

In addition, PayPal has a disciplined value chain that is focused on procuring the natural operating leverage inherent to payments and prudently reinvesting it into large and growing addressable markets. We think PayPal is capable of further leveraging its fixed cost base as the aforementioned partnerships will reduce customer acquisition and support costs.

Over the next few years, we expect PayPal to monetize their credit receivables portfolio, which should free up a substantial amount of capital for reinvestment. Also, we think the Company will begin to specify their strategy around their exclusivity agreement with eBay, which expires in a few years. We believe a substantial portion PayPal’s small and mid-sized merchants will continue to do business via the eBay marketplace. Considering that PayPal’s most valuable offerings are to its small and mid-sized customers; we would expect the Company to take the appropriate measures to maintain these lucrative relationships.

While PayPal sports one of the richest earnings multiples in the portfolio, we think the Company has a multi-year potential for double-digit revenue and profit growth, which is rare for a business of PayPal’s size. If they continue to execute on this growth strategy, leveraging their unique, dual-sided platform in addition to optimizing their capital structure and maintaining their relationship with small and mid-sized merchants, we think the Company will continue to be a core holding for many years.

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Shares of Paypal Holdings Inc (NASDAQ:PYPL) are up nearly 80% so far this year. The digital payments giant reported better-than-expected for the third quarter of 2017, with revenues growing year-over-year by 21% to $3.24 billion. Its net income grew 32% to $560 million. PayPal continues to build on its partnership strategy to reach out to more people and add value for its consumers and merchants. During the quarter, PayPal announced a partnership with Microsoft Skype to allow users in 22 countries to send money to other Skype users via a mobile app. In addition, the company also expanded its partnership with Mastercard into Canada, Europe, Latin America and the Caribbean and the Middle East and Africa.

Don’t miss Wedgewood Capital’s investment thesis on other companies. We’ve already covered the fund’s viewpoints on Alphabet, Cognizant Technology Solutions, Fastenal, and Qualcomm in other articles.