PayPal Holdings (NASDAQ: PYPL) reported its 2019 second-quarter results late last month and, since then, the stock has trimmed more than 10% of its value. It wasn't the quarterly results that caused the drop, as the numbers, once again, were more than solid. The digital wallet platform's revenue grew to $4.31 billion, a 12% increase year over year, while its adjusted earnings per share (EPS) rose to $0.86, a whopping 47% increase over last year's second quarter after benefiting from gains in strategic investments.
The strong top- and bottom-line growth was driven by a rise in active accounts and user engagement. In Q2, the number of active accounts grew to 286 million, a 17% increase year over year, and the number of transactions per active account rose to 39.0, a 9% increase over last year's second quarter. With such strong numbers across the board, it's natural for investors to wonder why shares have sold off like they have. The answer lies in the company cutting its full-year revenue guidance, even as it raised its full-year EPS outlook.
Due to its sheer size and complexity, PayPal pushed out the target dates for key partnerships this quarter. Image source: PayPal Holdings.
Despite the cut in the company's top line, I believe the company's shares remain a buy for investors with a long horizon. Here are three reasons why.
1. Revenue is being delayed, not lost
The reason PayPal gave for the decline in revenue guidance wasn't because there was softness in its account growth rates or that account holders were using their accounts less. Those would truly be reasons for concern. Rather, it was because PayPal is working on a number of big projects and integrations with large partners that, CEO Dan Schulman admitted, the company "probably underestimated the amount of work it would take" to implement. These projects include:
- An integration with MercadoLibre (NASDAQ: MELI) which includes PayPal's integration into the South American online marketplace, capabilities for MercadoPago and PayPal accounts to make P2P payments with each other, and allowing MercadoPago users to make purchases with PayPal merchants.
- The development of Uber Technologies' digital wallet.
- Integrating with the online bill-paying platform, Paymentus. Schulman called it "an extremely large strategic partner of ours" that required PayPal's integration with every single one of the multiple billers on its platform.
Schulman emphasized throughout PayPal's conference call that this revenue was not lost, just delayed as a "lot of scope expansion" occurred as these undertakings began.
2. PayPal's network effect continues to grow
A network effect is an economic moat that increases the value of a product or service as it gains more users. With so many users, online merchants feel compelled to offer PayPal as a checkout option. As more merchants add PayPal as a payment option, more users will feel compelled to open a PayPal account. With 286 million active accounts, PayPal's user growth is certainly feeling the tailwinds of a growing network effect. PayPal's leadership acknowledges this, too, with Schulman commenting:
But look you've got, obviously, a network effect that's really kicking in right now. If you're a merchant, we have so many consumers that want to use PayPal or Venmo now as a way to pay. You almost have to be a part of the network and the same thing from a consumer perspective. We've got merchants everywhere that are accepting us. And so that network effect is continuing to kick in
3. Margins improving
In Q2, adjusted operating margins grew to 23.2%, a 2 percentage point increase year over year, leading PayPal to raise its full-year EPS guidance despite lowering its revenue expectations. A particular point of excitement from this improvement is the company's transaction losses. CFO John Rainey explained:
Now one quarter does not make a trend, so I don't want to call this out as what we should expect going forward, but this was truly based upon improved modeling and capabilities that we have in our fraud detection and risk management. And so we're very encouraged about that. And as we ... continue to refine those models over time, hopefully, that type of decrease in the rate of losses for TPV is something that can become more sustainable for us.
Focus on the long term
PayPal's revenue slowdown seems decidedly short-term in nature. Remember, revenue growth has been negatively affected the past year due to the sale of its credit portfolio to Synchrony Financial. As its contract nears its expiration, revenues from eBay continue to lag behind its other marketplace partnerships, and complications with integrations and partnerships are taking longer, due to their sheer size and complexity.
As the Synchrony deal is lapped, the eBay contract expires, and these integrations are finally implemented, PayPal's revenue should rebound. Meanwhile, PayPal's network effect grows, and its margins improve, driving earnings growth. This seems like a classic definition of short-term FUD (fear, uncertainty, doubt) driving a stock price down while the long-term forecast calls for blue skies and sunny days. This is why PayPal remains one of the largest positions in my personal portfolio.
Matthew Cochrane owns shares of MercadoLibre and PayPal Holdings. The Motley Fool owns shares of and recommends MercadoLibre and PayPal Holdings. The Motley Fool has the following options: short October 2019 $37 calls on eBay, long January 2021 $18 calls on eBay, and short October 2019 $97 calls on PayPal Holdings. The Motley Fool recommends eBay and Uber Technologies. The Motley Fool has a disclosure policy.
This article was originally published on Fool.com