PYPL Stock: Could the Big Banks Take Down Paypal Holdings Inc?

PYPL StockIs PYPL Stock Protected?

The digital payments industry is undergoing a massive transformation right now and it could have an outsize impact on Paypal Holdings Inc (NASDAQ:PYPL). My guess is that PYPL stock will live or die depending on what happens in the next 18 months…

The company is under siege from various competitors, but it can survive by building a moat. “Moat” is a term that business writers borrowed from military strategy.

In military strategy, if you’re defending a fort or castle from an invading army, you’d dig a trench around the perimeter. After it’s sufficiently deep, you can fill it with water or sharpened stakes. The presence of a moat makes it difficult for rivals to launch a successful assault. That has been an essential truth in military strategy for centuries.

Likewise, in the business world, companies can develop a moat in the form of a competitive advantage that shuts out potential rivals. It’s similar to pulling up a ladder after you climb it, so no one can follow.

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PayPal is facing increased pressure from banks, blockchain technology, and more—there’s no question about that. The upside is that customers are finally warming to the idea of turning their smartphones into their wallets. A lot of people are making that shift and a lot of businesses are seeing it, which is why there are so many new digital payments companies.

That being said, PayPal was an early, early mover in this space. It is the biggest brand by far, but the real question is, have they developed a “moat”? If so, the returns on PYPL stock could be enormous.

Does PYPL Stock Have a Moat?

The first thing we can do to try and answer this question is to look at PayPal’s financial statements. PYPL stock has underperformed in the last year, so there could be something in there that suggests it has no moat.

Let’s take a closer look…

According to documents filed with the Securities & Exchange Commission (SEC), PayPal is maintaining 15% revenue growth each quarter, an impressive amount for a company that’s been around for almost two decades. That’s practically ancient in Silicon Valley.

The earnings picture is also pretty rosy, with a 10% year-over-year increase in net income. The company made $436 million in the second quarter of 2016, compared to $395 million in the same quarter last year. That’s not too shabby, I must say. (Source: “PayPal Reports Strong Second Quarter Results and Raises Revenue Outlook,” Paypal Holdings Inc, July 21, 2016.)

But does this mean that PYPL stock is protected? Can’t another company, say Apple Inc. (“Apple Pay”), poach some of Paypal’s market share? The simple answer: yes.

Apple could try and poach PayPal’s market share, but there are a couple of reasons why that might not work. In other words, here are three factors that could act as a moat for PYPL stock:

1. PayPal’s Contractual Agreement with eBay Inc:

Being an early player in this sector has its advantages. Even though PayPal is officially divorced from its former parent company, eBay Inc, the e-commerce platform still uses PayPal for more than 80% of its transactions. That’s not just an abstract number, either; it’s sealed with ink. There’s an actual contract between the two companies that requires eBay to use PayPal for a minimum of 80% of transactions. Even if Apple wanted to, it wouldn’t be able to touch PYPL stock on that score. (Source: “After planned split, eBay and PayPal promise to stay friends,” Fortune, April 9, 2015.)

2. Recent Acquisitions, Like Braintree and Venmo:

This particular moat should be more widely known. PayPal has made some of the smartest acquisitions in the payments space, which were only possible because the company is extremely profitable.

My favorite acquisition was Braintree. Think about it: when you take an Uber ride, how is your payment made? Unlike in traditional taxicabs, when using Uber, you just get out at your destination and the payment happens automatically. That payment is made electronically, through a service provided by Braintree. The company develops payment systems that it sells to other companies. Since enterprise clients tend to sign longer-term contracts with their partners, Braintree will be a relatively stable cash cow for PYPL stock.

3. Forming a Cartel with Visa and Mastercard:

“We have a clear mission at PayPal. We want to democratize financial services and become an everyday, essential service for underserved consumers,” said Dan Schulman, president and CEO of PayPal. “Our agreement with Visa enhances our capabilities, offers the potential to establish new contexts for our consumers and merchants, and lays the foundation for additional partnerships.” (Source: PayPal Holdings Inc, op cit.)

It turns out he’s right. Mastercard has come knocking on PayPal’s door to secure the same deal that the company has with Visa Inc. Both are powerful allies that can help PYPL stock on an upward trajectory. (Source: “MasterCard Doesn’t Think Visa and PayPal Are In An ‘Exclusive’ Relationship,” Fortune, July 29, 2016.)

The Bottom Line on PYPL Stock

No one has a “Magic 8” ball (that actually works), so we can’t say for sure how the payments sector will look a year from now. My guess is that PYPL stock is fairly insulated from substantial harm. It has strong alliances, solid growth, and the resources to buy startups with potentially threatening technology—that looks like a moat to me.