Mr. Market Needs To View PayPal As A 'Merchant Acquirer,' Analyst Says

Investors should view Paypal Holdings Inc PYPL as a hybrid between a merchant acquirer and a closed-loop network, according to Lisa Ellis of Bernstein who initiated coverage of the stock with a Market-perform rating and $43 target price. The analyst said the digital payments firm will deliver 13 percent non-GAAP EPS growth compounded through 2020.

"We believe investors should view PayPal as a hybrid between a merchant acquirer (akin to Vantiv Inc VNTV or World Pay), and a closed-loop network (akin to American Express Company AXP or Discover Financial Services DFS), specializing in online-centric and small/medium businesses," Ellis wrote in a note to clients.

Justification For Initiation, Rating And PT

The analyst said, "PayPal derives about 75 percent of its revenues from its Express Checkout button on merchant websites, and the majority of profits from the 45 percent of Checkout button volume made with PayPal stored balances or direct bank account debit."

Related Link: Atlantic Sets New Neutral Rating On PayPal, Warns Of Long-Term Uncertainty

"PayPal will perform as many payments players do: delivering consistent compounding low- to mid-teens EPS growth," Ellis said.

According to the analyst, California-based PayPal "will remain independent, and will skirt potentially catastrophic threats to its business model." However, Ellis believes that "PayPal's economic model will be strained, and the company will ultimately trade off margins to maintain volume growth."

"We believe PayPal will maintain strong TPV growth (23 percent CAGR through 2020, ~1.1x eComm growth), by growing transactions/user. However, we expect take rates to continue their 6–7 percent/yr declines through 2020 (driven by mix shift to large merchants), transaction expense to flatten (driven by Braintree growth), and operating leverage to decelerate as the cost base shrinks, eventually pressuring margins," Ellis noted.

As a result, the analyst expects 16 percent revenue CAGR and a 13 percent non-GAAP EPS CAGR through 2019.

On the competitive front, Ellis expects PayPal to "face pressure from alternative 'buttons' (likely Visa Checkout) on a 3–5 year time-frame, not imminently." She also believes the risk of a "catastrophic" event such as losing ACH access or facing banking regulations is low.

Commenting on the M&A scheme of things, Ellis said, "We also believe the likelihood PayPal will be a takeout target is low; we see Amex as the only real viable possibility, and believe the likelihood is low."

Shares of PayPal were up 0.48 percent at $39.72. They have gained 8.85 percent this year.