SQ - PayPal Vs. Block: Unlocking The Future Of Finance

2023-10-09 09:15:00 ET

Summary

• PayPal strategically focuses on branded checkout, buy now, pay later offerings, AI-driven innovations, and entry into the stablecoin market.
• Block operates multiple ecosystems, including Square and Cash App, with significant increases in gross profit from vertical point-of-sale products.
• From a technical perspective, Block appears to be trading at a discount relative to its historical averages, making it potentially attractive.
• PayPal and Block have lower revenue and EPS growth expectations than their historical averages, reflecting a cautious outlook under the Fed’s higher-for-longer stance.

Investment Thesis

In the ever-evolving digital payments and financial services landscape, both PayPal Holdings, Inc. ( PYPL ) and Block, Inc. ( SQ ) have emerged as key players with their unique strengths and strategies.

In the turbulent times of Q2 2023, when economic uncertainties cast long shadows, PayPal reported a staggering 8% YoY revenue growth on a currency-neutral basis. On the other hand, Block's diversified approach through ecosystems like Square and Cash App demonstrates resilience and growth, while its strategic initiatives in cryptocurrency and consumer-centric solutions enhance its competitive edge.

Finally, both stocks are strong buys as they remain undervalued due to the negative sentiment driven by the Fed's higher-for-longer scenario and consequent economic adversity in the US.

PayPal's Revenue Surge: Navigating Growth in a Challenging Economy

To begin with, PayPal's revenue growth remains a fundamental strength. For instance, in Q2 2023, the company reported revenues with an 8% YoY increase on a currency-neutral basis. The solid performance is even more impressive when considering the challenging global economic environment.

Furthermore, the company expects this growth to continue into H2 2023, projecting Q3 revenues to grow by approximately 8% on a currency-neutral basis. For the full year, PayPal anticipates revenue growth of between 9% and 10% on a currency-neutral basis. These figures underscore PayPal's ability to generate substantial top-line consistently.

Another key factor contributing to PayPal's long-term viability is its disciplined approach to managing operating expenses. In the recent quarter, non-GAAP non-transaction-related expenses declined by an impressive 11% YoY. This reduction in operating expenses enabled PayPal to achieve a non-GAAP operating margin of 21.4%, representing an increase of approximately 2.3% YoY.

Therefore, the company's focus on cost control is expected to continue paying off, with PayPal aiming to increase its non-GAAP operating margin by at least 1.0% for the entire year.

PayPal's Innovations: Revolutionizing E-commerce and Customer Experience

Notably, PayPal's strategic initiatives are central to three critical areas of focus: branded checkout, PSP (Payment Service Provider) merchant solutions, and digital wallets. These initiatives are interconnected and designed to increase PayPal's share of the e-commerce market while accelerating margin dollar growth.

For instance, in Q2 2023, PayPal reported that its branded checkout volumes grew in line with industry trends. More notably, the growth rate accelerated to nearly 6.5% in June and over 8% in July, the highest monthly growth rate since the pandemic's onset. This upward trajectory is expected to continue throughout the year's second half, driven by traction from strategic initiatives.

One standout achievement is the success of PayPal's BNPL offering, which has gained significant traction. Introducing pre-approved amounts for consumers has led to a meaningful acceleration in BNPL adoption. Furthermore, improvements in onboarding new experiences have resulted in higher engagement and lifetime value for customers.

PayPal also enhances the branded checkout experience through innovations like passkeys, which simplify log-in procedures and improve authorization rates. The company aims to continually close the gap in log-in and checkout experiences and surpass competitors within the following year.

Looking forward, differentiated wallet experiences across both PayPal and Venmo are also in development. PayPal believes that leveraging its unique and scaled data sets will enable it to utilize the power of AI for actionable insights and differentiated value propositions for customers. The company is experimenting with an AI-driven PayPal assistant, with plans to introduce it later in the year.

On the other hand, the implementation of AI is already evident in PayPal's software development process, where early successes have been achieved. Over 300 experiments were launched in the year's first half to improve the product experience continually.

These experiments may lead to incremental customer benefits and improvements in key metrics, such as branded checkout growth. Finally, AI will play a pivotal role in PayPal's next-generation checkout solution, leveraging the scale of its Vault network, a deep understanding of its two-sided network, and developing proprietary AI models.

Entry into the Stablecoin Market

One of the most significant moves by PayPal in recent times is its entry into the stablecoin market with the launch of PayPal USD (PYUSD). This US dollar-denominated stablecoin is designed to facilitate payments in Web3 and digitally native environments.

It is fully backed by US dollar deposits, short-term US Treasury bonds, and similar cash equivalents, ensuring its stability and utility. PayPal USD allows eligible US customers to transfer funds between PayPal and compatible external wallets, conduct person-to-person payments, fund purchases at checkout, and convert between supported cryptocurrencies and PYUSD.

Therefore, this strategic move positions PayPal to leverage the growing interest in stablecoins and solidify its role in digital payments.

PayPal and Uber: Driving Forward with an Enhanced Partnership

PayPal's extended partnership with Uber further exemplifies its strategic positioning. The expanded partnership includes additional processing through PayPal Braintree, domestic debit network routing, instant payouts to PayPal and Venmo, and custom support for new lines of business.

PayPal has been processing Uber's payments in nearly 200 countries and 50 currencies since 2012, contributing to high authorization rates and successful transactions. In addition to payment processing, PayPal will extend its payout solution to enable drivers and couriers to access their funds instantly through PayPal and Venmo.

Block: Fundamental Moat Through Multiple Ecosystems

Block operates multiple ecosystems, each catering to distinct audiences and industries. This diversified approach spreads risk and taps into various revenue streams. Block's Square ecosystem is a pivotal part of its business model. It offers a suite of services for merchants, including point-of-sale systems, payment processing, and financial services. The ecosystem has demonstrated resilience and growth, with gross profit marking an 18% YoY increase.

The company serves various industries within Square, including restaurants, retail, and appointments. Gross profit from vertical point-of-sale products was up 37% YoY, with individual segments like restaurants, retail, and appointments generating over $100 million in annualized gross profit each during Q2 2023.

On the other hand, Cash App, a consumer-centric ecosystem, has experienced significant growth. In Q2, it generated gross profit with a remarkable 37% YoY increase, highlighting Cash App's ability to engage users and monetize its platform. Under Block's leadership, Cash App possesses several strengths and vast growth potential; with $58 billion in peer-to-peer volume, it demonstrates the effectiveness of its network effect.

Key performance indicators for Cash App include monthly transacting actives, inflows per transacting active, and monetization rate. The ecosystem reached 54 million monthly transacting actives in June, a 15% year-over-year increase. Peer-to-peer transactions per active account reached an all-time quarterly high, contributing to $53 billion in peer-to-peer volume during Q2. Inflows per transacting active averaged $1,134 in Q2, showing stability and potential for growth.

The forecast for Cash App's number of users from 2024 to 2027 suggests continued growth. 2024, it's expected to reach 50 million monthly active users, showing a 9.9% increase from the previous year, and this growth trend is anticipated to continue. Over the next four-year period, from 2023 to 2027, Cash App is forecasted to add 15.7 million monthly active users, representing a significant 34.5% increase and an average annual growth rate of 7.7%.

Lastly, Cash App's user demographic skews towards young adults, with 39% of users in the 18 to 29 age group . The next largest user group comprises individuals aged 30 to 39, making up 35% of the user base.

Interestingly, Block's expansion into financial services, including banking products, has been fruitful. Banking products represented 19% of Square's gross profit, excluding PPP, up from 17% in the previous year. Features such as Instant Transfer, Square Debit Card, Square Savings, and Square Loans have been instrumental in driving growth in this segment.

Overall, this diverse set of ecosystems allows Block to cater to businesses and consumers, effectively capturing value across various industries and segments.

Block's Foray into Bitcoin Wallets and Contactless Payments

Block announced plans for the public beta testing of its Bitcoin wallet, Bitkey. It also secured strategic partnerships with Coinbase and Cash App, allowing customers to buy and transfer Bitcoin from custodial platforms into Bitkey's self-custody wallet. These initiatives position Block as a significant player in the cryptocurrency space.

Block's launch of Tap to Pay on Android in Canada simplifies the payment process, aligning with consumer preferences for contactless payments. Similarly, the introduction of Square Go, a consumer booking app, enhances customer experiences and provides convenience, leading to increased rebook rates. For instance, consumers using Square Go have shown a 23% higher rebook rate than non-users, illustrating the app's value in improving customer loyalty.

Additionally, Block may benefit fundamentally by partnering with Jane Technologies in the Canadian cannabis market. Firstly, this partnership enables Block to tap into the rapidly growing cannabis sector, which is projected to have an annual growth rate of over 18% through 2024.

The market expansion diversifies Block's revenue streams, reducing dependency on specific industries. Block's provision of an integrated commerce solution tailored for cannabis dispensaries creates a unique selling point. Finally, introducing an Early Access Program signifies Block's focus on understanding the cannabis industry's nuances and enhancing its payment solutions to cater to this niche market.

Head-to-Head: Valuation and Growth Metrics

Block generally shows a more significant undervaluation relative to 5-year historical averages than PayPal . This suggests a higher upside potential in valuations if these stocks trade at their historical averages. Notably, forward growth metrics are superior for Block , suggesting potential value and cash flow advantages over PayPal .

Similarly, evaluation of top-line, profitability, and liquidity growth expectations (forward), such as revenue growth, EBITDA growth, EPS diluted growth, EPS forward long-term growth (3-5 years), and FCF per share growth rate, highlight Block's growth superiority over that of PayPal's . These metrics suggest Block's potential value and cash flow advantages over PayPal.

Concluding Thoughts

In the dynamic realm of digital finance, where innovation and adaptability are essential, both PayPal and Block have proven their mettle. PayPal's unwavering revenue growth, backed by disciplined cost management and groundbreaking ventures like stablecoins, solidifies its position in the financial landscape. On the other hand, Block's diverse ecosystem, highlighted by the remarkable growth of Cash App and strategic forays into cryptocurrencies, positions it as a genuine contender for the future.

As we close the chapter on this comparison, it's evident that both companies bring unique strengths and opportunities. With its growth potential and undervalued status, Block is a compelling choice in an ever-evolving market. So, whether you're drawn to the steady growth of PayPal or the promising future of Block, the world of digital finance offers something for every investor's appetite.

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