To understand the difference between traditional business models and newer tech-enabled disruptive paradigms, consider the following basic valuation and DuPont model analysis of two financial companies whose products you likely use today:
- The setup: PayPal’s market cap of $130 billion is 33% higher than American Express’ $98 billion equity valuation.
- Their relative size: PYPL’s revenues last year ($15.4 billion) were basically a third (36%) of American Express’ $43.3 billion.
- Margins: AXP is not only much larger, but it also has better operating margins than PYPL: 18.8% vs. 15.4% last year.
- Asset turns: American Express uses $2.70 of assets (net of deposits) to generate $1 of revenues as compared to $1.30 in assets (net of transactional cash held) to support the same $1 of revenue at PayPal.
That 2:1 asset efficiency advantage is the difference between PayPal’s payment platform and AmEx’s more traditional credit/charge card business.Simply put, PayPal’s superior valuation to AmEx is not only due to better revenue/earnings growth. With roughly comparable margins but 2x asset turns, it also generates a better return on its capital.
Now, the trick with platform businesses is leveraging that asset efficiency with sustainable revenue growth. As long as fixed costs remain stable, free cash flow accelerates much faster than revenues because incremental capital needs remain low. That’s what PYPL’s premium equity valuation to AXP actually discounts – that a (much) smaller company has a pathway to generating (much) greater incremental cash flows because it has a superior business model.
So we were struck by PayPal’s decision to invest $500 million in Uber at the middle of the upcoming IPO price range. This is the second largest investment in PayPal’s history behind its March 2019 stake in MercadoLibre, essentially a Latin American eBay. Since PYPL itself spun off from EBAY in 2014, they likely have a decent edge to offer in consumer ecommerce and a LatAm partnership makes sense to increase global customer count.
PayPal’s Uber stake likely has wider-ranging goals, however, as Techcrunch noted in its write-up on the news:
- PayPal is already Uber’s leading payment provider in the US/Canada but an equity stake will give them the clout to ask for a closer relationship outside North America.
- Talking to some plugged-in tech analysts, they tell us the “real” bull case for Uber is that their platform can scale into logistics/shipping/shopping from its current base of personal mobility (ride hailing), trucking (Uber Freight) and food delivery (Uber Eats).
While Uber already offers Uber Cash (leaving money on your account to pay for future rides) and an Uber Visa Card (earn points), PayPal has the technology and customers to help them scale into new verticals.
- PayPal also brings millions of merchant relationships and these may want to accept Uber Cash, allowing customers to pay for goods and services with money housed at Uber rather than a transactional account. After all, Uber already knows when a customer is likely to be in a certain location. A local boutique or restaurant would find that very useful information for promotional purposes, for example.
- Read more here: https://techcrunch.com/2019/04/26/paypal-makes-a-big-marketplace-play-with-its-500m-investment-in-uber/
Why this matters: PayPal is a data-centric company with a very strong CEO in Dan Schulman so their decision to invest in Uber isn’t just them hopping on the flavor of the month. Exactly what they have in mind is hard to know just now. But between PYPL and UBER there’s +$200 billion of market cap at stake, so whatever they have in mind better be impressive. It will be hard to hide any failures here.