$PYPL – Bill Me Later

by Dan May 17, 2016 12:25 pm • Commentary• Trade Ideas

Event: PayPal (PYPL) will hold their first analyst day as a separate company tomorrow at their headquarters in San Jose, California.  The options market is implying about a 3% move in the stock between now and the end of the week.

On April 27th the company reported Q1 results that were ahead of consensus and reiterated guidance.  Here were the highlights summarized by SunTrust analyst Bob Peck in a note to clients from April 28th:

  1.   184M active accounts (up 4.5M q/q and vs. Street at 183M), with >170M buyers and >14M merchants on network;
  2. number of transactions continues to accelerate, on higher engagement (One Touch, etc);
  3. TPV also accelerated (up 31% ex-FX, from 29% in 4Q and 27% in 3Q), driven by 39% growth in off-eBay volume;
  4. transaction take rate continued to decline on mix shift to large merchants, Braintree, and Venmo;
  5. Other revs accelerated 7-pts on credit products and amended Symphony agreement;
  6. Revenue growth accelerated to 23% exFX and was the highest in 5 quarters;
  7. Non-GAAP Op margin declined ~70 bps, primarily on Xoom acquisition (but was up ex-Xoom), and was in-line with STRH expectations;
  8. FCF of ~$600M grew >70% YoY, as capex declined to 5% of revs from 9% a year ago.

I suspect management held back on raising 2016 guidance (just affirming) so they had a little something to drop at the analyst meeting.  This could be the catalyst for the shares in the near term.

My Take:  The company has a great balance sheet, $4.76 billion in cash, and no debt and is in the midst of a $2 billion share buyback announced in Q4 of last year.  The company has guided eps and sales to grow at about 16% this year, and the stock trades at 26x that expected eps growth, and 22x that for 2017, expected to be in high teens.

For comparison sake Mastercard (MA), which sports a market cap of $105 billion, more than double that of PYPL’s $47.5 billion, is expected to have 2016 sales of $10.5 billion, which after only growing 2% last year are expected to accelerate to 8% growth this year.  MA trades 27x expected 2016 eps growth of only 3% and 23x what is expected to be a meaningful acceleration to 17% growth.  Seems fairly hopeful.

If we were playing would you rather, I’d much rather PYPL, which is expected to have $10.7 billion in sales in 2017, and as Peck says, “benefit from strong network effects as it transitions from a payment “button” to providing end-to-end payment solutions”.  Which ultimately could lead a MA or Visa (V) to look to partner with PYPL (V & PYPL are currently discussing “legacy” data sharing issues, but could lead to partnerships that PYPL management suggests both parties could be winners).

Technical Set Up:  Since their July 2015 spinout from eBay, PYPL has traded in a fairly wide range between the low $30s and the low $40s, but most recently consolidating between $38 and $42 since early March:

PYPL 1yr chart from Bloomberg
PYPL 1yr chart from Bloomberg

Options Volatility Snapshot: Short dated options prices have just come off the mat, with 30 day at the money implied volatility (the price of options, blue below) at 32%, just off of all time lows, while realized volatility (how much the stock has been moving, white below) at all time lows:

PYPL 1yr chart of 30 day at the money IV vs Realized from Bloomberg
PYPL 1yr chart of 30 day at the money IV vs Realized from Bloomberg

With options prices elevated for tomorrow’s event, the set up is not bad for those looking to finance the purchase of longer dated options for directional views.

So what’s the trade?

*Trade: PYPL ($39.25) Buy June / Oct 42 Call Calendar for $1.60
  • Sell to Open 1 June 42 call at 45 cents
  • Buy to Open 1 Oct 42 call for $2.05

Rationale: The ideal situation for this is PYPL is up on earnings in line with the implied move, or even slightly more, without going above 42. If PYPL closes at or near 42 on June expiration we will then have financed cheap calls for a breakout into October. The short call strike can then be rolled out and possibly up. This trade is a loser if PYPL goes lower from here. It’s long about 15 deltas and a move lower with the implied move likely means about a .30 loss. A substantial move lower and losses could be more. But it’s unlikely that a significant loss happens and the most that can be lost on the entirety of the trade is 1.60, what was paid. One risk to the upside is a significant move through the 42 strike in which the trade could actually become a loser even though it starts long deltas, but that scenario is unlikely as it would have to move significantly higher than 42 in the near term.