eBay Inc (NASDAQ:EBAY)’s second quarter results were overshadowed by the company’s subdued outlook for earnings for the second half of the year. That’s left investors largely overlooking the continued strength of the payments division.
One of the biggest success stories of the Internet boom is PayPal. It first started as a third-party service for the settlement of eBay Inc (NASDAQ:EBAY) auctions. The company acted as a middle man between its users and a bank. It was such a desirable product that eBay tried to create a similar service. Unable to compete, eBay bought PayPal for $1.5 billion in the early part of this century.
PayPal has moved from being a way to pay for an auction to an almost universally accepted online payment system. Although the outlook for the rest of 2013 has soured investors, PayPal added 10 million customers since the start of the year and now has over 132 million user accounts. eBay Inc (NASDAQ:EBAY)’s Payments Group, which includes PayPal, has revenue of $1.6 billion, accounting for just over 40% of the company’s top-line.
Brick and Mortar
eBay Inc (NASDAQ:EBAY) has been working to expand PayPal out of the digital realm and into the real world. That’s where the real potential comes in. It has created a credit card-like system to compete with brick and mortar players like Visa Inc (NYSE:V), Mastercard Inc (NYSE:MA), and American Express Company (NYSE:AXP). That’s a pretty tough group of competitors, but don’t count PayPal out.
Since it has attracted the younger set already, PayPal could wind up being something of an affinity card with a loyal following. That’s part of what turned American Express Company (NYSE:AXP) into such a strong business. It caters to the well off, using service and brand image as a differentiation point.
American Express Company (NYSE:AXP) has remained soundly profitable in each of the last 10 years, including through the 2007 to 2009 recession, which dragged competitors like Mastercard into the red. Last year it earned nearly $3.90 a share on about $31.6 billion in revenue. And it’s nearly three times the size of its next largest competitor, Visa. American Express, with a price to earnings ratio well below those of Visa and Mastercard, is a great option for conservative investors seeking a credit card investment.
While PayPal is a long way from that scale, American Express Company (NYSE:AXP) had 102 million cards “in force” at the end of 2012. With over 130 million customers, PayPal already has a massive foundation to build on in the real world. True, PayPal customers probably don’t have the financial wherewithal of American Express’ customers, but it is building important brand equity with customers while they are young and can grow with users as they enter the “real world.”
Tough to Break in
With an installed base of customers, PayPal clearly has a head start for entering the credit card business. However, it isn’t doing it alone. The company is partnered with Discover Financial Services (NYSE:DFS), which itself broke into the credit card ranks nearly 25 years ago. Thus, PayPal doesn’t have to build out its own network. That’s a good move for PayPal, but perhaps an odd move for Discover.
On the surface, Discover Financial Services (NYSE:DFS) is helping an upstart looking to eat away at its credit card business. While that’s true, Discover is also leveraging its payment network so it can get a piece of the action as a new entrant grows its business. And, with some 130 million potential customers already using PayPal, Discover seemingly chose a partner with good growth prospects.
That bodes well for the company, which has seen its top-line move steadily higher over the past decade. That said, the company changed its fiscal year starting in January, which confuses the picture somewhat. However, recent performance has been so strong that the dividend was increased over 40% in the first quarter. Although still not an income stock, that’s a nice vote of confidence from management.
Moving to the Big Leagues
eBay Inc (NASDAQ:EBAY)’s PayPal is a hidden gem, especially as it moves to enter the big leagues with Discover Financial Services (NYSE:DFS)’s support. Conservative investors should look at American Express Company (NYSE:AXP) because of its loyal and wealthy customer base. However, more aggressive types might like eBay. The company has a loyal base of customers that are quickly entering their working years. It isn’t a stretch to think they will put a PayPal card in their wallets. Discover, meanwhile, might be a way for less aggressive investors to play PayPal’s move into the real world without taking on the risk of a tech name. And Discover’s core business is performing well, too.
Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends American Express and eBay. The Motley Fool owns shares of eBay.
The article They Should Rename it PayPal originally appeared on Fool.com.
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