How PayPal Can Become a $100 Billion Company

PayPal's co-founder Elon Musk and former Chief Operating Officer David Sacks have both shared similar beliefs -- that it makes no sense for PayPal to be a part of eBay . Both believe that PayPal could ultimately become a dominant force in the payments industry, with Sacks saying in a Forbes story that PayPal could top a market capitalization of $100 billion.

With most analysts expecting PayPal's market capitalization to be around $40 billion, at most, following its split from eBay, how can PayPal eventually become that $100 billion company?

Is $100 billion absurd?
Based on PayPal's current fundamentals and business model, it would be near impossible to justify a $100 billion market capitalization. PayPal has grown revenue by 19% during the last 12 months, to $7.2 billion. PayPal's operating margin last year was 24%, so on $7.2 billion of revenue, PayPal would trade at nearly 60 times 12-months operating income.

While not absurd by today's technology standards, 60 times 12-month operating income is quite pricey when you consider the rise of Apple Pay, Amazon Payments, and others. Visa , another company in the payments business, trades at just 17 times 12-month operating income, creating a wide disconnect between it and PayPal, and making $100 billion rather absurd.

A new business approach
That said, Musk and Sacks are both leading technology thinkers who understand the market well, so there must be a reason behind such bullish sentiment. The logic might lie in Sacks' comment about PayPal having the opportunity to "become the largest financial company in the world."

In order to do so, PayPal would have to make drastic changes to its business model; but with more than $200 billion in 12-month payments volume, and a presence in more than 200 markets, the potential is definitely present. Therefore, the key to understanding these changes lie in PayPal's current business model.

Apple will reportedly earn $0.15 per $100 spent via Apple Pay from transaction processors like Visa and Mastercard, but PayPal earns its revenue by collecting fees from consumers or merchants using its service. While the fee varies depending on the service, PayPal's traditional core service of sending and receiving cash online is around 3% of the monies transferred.

The problem for PayPal is that it only collects the 3% fee when users either have money stored on PayPal, or bank information tied to the PayPal account. When using a credit card, Visa, Mastercard, and others alike receive the 3% fee, which PayPal, as the vendor, is responsible to pay.

In other words, PayPal is losing a lot of money by having to pay the likes of Mastercard and Visa when credit or debit cards are used for payments. This brings about the possibility of PayPal becoming an actual transaction processor, rather than an aggregator, or a platform for transferring currency. Essentially, this move would mean that PayPal would operate like Visa and Mastercard, but through an online model.

As a result, PayPal might then find itself processing transactions for competing services like Apple Pay or Amazon Payments, who are both aggregators. In all likelihood, this reality of doing business with the enemy might have persuaded eBay against the move; but with eBay and PayPal split in two, and the latter seeking new business opportunities, the possibility of becoming a transaction processor makes sense.

$100 billion is possible
All things considered, PayPal's network of 152 million active users is large; but competing networks from the likes of Apple,, and perhaps Facebook in the future, are enormous. For the first time. eBay's existing business model is faced with real competitive threats. This fact further adds to the notion of expanding PayPal's reach into new financial markets, such as processing transactions.

The margins for companies like Visa and Mastercard are incredible. During the last 12 months, Visa and Mastercard have operating margins of 62% and 55%, respectively. The reason lies in the fact that both companies collect fees on all services offered, unlike PayPal. Even if PayPal's annual revenue stays at $10 billion due to competitive pressure in its core business, yet the company becomes a transaction processor with an operating margin of 60% (meaning it collects all fees), the company would trade at less than 17 times operating income at a market capitalization of $100 billion.

Foolish thoughts
Obviously, $100 billion is not a short-term market capitalization goal for PayPal; but because of its reach, the company has options in order to drive margins higher and enter new markets. In fact, becoming a transaction processor is just one option. Perhaps PayPal wishes to become a full-blown bank, offering checking accounts, direct deposits, saving accounts, mortgages, and maybe even investment options -- all online.

While all of these things may seem foolish today, eBay has decided to separate PayPal to explore strategic options and new partnerships with independent management. If PayPal decides to partake in any of these big changes, it's quite possible that Musk and Sacks are correct in seeing a grand future, one that might include a $100 billion market capitalization.

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Brian Nichols owns shares of Apple. The Motley Fool recommends, Apple, eBay, MasterCard, and Visa. The Motley Fool owns shares of, Apple, eBay, MasterCard, and Visa. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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