Motley Fool Hidden Gems Investing - Is PayPal the Next Meta?

Episode Date: February 21, 2024

Investors want PayPal to become the next Meta, but it’s not easy to transform a business. (00:13) David Meier and Deidre Woollard discuss: - The reason behind Palo Alto Network’s lowered outlook. - Where the next big cybersecurity threats could come from. - Fubo’s attempt to sport a sports streaming superpower. (17:12) Matt Frankel and Ricky Mulvey look at Meta’s rebound and if PayPal could be next for a glow up. Companies discussed: META, PYPL, ADYEY, NVDA, PANW, ZS, CRWD, FUBO, DIS, WBD Claim your Epic discount: www.fool.com/epic Host: Deidre Woollard Guests: Matt Frankel, Ricky Mulvey, David Meier Producer: Ricky Mulvey, Mary Long Engineers: Rick Engdahl, Tim Sparks Learn more about your ad choices. Visit megaphone.fm/adchoices

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about a company that maybe isn't having the best Wednesday we've ever heard of. No, I don't think it is. And that's cybersecurity firm Palo Alto Network. Now, they had a solid quarter, revenue up around 19%. They met expectations. They're growing their business, their biggest customers. There's a lot to like there, but the market did not like this usual foe of late poor guidance. So, tell us a little bit about what's happening here. So, you're exactly right. Q1 performance came in pretty much as expected, but the guidance for fiscal Q2, as well as fiscal year 2024, the growth for those two came in much lower than expected. Um, so the company had been and had been continued to achieve this, uh, just under 20%

revenue growth, but now the expectations are for mid teens. And look, that's, that's a big difference. Um, especially when your stock is trading at premium valuation metrics before the earnings report, it was trading at just under 13 times forward sales. So, you know, When you don't meet expectations and you're trading for a premium, unfortunately, your stock is going to sell off sharply, and that is exactly what is happening today. Well, management was really careful on the call to try to explain why this is happening. Were they? Were they?

I feel like they were. They were talking a lot about the demand's not going away. We're stepping back to go forward to some extent. The guidance is not a consequence of demand. And so what do you think? You study this company. Do you believe it? Well, okay. So the first thing is, we're going to see what happens. We're going to actually, we don't know exactly today what exactly happened. We have management talking about a lot of things that they saw happen, such as spending fatigue or customers wanting more value for the dollars

that they're spending on their cybersecurity. And we've got management also saying, hey, we're still pushing this idea of selling the platform as opposed to selling individual modules. So again, those are, we'll call them excuses, but it didn't say, hey, the sales cycle is lengthening, or we didn't get a deal in that we were expecting to, and it's pushing into 2Q. We didn't get any really specifics. We got some broad terms. So right now, I'm willing to give this management the benefit of the doubt because of what they've done in the past. But the little yellow flag in my head has gone up. Well, and I think the yellow flag goes up because of what you mentioned about trading at a premium. And it's giving me a little bit of,

we've got NVIDIA after close of bell today. So thinking about what happens when the guidance doesn't meet the really high expectations. Yes. The higher the premium, unfortunately, the more the stock has the potential to fall if you don't meet those very high expectations. That's kind of the way the markets work nowadays. Indeed. Well, I want to zero in on the platform thing that you mentioned, because they talked a lot about this on the call. It's a big part of their earnings is this, they say they've validated platformization in the cybersecurity space. Now, that seems like some lingo to me. My lingo meter went off, but what does it mean? And is it any kind of moat for them? Because they're a little different than some of the other cybersecurity

companies. Yeah. So yes, that's an interesting buzzword. Again, let's go back and look at what Palo Alto has done. And over time, and especially since CEO Nikesh Arora took the helm, they've been transforming from mainly a firewall hardware and software provider into a complete cybersecurity platform. We'll call that a one-stop shop. Look, they've made that transformation. They've spent a lot of money and a lot of time getting to be from a one-product company to, I believe in the pitch to investors, they said they were a leader in 21 individual categories. They put those all together, and that's your validated platformization strategy coming to roost. So again, they've done that. And it's proven to be a good strategy. If you look, their sales growth increased as a result,

their stock price has gone up. And the CEO says, look, I want to lean even more into this, especially if customers are demanding more value for their cybersecurity dollars. You can come to me and through one channel, you can turn on all the things you want from us as a result of having a platform or having a one-stop shop. So I do agree, the phrase notwithstanding, I do agree that they have turned into a formidable one-stop shop. The challenge, to get to your second part of your question, is does this provide a moat? None of their competitors are standing still. Some of their competitors are saying, hey, we're going to just focus on one thing and we're going to be really good at that.

And so companies, buyers do often like to have go with best of breed. And then the other part of it is there's no reason that other companies can't try the same strategy. So will it provide a moat? We'll see. This is a very competitive industry. But right now, or for the last, let's say, five to seven years, and I think going forward, it does give them a little bit of an advantage to have one or more salesperson be able to give them the whole pitch as opposed to lots of individual salespeople giving them separate pitches. I'm thinking about this because you were on our member facing programs this morning and you were talking with one of our other analysts and about cybersecurity, about like, you know, CrowdStrike and Zscaler. And

the other person said, why not just buy the basket? Like you can't call it at this point. What do you think about that? I think that's a good strategy. And, and I, the reason is, is because, okay, Palo Alto has a platform. They've made acquisitions. They've done technology development. They have their technology foundation that they use within their products, but it's not necessarily the best one. And it has to evolve over time. So having a basket of technology innovators within the cybersecurity industry is probably a better bet than just making one bet on a platform because there are lots of smart people who are attacking this problem differently. And the other thing is we don't know. We don't know where the threat vectors are going

to come from next. We don't know necessarily the technological foundations that are going to nullify those threat vectors. So you could go back and forth between who's the leader in this area of cybersecurity and who's the leader in that area. So I do think the basket approach is a better one, basically diversifying across the technology innovations within cybersecurity. You had such a good point there about we don't know where the threat factors are coming from. Because, I mean, we talk so much about the good side of AI, but the bad side of AI and the need to protect against AI and the need to protect your AI, there's all these different things that are, that are going to come up. And so, uh, Palo Alto, they talk about this goal. They wanted to

achieve a 15 billion in annual recurring revenue by 2030. And they had this, this way to, uh, to kind of do this with AI security. They have these three components. They want to keep employees safe while using AI, of course, makes sense. They want to secure the deployment of AI models. Of course, you don't want, you know, you don't want threats tinkering with your, your large language models or anything like that. And then securing AI apps from real-time cyber attacks, which sounds terrifying. So this sounds like a good theory and a good plan. What could go wrong here? So I agree with what you're saying in terms of this sounds like a good plan. But I think the challenge going forward is going to be, are these really serious threat vectors?

And the other part that you have to ask is, what is the cost of having an attack within these three areas? So let's go back to what Palo Alto did originally, and that's firewall. Having somebody attack your firewall and get into all of your computer systems, that's very bad, right? Could be potentially catastrophic. Yeah, I don't. And so you you are willing to spend a lot of money in order to protect against that threat. I'm by no means I don't want to trivialize anything within the AI threat vector. But is the worst thing going to be somebody attacks what the answer to your prompt is? is it messes with the AI generative video that you're looking to create? Again, I've realized that I am in some ways trivializing this. I don't know what the threat vectors are. I imagine Palo Alto knows better. They gave actually some pretty big total addressable

markets for the three categories on the order of 3 to 5 billion, 5 to 7, and I think 6 to 10. So they think it's real. So the challenge will be, are they right? Can they use their technology in order to go after and nullify those threats? And then can their marketing and sales do a good job of convincing people that, yes, this is something you need? So it's early days. We'll see. Yeah. The early days factor is one of the things that I think makes this particular category so challenging to invest in and try to figure out where things are going next. I think it's a safe bet to say that someone will attack it. We just don't necessarily know how. exactly well i want to switch categories a bit uh i know you like to watch sports i like to watch sports too and i'm wondering if you had a take on fubo's move to uh basically to go after disney fox and warner brothers discovery they announced that their sports bundle and so fubo is basically saying it seems to me like hey you stole our idea we've already been doing this so

don't do that. The full lawsuit's not out yet, but it feels a little like a Hail Mary to me. What do you think? As a former Fubo subscriber, I will say for full disclosure, I do subscribe to Hulu now, Hulu Plus, and they give me 75% of my sports that I actually religiously watch, And I subscribe to other providers as well to get the things that Hulu doesn't provide me. So I'm not going to speak to the legal challenge as I'm not a lawyer, but I think if we step back and think about what Fubo is doing against major content producers such as Disney, Fox, and Warner Brothers, this really shows the challenges of being solely a distributor of

content in an era where there are essentially no barriers to entry. Look, you and I could start a platform to distribute content. And I realize, you know, maybe technologically that might be a little bit difficult to do us, but seriously, we could do it. All we need to do is, you know, create the platform, go to the content providers, cut deals with them in terms of paying for their content, and then figure out how to get subscriptions. There's nothing that is actually preventing you and I, or from anybody else, of doing that. And since it's so easy now, and it's so cheap to basically distribute content over the internet, you know, Fubo stands to lose quite a bit as a result of not having their own content.

And this gets back to the same, you know, timeless debate. Do you want to be a content creator or do you want to be in the distribution business? Well, Disney, Fox, and Warner Brothers on the sports side have said, we can do both now. And, you know, again, I don't know about the merits of of Fubo's case because I don't know all the details. They came out and said, hey, you're doing some anti-competitive practices. That's certainly going to get some lawyers' attentions in terms of they have a case, but I don't know. Are they? They're just saying, you can access our content here. You can access our content on Fubo. They want as many people as possible and as many platforms as possible to access the content. That's why they're content

producers, but, but you know, we'll, we'll see. It does feel like a little bit of a Hail Mary and I don't want to see Fubo fail in any, you know, in any shape or form, but yeah, this, this is the big guys essentially throwing their weight around as there's no barrier of entry to distributing your content. Yeah. And they've got, they've got the deep pockets. So I'm curious, why did you, why did you stop having Fubo? Was it because you could get most of what you needed and get other content? It was because I couldn't get TNT and sometimes there was hockey and basketball that I didn't get to see. And at the time, I believe that Fubo also was not able to, or they weren't able to re-sign their deal with Monument Sports, which is the Washington Capitals. And I was

watching those capitals religiously. So I went to Hulu and got that. And then when I moved, I actually was not able to get the Carolina Hurricanes, which is the other team that I support because apparently Pauley's Island being four and a half hours away from the Raleigh-Durham area is still in the area where they want me to go to the game. So I actually had to purchase Bally Sports South in order to get access to my Carolina Hurricanes. Well, I think that's, I'm glad you shared that because that's an example of some of the hoops we go through, especially as sports fans. Because I'm in Alexandra, I'm also a Caps fan, but my my core team is the Bruins. So I had to get ESPN in order to get my Bruins.

And the good, yes. And so I have the plus package as well. And ESPN plus has so many great games and I get them for such a, you know, a very, very, um, uh, a great price that I, you know, cause I, even though I follow the hurricanes and the capitals, like I love watching the Bruins play. I love watching the Rangers play. I love watching the red, like I love all these teams and ESPN plus is the perfect venue for it. Yeah, that is the other thing. I watch too much sports. So do I. So do I. Well, let's leave it there. Thanks for your time today, David. Thank you so much. We talk about a lot of stocks on the show, but it's just a peek at the Motley Fool's investing universe. This year, we're rolling out a new offering. It's called Epic Bundle. The service includes seven stock recommendations every month, model portfolios, and stock rankings,

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That's r-i-p-p-l-i-n-g dot a-i slash f-o-o-l. Sign up for exclusive access today, rippling.ai slash fool. Is PayPal the next Meta? Or is Meta the next Meta? Ricky Mulvey caught up with Matt Frankel to talk about how the payments company can turn its story around. All right, Matt, I'm seeing a lot of internet chatter where people want to find the next Meta. Some folks are hoping that it's PayPal. Before we get to how the story translates, let's start with the Meta turnaround story. The stock has been a five bagger since its low in November of 2022. A little uncommon for now

a mature-ish tech company. That's not something you would expect to see. So while it's easy to see the chart in hindsight, why were investors so pessimistic about Meta just a year and a half ago? Well, think about what was happening a year and a half ago. So it bottomed in late 2022. This is when all the air had gone out of the big bubbles of the tech companies. Money was free for a long time, things like that. So it's like a perfect storm of two things. One, Meta was investing billions of dollars in the Metaverse side of the business that was losing those billions of dollars. And at the same time, its ad business was in terrible shape. Advertisers stopped spending money because of economic fears. This is what happened with other social media companies as

well. That's what happened with Alphabet. Their ad business was just terrible. So investors really couldn't fathom why they were throwing billions of dollars into an unproven technology at the same time while their ad business was losing money or was declining. And since then, the ad market has recovered. Ad revenue, in Meta's case, was up 24% year-over-year in the fourth quarter, which, as you mentioned, for a mature company, that's a pretty big jump. And the Metaverse part of the business is still unprofitable, but it's hitting some impressive milestones. Reality Labs is what they call their metaverse division. It broke a billion dollars in revenue for the first time ever in the fourth quarter. So it's not profitable, but the metaverse side is showing

promise and the ad business has recovered nicely. Its margins are really strong, 54% operating margin in the fourth quarter. And the stock is actually trading even after that, the giant move that you mentioned, it's been a five bagger in a year and a half. It's still trading for a lower forward PE multiple than Microsoft or Apple. So a lot of investors would argue that meta is still the next meta because it still looks reasonably priced for what's going on. Yeah, that's a good point. There's the year of efficiency that's been well discussed. I also think there has been a narrative shift where you saw Zuckerberg talking pretty much, he went all in on the metaverse by changing the company's name to it. The Metaverse Reality Lab is doing well. They're generating

revenue, I should say, coming up in earnings calls. What you're also seeing is a narrative shift with the new AI components, how that's becoming more and more a part of the public strategy for Meta. Yeah. It would be dishonest of me to say that the AI surge hasn't had anything to do with the move in the stock. They're arguably one of the biggest potential beneficiaries of the AI investment boom, just in a lot of different ways. On both the ad side of the business, which, I mean, look at the trade desk, which is a foolish favorite. AI and ads are a good combination when they're done correctly. So that part of the business benefits a lot. the Metaverse side of the business. It's an AI technology, essentially.

So the AI surge has increased investor optimism beyond what the numbers are telling us right now. So I would say that that's a fair statement as well. Now I'm seeing a lot of chatter. Let's move to PayPal. Because I think a big question is you have this dominant, in many ways, payments company. It's been beaten down. it's in a position where it's either going to languish or turn around. And to be clear, we're in a pessimistic era for PayPal. We're going to maybe criticize the bulls in a sec, but are the bears underestimating the power of PayPal's platform? I'll note a 2023 Motley Fool survey that found PayPal is the most popular digital payment app followed by the cash

app, then Venmo, which PayPal also owns. Yeah, I would say they are underestimating the network effect and the usefulness factor, I guess I would call it. One thing that I personally know, this is just completely anecdotal evidence, but I've noticed PayPal available as a seamless checkout option at more and more websites that I use over the past, say, two years. It's a functionality thing. I know we'll probably talk about this more later, but PayPal and throughout the industry, take rates are going down in the payment industry. Payment processing services, they're becoming a commodity, essentially. Whereas a lot of companies offer them, there's very little pricing power. The real differentiator is the usefulness of PayPal's

business. And I mean, I can check out with PayPal on 90% of the websites I go to. I can't say the same for Cash App or Zelle. So it's becoming a real usefulness factor. And that's what the new CEO Alex Chris seems to be really focused on is increasing the usefulness. You're right, if I own an online business, I can find 10 different payment processors that would be happy to process my money. I want to go with the one that detects fraud better. I want to go with the one that converts sales better because it's easy. I've gone away from websites because their payment process is clunky and I can't remember 10 different passwords. I'm an old guy, we don't have our passwords memorized in our heads. You know what I mean? It's more than just the payment

processing. It's which one's going to be the most useful partner for its customers. And that's what I think the bears are missing about PayPal. Yeah. I think there's also the competition component, which is maybe more important to the PayPal story, where I think at the time of Meta's peak pessimism, there was everybody's going to leave for TikTok. Meta's declining. Folks forgot that there were still like 3 billion people on the platform. And Instagram is incredibly popular and also can be used together with TikTok. This is a bit of a different story where the payment volume has been growing for PayPal, as you mentioned. But when people are looking for partners, yes, they're looking for fraud detection. They're also looking for that

transaction take rate, and that has steadily been declining. So I know you follow PayPal. Are the bulls maybe underestimating the power of the competition in this space? I mean, that would be fair to say to a degree. The barriers to entry have gone up considerably. There are a few big players in the space. It would be real hard for someone to just start a new payment processor at this point. But yes, there is a lot of competition in the space. PayPal is a very profitable company. It's worth pointing out. You mentioned the take rates are going down. PayPal is still a very, very profitable business. Its overhead is very low compared to its margins. So I'm not that concerned. The take rate, yes,

it's dropping a little bit, but this is still a very in-demand business. They're still in the very early stages of figuring out how to monetize certain parts of the business, particularly Venmo. So there's a lot of different ways they can monetize. I love the Honey acquisition, for example, because it helps convert its payment processing customers into another form of monetization. And I think that's where the business is going to head. Think of commission-free stock trading. Brokerages make money off of other things because they have those customers with their money and their investments at those certain firms. PayPal is going to head in that similar direction where maybe eventually they don't make the bulk

of their money off of the percentage they're getting from payments. And they have a bunch of adjacent businesses and things like that. Remember, this is Alex Chris's first, I call it his first semester as CEO. So he's still in the early innings of figuring out where he's going to take this, but I like what I'm seeing so far. So Honey is a browser extension where if you're shopping for online, it'll show you deals, promo codes, where else you can buy a product. CEO Alex Chris in his first semester has been promising a more focused company and some new innovations, such as smart receipts for merchants that can offer personalized deals to customers after a transaction. However, he's also been offering lighter earnings guidance than Wall Street

analysts have wanted. One of the big moves that Zuckerberg did, he changed the narrative around meta promising, this is our year of efficiency, we're going to be more focused. What can Chris do in his first year to change the narrative around PayPal? I feel like he's being a little conservative on purpose with that guidance that you mentioned. A few days before the earnings report, they unveiled a bunch of different AI initiatives. You mentioned the smart receipts. There's also kind of a revamped PayPal checkout experience online for customers. The guidance doesn't include any of those new initiatives, so it's worth pointing that out.

He reduced the workforce by 9% just a few days before that guidance was out, too. I feel like, first, he wants to make the business as lean as it should be, which we're seeing a lot of these big workforce reductions throughout the fintech industry. A lot of them had too many people working there, for lack of a better term. So he's right-sizing the business first, doubling down on AI. And then I think once the business is where it needs to be headcount-wise and things like that, that's when you figure out what the next monetization steps are. So just like when any new CEO jumps into a big company and really wants to pivot, because let's be honest, previous management's growth strategy wasn't exactly great.

Remember when they were going to buy Pinterest for $70 a share and no one knew why? Why not? I mean, as a Pinterest shareholder, I loved that move. But as a PayPal shareholder, I thought it was, why? Why would you do that? The last management was just growth at all costs, things like that. So, point being, I'm willing to give Alex Criss a little bit of time to kind of figure things out. I mentioned this was his first quarter. The fourth quarter was his first quarter as CEO. So, I feel like he's been reasonably active so far when it comes to making his efficiency moves. I'd like to see a little bit more of the long-term vision beyond just,

okay, we're going to incorporate AI into what we already have. How are you going to monetize better? And I think that's why the stock's still beaten down. I mean, it's pretty clear on that. Everyone thinks that the business is mature. It's not going to be able to monetize any better. And until he shows otherwise, I don't know if the stock's going to become the next meta or anything like that. Yeah. I mean, on yesterday's show, I talked with Jim Gillies about the Home Depot transition from growth story to cash cow. So even a large mature business with flat revenue can still outperform the market. One less discussed comparison that I think might be able to be made to PayPal is Adyen, which is sort of a plug and play payment processor. You don't see it as much

as a customer, but you've used it with companies like Uber and McDonald's. It's starting to get back on track with payment processing growth and margin expansion forecasts. The stock got beaten up after growth came in a little lighter than expected. And also, they were adding to their workforce at the time where Wall Street wanted them to get a little bit leaner. When you look at Adyen's comeback from a stock perspective, do you think PayPal can take any tips from that story? Well, there's a few things they can learn from Adyen. They should have started learning from Adyen when Adyen stole eBay from them. PayPal was a spinoff of eBay. You probably remember that headline a few years ago where eBay ended its relationship with PayPal. That was in favor

of Adyen. A couple of things Adyen does better is, one, they focus on the long-term. You mentioned they were investing heavily in the business at a time when just the macro environment was terrible. That's because they didn't really care what was going on in the economy this quarter. They had the money to invest. They knew where their business needed to be. so they made decisions regardless of what the quarterly results were telling them to do. I would love to see that. Adyen doesn't give quarterly or annual guidance. They focus on long-term metrics.

I would like to see PayPal shift to that. And I'd like to see PayPal really double down on being kind of an omni-channel payment solution like Adyen is. You mentioned McDonald's. They need a payment solution that you can pay in the app, you can pay online, and you could pay in the store. PayPal could do better. They've tried a few times to incorporate in-store checkout and they do a decent job with it, but they're not an omnichannel payment solution. They're just not at this point. I'd love to see them really double down on being merchants' one-stop payment solution. That's one thing that Adyen does really well and that's why

they've been so successful with these big businesses. You mentioned McDonald's, they have Uber, they have Etsy, they have a bunch of different big businesses that you use constantly. And they're just killing it when it comes to big businesses. And I love that long-term focus is really helping them do it. So PayPal still has some work to do, maybe a longer-term focus to take, and maybe Meta is the next Meta. Matt Frankel, as always, appreciate your time and insight. Thanks for having me. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have former recommendations for or against. So don't buy or sell stocks based solely on what you hear. I'm Deidre Willard. Thanks for listening. We'll

see you tomorrow.