Fitch Affirms PayPal's IDR at 'BBB+'; Outlook Stable

CHICAGO--()--Fitch Ratings has affirmed the Long-Term Issuer Default Rating (IDR) for PayPal Holdings, Inc. (PayPal) at 'BBB+'. PayPal separated from eBay, Inc. in July 2015 with no debt. Fitch has also assigned a 'BBB+' rating to PayPal's $2 billion senior unsecured, five-year revolving credit facility.

In addition, the 'BBB+' IDR assigned to PayPal's wholly-owned subsidiary, PayPal, Inc. has been withdrawn, as Fitch does not anticipate debt to be issued at this entity.

The Rating Outlook is Stable.

KEY RATING DRIVERS

Strong Secular Growth: The ratings and Outlook reflect Fitch's expectations for a continuation of strong operating performance within the context of secular growth markets and conservative financial policies through at least the intermediate term. We also expect strong total processing value (TPV) growth to drive solid mid-teens FX-neutral organic revenue growth through the intermediate term, despite lower take-rates associated with rapidly growing mobile payments. In addition, significant market fragmentation supports Fitch's confidence in PayPal's growth prospects.

Profitability Strong; Potential Margin Pressure: Fitch expects profitability will remain strong although margins are expected to be modestly pressured over time due to a number of factors, including intense competition, large merchants in the revenue mix, a change in product mix, recent agreements with Visa and MasterCard, and increased mobile penetration. Nevertheless, Fitch expects operating EBITDA margins to remain in the mid-20% range through the forecast period.

Customer Concentration: PayPal has exposure to its former parent, eBay, as 26% of revenues in 2015 were derived from customers and merchants on the eBay marketplace, down from 29% in 2014. Fitch expects the level of exposure to continue to decline over time as PayPal invests in other areas and as other merchants adopt PayPal on their platforms. PayPal's relationship with eBay is governed by an operating agreement which should provide near-term support for revenue stability, but the agreement's expiration or termination prior to expiration, or other changes in the relationship, could pressure PayPal's revenues.

Intense But Fragmented Competition: Fitch believes the rapidly growing and highly fragmented digital payments market tempers the significant risks associated with emerging payments players and technologies. Expectations for share gains by formidable new entrants, including Apple Pay, Google Pay and Facebook, may be constrained by these companies' footprint, investment thresholds and focus, and regulatory infrastructure. At the same time, a lack of scale could constrain penetration by smaller mobile players.

FCF: Fitch expects mid-teens (or higher) revenue growth and strong profitability will drive solid annual free cash flow (FCF) of $2 billion or more. Cash will be used to expand credit, as well as to make acquisitions to expand its mobile payments platform. Large acquisitions could potentially be debt-financed. We do not anticipate meaningful shareholder returns through the intermediate term, with share repurchases primarily focused on offsetting dilution.

Excellent Liquidity: PayPal has strong liquidity, aided by approximately $6.2 billion in cash, cash equivalents and investments. FCF of at least $2 billion annually and an undrawn, $2 billion revolver also bolster liquidity. Fitch expects financial policies to be conservative through at least the intermediate term.

KEY ASSUMPTIONS

--Revenue growth in the mid-teens through the intermediate term, in line with the growth of e-commerce retail online spending. Potential upside from share gains in mobility and offline;

--Operating EBITDA in the mid-20% range, driven by solid revenue growth and partly offset by growth in lower-margin areas, including the addition of large merchants and the deals with Visa and MasterCard;

--Capex approaching 7% of revenues;

--Acquisition levels similar to recent history;

--No dividend currently contemplated;

--Share repurchases primarily focused on anti-dilutive buybacks;

--No debt issuance through the forecast period, given strong cash balances.

RATING SENSITIVITIES

Positive: Sustainable share gains in mobility and offline, driving revenue growth in line with the broader market and resulting in greater FCF scale; or management commits to total leverage near 1.5x, signalling the company is confident it has achieved sufficient scale to organically fund acquisitions over the longer term and organic growth prospects to limit share repurchases to FCF.

Negative: Meaningfully lower than market top-line growth, pointing to a less competitive mobility and offline strategy; or total leverage near 2.5x on a sustained basis from debt-financed acquisitions and share repurchases, indicating a shift in financial policies in the face of greater than anticipated profitability pressures.

LIQUIDITY

Fitch believes PayPal's liquidity is strong and supported by $6.2 billion of cash, cash equivalents, and available-for-sale securities ($4.9 billion of which is located outside the U.S.) and strong annual cash flow of $2 billion or more.

The company has no debt outstanding. PayPal has an undrawn, $2 billion senior unsecured RCF to support liquidity needs that is in place until July 2020. The facility is guaranteed by PayPal, Inc.; with agreement of the applicable lenders, the company can increase the commitments under the facility by up to $500 million.

The principal financial covenant calls for the consolidated interest coverage ratio to be no less than 3.0x and the consolidated leverage ratio to be no more than 3.5x. The consolidated interest coverage ratio is released if the company attains two 'BBB+' equivalent ratings, and would be reinstated if this equivalent is no longer true.

Customer balances are a direct claim against PayPal and are reflected as a liability classified as amounts due to customers. Various jurisdictions require PayPal to hold liquid assets (defined by the regulators) equal to at least 100% of the customer balances. The assets underlying the customer balances meet the regulatory requirements and PayPal separately classifies the assets as customer accounts in the consolidated balance sheets. The assets underlying customer balances are not commingled with corporate funds and are in separate bank deposits, time deposits, corporate debt securities and government (U.S. and foreign) and agency securities. At June 30, 2016, customer balances were $13.8 billion.

Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below:

-- The EBITDA(R) metrics are unadjusted for dividends received from Associates/paid to Minorities.

Additional information is available on www.fitchratings.com

Applicable Criteria

Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)

https://www.fitchratings.com/site/re/885629

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1012416

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1012416

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
John C. Culver, CFA
Senior Director
+1-312-368-3216
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Zack Schroeder
Associate Director
+1-312-368-2056
or
Committee Chairperson
David Peterson
+1-312-368-3177
or
Media Relations
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
John C. Culver, CFA
Senior Director
+1-312-368-3216
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Zack Schroeder
Associate Director
+1-312-368-2056
or
Committee Chairperson
David Peterson
+1-312-368-3177
or
Media Relations
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com