Should You Dump PayPal Shares After Fintech’s Latest Gaffe?

No matter how good a company appears on paper or market opportunity, consistent management missteps are a red flag for investors. Unfortunately, this is exactly what many investors face PayPal (PYPL 0.37%).

PayPal has had its fair share of hiccups over the past two years. First there were rumors of a purchase Pinterest. It then scrapped aggressive growth forecasts just one quarter after they were released. And recently it made perhaps its biggest blunder yet – the $2,500 misrepresentation fine.

Even unintentional actions have consequences

On October 8, PayPal released an update to its user agreement that included a clause allowing PayPal to fine its users $2,500 for using the service to spread “misinformation.” However, PayPal quickly retracted the update, saying the misrepresentation clause had been included in error.

Regardless of whether the policy was published in error or dumped due to the public backlash, the damage has already been done. According to Google Trends, the phrase “delete PayPal” is about 10 times more popular in searches now than it has been in the last five years. In addition, many members of the so-called “PayPal mafia” – founders and early employees of fintech who have since gone on to found a number of other companies – have spoken out against the policy.

For example, one-time president David Marcus tweeted in part: “PayPal’s new AUP goes against everything I believe in.” Elon Musk (another PayPal mafia member) responded in agreement with Marcus.

It remains to be seen how this stunt affects the business, but PayPal was already on a downward spiral before this story broke.

Investors will have to wait to see what the damage is

Regardless of whether management ever actually intended to adopt this policy, it has now been definitively dropped. But since news of it broke on October 8, PayPal shares are down approx. 6% against the broad market’s rise of 1%. From a bigger picture perspective, the stock is now down more than 70% from its all-time high.

A 6% drop is significant, but it also indicates that investors are not viewing this event as a thesis. Management will likely face questions about it during PayPal’s upcoming third-quarter earnings call on Nov. 3. But until the next report comes, investors can only evaluate the company based on the most recent data they have – the results for the second quarter.

In that quarter, PayPal’s active accounts rose 6% year-over-year to about 429 million. But because the third quarter ended on September 30 – before the user agreement fury erupted – investors won’t actually get a clear picture of the impact (if any) until year-end results.

While PayPal grew its revenue 9% year-over-year in the second quarter, adjusted earnings per share fell 19% to $0.93, but free cash flow still rose 22%. To improve its bottom line, PayPal announced cost-cutting initiatives that management expects will save the company about $900 million in 2022 and $1.3 billion in 2023. Those plans helped management raise its full-year outlook. In terms of valuation, PayPal currently trades at 19 times free cash flow – not expensive, but not cheap either.

The “misinformation” fine has scared off some investors and users (as it should), but until we know what actual effect it has had on the business, I won’t be buying PayPal stock. Even then, the incident makes me reconsider my PayPal position. It is not about intentions or thoughts behind the user agreement blunder. It’s more about a company that can’t seem to get out of the way.

Depending on how the next few quarters shape up, I may sell my shares – even at a loss. There are a lot of amazing businesses out there and I’m not going to waste my time owning stock in one that isn’t doing well.