PayPal Holdings (PYPL) shows unusually large call options activity today based on a Barchart report. This may be the result of the company's recent Q3 earnings report where it reported huge adjusted free cash flow (FCF). As a result, based on its high FCF margins, PYPL stock could be worth well over 50% more. This explains the large call option activity.
Here is what the Barchart Unusual Stock Options Activity Report for Nov. 15 shows. Over 9,000 call option contracts have traded at the $60 strike price, just over $2.00 higher than the spot price of about $58.00. The expiration period is Dec. 29, 2023, or 44 days from now.
That means these medium-term expiration period calls are close to the money and it's likely the initiating investors are long the calls. In other words, they essentially are bullish on PYPL stock, especially given that this number of trades is over 38x the normal outstanding call contracts at this strike price.
For their trade to be profitable, the stock has to rise to $61.78, since the average premium for the calls is $1.78. That implies PYPL stock needs to rise just $3.78, or 6.5% in the next 44 days for a breakeven trade.
Clearly, the long-call buyers expect PYPL stock will rise much further than this. Let's look at what may be influencing their decision.
PayPal's Huge Free Cash Flow and FCF Margins
PayPal generated $1.9 billion in adjusted free cash flow (FCF) during Q3. This came from just $7.418 billion in revenue. So, its adj. FCF margin was at a very high level - 25.6% (i.e., $1.9b/$7.418b). That was even higher than its 15.7% operating margin.
This was the result of a massive 15% growth in its total payment volume (TPV) on a year-over-year (YoY) basis. In addition, it came from an 11% growth in total number of transactions. As a result, revenue of $7.481 billion was up 8.36% YoY.
In effect, the company's popularity and market share in payments and trading have been growing.
As a result, we can project how much FCF the company will make going forward. That will help us determine what the company is worth.
PYPL Stock Worth Over 50% More Based on FCF
For example, analysts now project that revenue in 2023 will reach $29.6 billion and $32.2 billion next year. That implies over the next 12 months it will average about $31 billion.
So, if we apply this company's latest FCF margin (and round it up to 26%), we can expect to see about $8 billion in free cash flow (FCF). This is the result of multiplying $31 billion by 26%.
We can use this $8 billion FCF estimate to project its valuation. For example, using a 7% FCF yield metric, PayPal's market cap could rise to $114 billion (i.e., $8b/0.07). This is also the same as multiplying the FCF figure by 14.3x (i.e., the inverse of 7%).
This $114 billion market cap estimate is 87% over the present $61.1 billion market cap.
But even if we use a 10x FCF multiple, the stock would be worth $80 billion (i.e., $8b x 10). This is 31% over today's price. The average of these two estimates is $97 billion, or 58.7% over today's price.
That implies that PYPL stock could be worth $92 per share (i.e., $58 x 1.587). This shows how high the stock could rise based on analysts' revenue estimates and conservative FCF metrics.
No wonder investors are buying large amounts of PYPL call options today.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
