PayPal (ticker: PYPL) has long been the dominant player in the digital payment services industry, but its lead is starting to shrink as competitors gain traction. According to analyst Lisa Ellis from MoffettNathanson, Apple Pay, launched by Apple (AAPL) in 2014, has been making significant strides in the market.

This challenge is evident in PayPal's stock performance this year. While PayPal's stock has only seen a modest 3% increase, its closest rival, Square (SQ), has surged ahead with a 23% gain. Affirm (AFRM), the "buy now, pay later" lender that also delves into payments, has achieved a staggering 90% increase. Apple itself has enjoyed a near 50% growth in its shares.

Research conducted by Ellis reveals that the percentage of online retailers offering at least one checkout button linked to a payments company has risen from 83% to 86% over the past four years. More importantly, the number of retailers with two or more checkout buttons has skyrocketed from 27% in 2018 to an impressive 65%.

This indicates that the overall payments market is expanding; however, it also highlights the intensifying competition within the industry. "An increasing number of checkout buttons per site is an indicator of checkout button popularity as a payment method," Ellis noted. This trend benefits checkout button providers by allowing them to capture more volume share through their buttons. Nevertheless, it poses a risk to PayPal as the market leader, as it heightens the competitive pressure during the checkout process.

At the time of writing, PayPal has not responded to a request for comment on this matter.

PayPal Faces Competitive Threat from Apple Pay

According to industry expert Ellis, PayPal is currently facing a significant competitive threat from Apple Pay. While PayPal's checkout button appears on about 80% of retail websites, the same percentage as five years ago, Apple Pay has made its way into 80% of iOS apps, leaving PayPal behind at 44%. This discrepancy is concerning for PayPal considering the wide reach of Apple devices, especially as more consumers shift towards making payments on their phones rather than using cash or desktop computers.

Ellis considers Apple Pay's rapid growth and encroachment into the market as the biggest challenge that PayPal is currently dealing with. This issue is expected to be the top priority for PayPal's future CEO, as Dan Schulman, the current CEO, plans to retire at the end of this year. However, no successor has been announced by the company so far.

While PayPal experienced substantial growth during the pandemic due to the surge in e-commerce, the competitive landscape has changed, causing its growth trajectory to slow down. In the first quarter of this year, PayPal reported a 30% year-over-year increase in unbranded payment volumes. In contrast, its higher-margin branded business, represented by the PayPal-branded checkout button that customers are familiar with, only grew by 6.5%.

As a result of increased competition and a shift in expectations, PayPal's stock performance has decreased significantly. Currently trading at 13.9 times forward earnings, well below its five-year average of 32 times, it pales in comparison to Block, which trades at 36.6 times earnings. Over the past two years, PayPal's shares have fallen by 75% and are currently valued at around $73 per share.

Despite this downturn, analysts remain optimistic about PayPal's future prospects. Out of the analysts surveyed by FactSet, 68% have given the stock a Buy rating. The average target price for PayPal's stock is $89.99, indicating a potential gain of 23% from its current levels.

Investors will have the opportunity to gain further insight into PayPal's performance when the company reports its earnings on August 2nd. The upcoming earnings report will likely provide a better understanding of PayPal's competitive position and its ability to navigate the challenges posed by Apple Pay.

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