Since its spin-off from eBay (EBAY), PayPal Holdings (PYPL) has fallen over 10% as of this writing. We have been researching PayPal as a possible investment and believe that some of the fears surrounding the stock are overblown, and PayPal currently offers a compelling opportunity for growth investors. We thought we'd share the results of some of our research on the company's competitive position that prompted us to finally buy the stock. We'll start with talking about the proverbial elephant in the room, Apple Pay (AAPL).

• Warning! GuruFocus has detected 2 Warning Signs with CRM. Click here to check it out.

• PYPL 15-Year Financial Data

• The intrinsic value of PYPL

• Peter Lynch Chart of PYPL

Competitive threats from Apple Pay and others

The key for any payment solution to become widespread is the network effect. Payment solutions become successful when everyone uses them. Merchants use it because it's what customers use, and customers use it because it's what merchants accept. It creates a virtuous cycle and makes it very difficult for new entrants to enter the market. The credit card business is a great example. You have Visa (NYSE:V), MasterCard (MA), and to a lesser extent American Express (AXP) and Discover (DFS), a line-up that has been virtually unchanged since credit cards were first introduced.

PayPal has arguably reached critical mass with over 162 million active users in 200 markets using 100 different currencies. It's going to be extraordinarily difficult for a new entrant to unseat PayPal given its enormous head start on building up a network. Even Apple Pay will likely find it difficult to unseat PayPal.

The role of Apple Pay

The first thing to point out is that Apple Pay is primarily a physical point of sale solution. While there have been rumblings about peer-to-peer payment capability being added (and let's face it, why wouldn't Apple add it?) it likely won't be the primary focus of Apple Pay. At this point Apple Pay is not really a competitor to PayPal due to their focus on different (but adjacent) markets.

Apple Pay's biggest issue, particularly in regards to peer-to-peer payments, is the network effect problem. Apple's global iOS market share has been bouncing between 15% and 20% (depending on the timing of the release of new models) over the past three years.

(Graphic source: http://www.idc.com/prodserv/smartphone-os-market-share.jsp)

It's going to be very difficult for Apple Pay to reach critical mass if the product is severely restricted. A common theme with Apple Pay seems to be that Apple can somehow take 800 million or so iTunes accounts and seamlessly convert those users into Apple Pay users. We question how easy that process would be and how many users would actually be able to convert considering iTunes is multi-OS, while Apple Pay is not.

It's also worth considering just how appealing Apple Pay is to consumers. While paying by just swiping your smartphone is certainly appealing, it's questionable whether traditional payment methods are a big pain point for consumers. Waiting in line, scanning and bagging items takes far longer than paying. Well, provided someone is not attempting to hark back to caveman times and pay by check or attempting to pay with exact change. We found this comment by someone who used to work at PayByTouch particularly insightful about how consumers view the checkout process.

If Apple Pay expanded beyond iOS-only devices and focused financial resources on digital payments, it could become a competitor, perhaps even a significant one, to PayPal. But the longer Apple waits, the more entrenched and untouchable PayPal becomes. While PayPal may not have the "unmovable incumbent" status of say a Visa or a MasterCard, it is starting to approach that threshold. In fact, digital payment solutions offered by credit card incumbents such as Visa Checkout pose the biggest threat to PayPal in our opinion.

Growth opportunities for PayPal beyond the core business

While the appeal of PayPal's core payments business is well understood, there are several other businesses and growth opportunities worth examining.

Braintree and Venmo

Braintree is a payment processing platform that lets businesses accept online payments. The platform is used by companies such as Uber and Airbnb. While Braintree is a relatively young business (founded in 2007), it is an important acquisition for PayPal (purchased for $800 million) as it gives PayPal more vertical scale and integrates PayPal's core business deeper into the digital payment ecosystem.

Venmo offers peer-to-peer payments and seems to be the preferred payment method among millennials. Though Venmo and PayPal are very similar and both enable peer-to-peer payments, Venmo is easier to use. Most importantly, Venmo accounts are tied to a mobile phone number versus PayPal accounts, which are linked to an email address.

PayPal credit

PayPal has recently begun offering lines of credit to consumers. While the strategy does come with some risks and adds another layer of work for investors in tracking the business with the need to monitor credit quality, it offers some compelling upside.

First, it strengthens PayPal's position with consumers by offering more financial products under one roof. Additionally, it makes users more "sticky" as those with open credit lines at PayPal are less likely to adopt a competing payment solution that does not offer a credit line.

Second, it provides PayPal with another source of income via interest. Already PayPal is able to earn something akin to net interest income at banks by taking customer payments first and paying merchants later. As of their last quarter, PayPal had $11.8 billion in "funds receivable and customer accounts" (of course, it also has a corresponding $11.8 billion liability of "funds payable and amounts due to customers"). PayPal essentially takes in these funds at no cost (in contrast with banks that pay interest on deposits), and then can earn a return on the funds during the delay. As payment volumes and interest rates rise, this "float" will contribute more meaningfully to PayPal's profits.

Real concerns

While we have been quick to dismiss many of the concerns surrounding PayPal, there are a few that we view as legitimate, the most serious of which is the issue of declining take rates. For those unfamiliar, the take rate refers to the percent of total payment volume that PayPal receives or takes as profit. The take rate has declined from roughly 3.4% in 2012 to around 2.8% today and is projected to decline further.

A declining take rate in and of itself is not concerning if total volumes are growing. As PayPal signs up larger merchants and other merchants see volumes grow, PayPal offers discounts on its cut of payments processed. With PayPal focusing on signing up larger merchants, a declining take rate is to be expected. Additionally, take rates usually decline when PayPal expands into new markets. Again, this is not a problem as some short-term pain is more than offset by the long-term gain of growth of the company.

What can be worrisome is if the take rate declines due to increased competition. As more competitors enter the digital payment scene, it can put pressure on take rates as competitors rush to undercut each other and offer better terms to merchants to get their solutions accepted. While PayPal is deeply entrenched due to the network effects we cited earlier, it is still likely not at the critical mass necessary to essentially dictate terms to merchants as the incumbent credit card companies do.

Summary

We found PayPal's business and valuation to be very attractive. PayPal trades at just 4.6x sales and a forward P/E of 19, compared to a forward P/E of 21.6 and a price/sales of 11.9 for Visa, and a forward P/E of 20.2 and price/sales of 9.8 for MasterCard. PayPal trades at a discount despite higher growth rates and a larger opportunity for expanding margins due to increased operational leverage.

Despite a lower valuation, PayPal is growing faster than Visa and MasterCard. Visa and MasterCard's five-year revenue and operating income CAGR's are shown below.

Visa and MasterCard growth rates

(Data from Morningstar.com)

By contrast PayPal has grown revenue by 18% over the last five years and operating income by 26%. Of course, PayPal is a smaller business growing off of a smaller base, so higher growth rates would be expected. Even over the last nine months, however, PayPal has grown revenue and operating income 11% on a trailing 12 month basis. We found PayPal's economic moat and attractively priced growth opportunities compelling enough to make an investment.

Disclosure: Long PYPL, V.

This article first appeared on GuruFocus.

• Warning! GuruFocus has detected 2 Warning Signs with CRM. Click here to check it out.

• PYPL 15-Year Financial Data

• The intrinsic value of PYPL

• Peter Lynch Chart of PYPL