Braintree – Minh Quang Duong

In Q1 FY2022, there were 3 mentions of Braintree and none of “Unbranded”. One year later, “Unbranded” was uttered 38 times.

	Q1 2021	Q2 2021	Q3 2021	Q4 2021	Q1 2022	Q2 2022	Q3 2022	Q4 2022	Q1 2023
Mention of Braintree	2	0	0	3	3	15	11	21	11
Mention of “Unbranded”	0	2	0	0	0	2	4	10	38

PayPal’s executives tried their hardest to push a narrative around unbranded processing. Here is what the soon-to-retire CEO, Dan Schulman, had to say:

First, unbranded processing is a strategic imperative for us. Enabling our merchants with our unbranded service helps ensure that we have a deep relationship with our most important merchants. It enables us to bring our latest and most technologically sophisticated checkout integration across PayPal and Venmo and our Buy Now, Pay Later service to our merchant base. Going forward, we will primarily focus on enabling unbranded processing and our latest branded checkout experiences through Braintree and PayPal Complete Payments.

Second, we will continue to invest to help ensure our unbranded platforms are best-in-class, enabling our merchants to reduce fraud and increase their sales conversion rates. We will do this while providing a comprehensive orchestration layer that enables our merchants to have a single point of contact and integration in a multi-PSP environment.

Third, we are focused on substantially improving the margin structure of our unbranded business. Our PayPal Complete Payments platform opens a new $750 billion TAM in the small and midsized business market, with a significantly enhanced margin structure compared with our largest enterprise customers.

Finally, enabling merchants with our unbranded services will provide a constant stream of incremental data to feed our AI engines and fuel our next-generation checkout platform. We believe no other company will be able to replicate the unique nature and scale of our data set. And in the future, our AI engines will use that data to drive differentiated capabilities to improve the entire checkout experience for our merchants.

On the surface, what Dan said makes sense. Digging a bit deeper, I had a few problems with such a narrative.

First, PayPal acquired Braintree ten long years ago. Hence, I found it strange and concerning that the company’s executives seemed to only recognize this asset just recently. Unbranded received little attention prior to the last eighteen months, yet suddenly became a “strategic imperative”. Confidence in a management team’s ability to create a vision and execute is critical to investors. How can we be confident in this new plan when it should have been thought of and executed a long time ago?

Second, will this newly found focus on unbranded last? With the retirement of Dan Schulman, PayPal is going to have a new CEO next year. When appointed, the new CFO will be the company’s third in the last two years. The turnover in the leadership ranks is troubling, but not as much as the change in strategy. During Covid, being a Super App was the dominant theme backed by a host of new products and numerous incentive-driven campaigns The explosion in online shopping, driven by Covid, inflated PayPal’s growths and led its executives to make wildly ambitious projections. Targets shared on Investor Day 2021 were soon embarrassingly abandoned. Only then did the management team pivot and try selling investors on cost savings and now the power of unbranded solutions. It’s entirely possible that there will be another strategy 12 months from now. And when a company changes strategy that often, investors have the right to question its growth and competitive advantages.

Third, PayPal claimed that data from unbranded processing would help improve its branded checkout solutions. I don’t doubt the basis of the claim. I question the extent to which it is true. Gains from machine learning are not linear. Applying twice the amount of data to a model will not guarantee the outcome will be twice as good. Braintree already powers some high-volume merchants. How much could additional data from unbranded enhance its sibling branded checkout? Yes, there will be improvements, but the connection between branded and unbranded is not as strong as PayPal makes it out to be.

Fourth, there is a significant threat to the company’s branded checkout. The future of payments lies on the phone. The likes of Apple and Google have a sizable advantage of preinstalled their wallet apps on devices. PayPal must convince users to download its app. The task involves only a few clicks, but it’s a daunting challenge to overcome. The plan is to use unbranded processing as a growth catalyst for branded solutions which, in turn, will help generate margin. But if that margin engine were under threat, where would profitability come from for PayPal?

Last but not least, what’s the time horizon on this plan? Three biggest contributors to PayPal’s Total Payment Volume are branded checkout (30%), Braintree (30%) and Person-to-Person (P2P) (28%). The new service, PayPal Commerce Platform (PPCP), is slated to improve the company’s margin and drive growth. In the next two years, what I expect from the management team is plenty of meaningless word salad touting impressive growth and no concrete figures. That’s because PPCP will start from a tiny base and as a result, it won’t move a needle much.

On the flip side, we can’t completely discount the possibility that PayPal will make good on their word this time and their plan will actually work. The thesis is 1/ use Braintree to drive volume growth as it works with biggest merchants; 2/ improve margin with PPCP and value-added services; 3/ increase efficiency by overhauling the infrastructure; 4/ continue to push branded checkouts which keep consumers in the ecosystem and bring the highest margin among services. Could it work? Entirely possible.

In short, I am NOT saying that PayPal is a doomed company. It still has a trusted and popular brand, along millions of active users. The problem stems from the turbulence in the leadership ranks, competitive threats on every front and recent track record. The new narrative has me at 70% bearish and 30% bullish. I’d be more confident had the company announced the new leadership. In the past, I used to buy in what the management sold. I was wrong. I’d wait for at least 1-2 more quarters and especially the upcoming in-person Investor Day before I make any decision. The time to be disciplined and ruthlessly execute for PayPal is now.

Last week, PayPal announced its Q2 FY2022 results, its forecasts and some important personnel changes. Here are the headlines:

Net revenue hit $6.8 billion, a 9% YoY growth
International revenue declined by 1.7%, to $2.9 billion, while US revenue was $3.8 billion, a 19% growth YoY
Operating cash flow and free cash flow grew to $1.5 billion and $1.3 billion respectively, meaning that FCF margin is 19%
Total Payment Volume increased by 9% to $340 billion
Total payment transactions of 5.5 billion
US TPV grew 16%, to $219 billion, while International TPV and Cross Border TPV decreased by 1.6% and 11.8% respectively
Venmo recorded $61 billion in TPV, an increase of 5.2%, and 90 million active accounts
Total active accounts went flat sequentially at 429 million with 35 million active merchants
While the company welcomed a new CFO, it’s now looking for a replacement for their CPO, who is retiring at the end of the year
Cost-saving initiatives are expected to save the company $900 million by the end of 2022 and $1.3 billion next year
$15 billion in share buybacks was authorized, $4 billion of which will be realized by the end of 2022
PayPal expects operating margin expansion in FY2023

Despite the tough macro challenges and fierce competition, PayPal’s TPV increased by 9%, on top of the 30% and 40% YoY growth in the last two years. That’s pretty solid because Visa grew payment volume in the same quarter by 12%, even with its duopoly market power. The divorce from eBay is entering the final stages as the famed marketplace now makes up only 3% of PayPal’s TPV and is projected to have negligible impact in the future. Losing a household name like eBay isn’t great, but because the partnership was exclusive, PayPal couldn’t work with any other retailers or marketplaces. Hence, the separation paved the way for deals like the one with Shopify or Amazon, and would benefit PayPal more in the long term.

Another bright spot is the US market. PayPal’s home soil saw a 16% increase in TPV and a 19% expansion in revenue. Considering that the US is home to other payment alternatives, including some fierce direct competitors, those US numbers showed resilience and a formidable market presence of PayPal. Because the company barely added new active accounts, given the lack of full disclosures, my guess is that PayPal managed to increase usage among existing users.

Among the factors that contribute to the domestic success, I want to call out Venmo. Popular among young consumers, Venmo boasts 90 million active users, double from what it had three years ago. In the same time frame (from Q2 2019 to Q2 2022), Venmo TPV grew by 150% from $24 billion to $61 billion. Despite this growth, Venmo still has a lot of grow to monetize. The three main levers are debit card, credit card and the partnership with Amazon. While I suspect that PayPal will have to make some financial concessions to be on Amazon’s marketplace, this will undoubtedly help grow both revenue and margin. Meanwhile, the management team has high hopes for what the Venmo debit and credit card can bring onto the table. If PayPal can monetize Venmo more, the company will become so much more secure and attractive in the eyes of investors. In case you forgot, despite the massive scale of adoption, Venmo is still only available in the US.

Gabrielle Rabinovitch

I’d also point out the card strategies for Venmo are important, as well. The debit and credit cards continue to grow their volumes and those are really important for habituation. They reinforce all the in-wallet spend with offline spend, as well.

Dan Schulman

Yes, I totally agree with that. If you look at Cash App, their big growth is off of their debit card. We have a lot of room in our debit card and credit card to grow too.
Source: PayPal’s Sell-Side Analyst Conference

Moreover, I am very pleased with the switch of focus onto increasing efficiency. I used to receive a bunch of promotional offers from PayPal. $5 here, $10 there for low-impact activities. Now, the company is willing to let go low-engagement customers and focus marketing dollars on driving usage from active users. Efficiency is also apparent in the product development side as well. Although stock trading was on the plan last year, PayPal decided to put a halt on its development. The push for in-store QR code is now replaced by efforts to promote card usage. These decisions obviously led to surplus in headcount and dismissals, where necessary. Due to its enormous scale, PayPal managed to negotiate more favorable contract terms with suppliers. The management team believes that these efforts will drive ROI and yield higher results for the organization. Concretely, they are estimated to bring $900 million in cost savings for the rest of FY2022 and $1.3 billion next year.

These cost savings are likely the main reason why the management forecasts operating margin expansion next year. Low-margin businesses such as BNPL, Venmo and Braintree are expected to grow in the near future. It’s unclear to me, reading their reports, where the margin will come from the revenue side of things. Hence, the gains must come from being a leaner organization with reduced expenses.

On the other hand, it’s not all smooth and rosy with PayPal. I am concerned about the uncertainty that changes at the top level will bring. They have a brand new CFO, who was chosen among at least 14 candidates. By next year, they will have a new Chief Product Officer. These changes may bring about new ideas and positive results, but they may also delay the progress as new hires need time to acclimate themselves to the new work settings.

PayPal's Revenue Growth — Figure 2 – PayPal’s Revenue Growth

While it’s good that a business wants to be laser-focused and mindful of expenses, it remains to be seen whether PayPal is doing too much. After riding to new heights amidst Covid, PayPal’s stock got clobbered, down from more than $300 to $90, due to abandoned forecasts and slowed growth. Then, the narrative switched to higher efficiency and more focus. I get it. The leadership wanted to present a nice story to investors to stop the bleeding. They may even genuinely want to set the company on a better course for the future. But they also have a history of botched plans and forecasts. Who is to say that they are not being too aggressive at the moment? What if the cost cuts hurt the business in the process? We already have three consecutive quarters of decline in International. PayPal competes on multiple fronts and their competitors are fierce. Can they right-size their capital allocation to avoid disasters?

Overall, this is not a disastrous quarter. There are some bright spots, including Venmo, solid growth overall, the US market, the cost-cutting initiatives (at least for now) and the buybacks. However, there are also things that give me pause for concern. As bullish as I want to be on the company’s outlook, I’ll wait for another quarter or two so that by then some of my concerns will be hopefully eased.

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