Weekly reading – 19th November 2022

What I wrote last week

PayPal has a monetization problem with Venmo

Harvard Business Publishing

Business

Why investors have jumped off the Carvana bandwagon. Carvana is another example that reminds me of that famous quote from Warren Buffett: “Only when the tide goes out do you discover who’s been swimming naked.”

Basically everything on Amazon has become an ad. “Successful Amazon sellers have to spend anywhere between 10 percent and 20 percent of their sales on Amazon ads, according to six high-volume sellers Recode interviewed. That’s on top of the other listing and warehousing fees they also give Amazon. Some said that the pay-to-play evolution of the site is one of the top two reasons they have had to substantially raise the prices of their merchandise on Amazon over the past year.” This is going to spell trouble for Amazon soon. A few of my purchases were off Amazon simply because the same items sold on the site were markedly more expensive. Keep this up and the company will soon have to re-acquire customers and rebuild its brand image. That’s too high a price to pay, just for advertising dollars.

Local ride-hailing startups thrive in the towns that Uber forgot. Giant ride-hailing companies compete fiercely with one another in big cities, leaving small and medium-sized towns ripe for the taking. And they are being taken over by local startups that saw unserved markets and decided to act. To grow, these startups should not venture into big cities. They should strive to continue to serve small and medium-sized towns across the continent. Regarding the likes of Uber, I don’t blame them for not attending to these small towns. Resources are limited and they can’t stretch themselves too thin.

Global Twitter employees describe chaos as layoffs gut their teams. The word chaos can’t even describe what is going on at Twitter, especially to the staff in India. Axing 50% of the policy team and 75% of the product team can’t benefit the company.

Sam Bankman-Fried vs. The Match King. The last few days have been littered with news and coverage of Sam Bankman-Fried (SBF) and FTX. The glamour and the superficial valuation masked the mess that went on behind the scenes. But this scandal is hardly the first. Not even close. This post compares what happened with SBF & FTX with the Match King, a businessman who had great success early on yet ruined everything when he was consumed by greed

The vomit-inducing piece on Sam Bankman-Fried by Sequoia. The venture capital firm is legendary for its longevity, success and role in helping entrepreneurs and startups thrive. However, this is a serious black eye. They penned this ridiculously flowery article on SBF, stuck it on its website under the tagline “We helped the daring build legendary companies”, yet removed it the moment news of trouble at FTX surfaced. Worse, the article recalled a meeting where the firm’s partners met Sam. No hard questions and little due diligence. They were wowed by SBF, who was literally playing games during the meeting. Mind-blowing stuff

Other stuff I find interesting

FTX turmoil destroys clout of crypto’s Washington spokesman. The fall of SBF and his companies apparently threatens to bring my regulatory heat onto crypto firms in the future. Well, I personally think that it’s a bit late. Regulators should have had more oversight and scrutiny over these crypto companies and celebrities.

TikTok’s Subcontractor in Colombia Under Investigation for Traumatic Work. On one hand, I understand that a job is a job, even one that requires people to watch horrifying content for hours. On the other hand, there should be safeguards built to ensure that these workers are treated properly and all measures are taken to limit the exposure to mentally harmful content.

People protested when this capital city went car-free. Now they love it. Ljubljana, the capital of Slovenia, sets an excellent example of how cities can transform themselves with micromobility and car-less space.

Stats

US consumers spent $72.2 billion online in OCtober 2022, according to Adobe

Americans have almost $5 trillion in cash as of Q2 2022

Honey bee life spans are 50% shorter today than they were 50 years ago

The world’s population hit the 8-billion mark on 11/15/2022

US online grocery sales totalled $7.8 billion in October 2022

Global lithium supply & demand forecast
Source: Global lithium supply & demand forecast by BloombergNEF

PayPal has a monetization problem with Venmo

The past three years has seen a breathtaking growth of Venmo. The number of active accounts grew from 40 million in Q1 2019 to 90 million in Q2 2022. Its Transaction Processing Volume (TPV) almost tripled in the same period of time, reaching $61 billion in Q2 2022. However, growth has been hard to come by in the last two quarters, especially in Q3 2022. TPV growth was only single digit in the last two earnings reports. The number of active accounts plateaued at 90 million. Available only in the US, where there are about 230 million consumers, one has to wonder how much room there is for Venmo to continue to expand domestically.

Venmo TPV and Active Accounts
Venmo TPV and Active Accounts

Going overseas sounds like a straightforward answer, but operationally, it is anything but. It would require a lot of investments in localizing the product, marketing to acquire customers, customer management to maintain engagement and compliance to stay on the good side of lawmakers. There must be a reason why PayPal hasn’t taken Venmo outside of the US. Given the missteps that the management has taken over the last few years, it’s not impossible that restricting Venmo to the US is a mistake. Personally; however, I can see why they haven’t.

If growth in TPV and user base slows down, what about monetization? PayPal reported that Venmo earned $250 million in revenue in Q4 FY2021 and $900 million in FY2021. Since Venmo processed almost $61 billion and $230 billion in TPV in the same periods respectively, Venmo’s take rate is about 0.4%. To put that take rate into context, let’s compare it to Cash App

VenmoCash AppNote
Monthly Active Accounts (in million)5749the Cash App number is the number of transacting accounts in September 2022
Transaction Volume (in $ billion) in the quarter ending Sep 30th, 2022644.3
Revenue (in $ million) in the quarter ending Sep 30th, 2022270118Venmo’s revenue is my estimate based on the $250-million figure reported for Q4 2021 while Cash App’s revenue only includes transaction-based revenue
Take-rate0.42%2.7%

The comparison shows that Venmo is seriously under-monetized compared to Cash App. PayPal has a valuable asset in Venmo that resonates with a lot of consumers in America, especially the younger crowd, but they don’t seem to be able to benefit from said asset. And don’t take my word on it as the CEO of PayPal is not entirely happy either

I am pleased with Venmo’s progress but I am not thrilled with all the progress that we’ve had. I just want to be up front with that. I feel like we can do a lot more with that asset than we have been able to do so far. There is a ton of potential there. The people who use Venmo, our customers love Venmo. It is a beloved brand. They use it all the time. You can tell from our monthly active users [of 57M]. The monthly active users are up by ~85% in the last 2 years or so. So, a lot of progress there. But I feel like there can be more progress.

These are some big merchants that are implementing Pay with Venmo and I think we will see more. We are going to revamp the card strategy, we started to begin to do that. We think that is one place that Cash App has done particularly well on, and there is no reason why we should not with our scale and size be able to really tap into a revamped card functionality. Over time, we will also begin to see more basic financial services there, savings and other things come into the Venmo wallet. There is focus on things that have to get done right now. Amazon and Apple are big opportunities, we want to make sure we take full advantage of those. We’ve got some basic hygiene work to do there. Good progress, but I wouldn’t call it great progress right now. In terms of revenue growth, we had anticipated that we would be about 50% revenue growth [for FY’22] and that is where we are year to date. Q4, like the rest of the business, is going to be weaker than we expected. That will probably take Venmo revenue growth into the 40%’s [year over year growth for FY’22]. That is probably a good place for you to assume it will end

Source: PayPal Third Quarter 2022 Buyside Call

Platforms like Venmo and Cash App monetize by charging sellers on every transaction and the majority of retail sales still takes place in stores. To facilitate in-store transactions, cards are the most successful medium. PayPal put a lot of efforts into QR Code during the pandemic, but they abandoned that push and have since switched focus to cards. Venmo credit card doesn’t require a Venmo balance, but it’s not available to every consumer, especially Gen Z users whose lack of credit history prevents them from qualifying for a credit card. I wouldn’t be surprised if Venmo credit card users constituted only a small percentage of Venmo active base.

While accessible to many more people, Venmo debit card requires a Venmo balance. The question then becomes: how can Venmo get users to park money on a Venmo account? Users only maintain a balance when there is enough utility, whether it’s rewards or accessibility at a variety of merchants. Cash App has been successful so far in this regard. Cash App reported that it had $2 billion of direct deposits in September 2022. Paper direct deposits into Cash App which was launched nearly a year ago cumulatively crossed $3.5 billion. These figures indicate how much Cash App users value the platform and how much they want to use it. This is something that Venmo has to, at least, replicate and there certainly is work to be done.

Cash App users can paper-deposit funds into their accounts at some retail stores, but Venmo doesn’t have this feature. Checks deposited electronically into Cash App will be available on the platform the next business day at no additional cost. With Venmo, users may have to wait up to 10 days to receive funds from an electronic check unless users pay a small fee to expedite the process. Any additional friction to the deposit process will deter users from bringing cash to the platform, so obviously I’d love to see Venmo at least get feature parity with Cash App.

Moreover, Venmo also needs to be available at more checkout pages. The partnership with Amazon which enables customers to add their Venmo account as a payment method will likely boost the perceived utility of Venmo. But there should be more partnerships like that. PayPal powers payments for some of the largest merchants in the US, whether it’s the branded PayPal or the unbranded platform Braintree. They should look into leveraging such an advantage to make Venmo more prominent. If a user could pay for Uber, Amazon or Instacart with their Venmo balance, that would obviously make Venmo more useful and appealing.

There is also a side benefit from having more customer funds. The more funds the likes of Venmo or Block have, the more interest income they can earn. In Q3 2022, PayPal’s Other Value Added Services revenue increased by $37 million year over year. One of the main drivers of such an increase was higher interest income on customer funds due to higher interest rates. Block itself made $7 million in revenue from customer funds as well.

Next, rewards is a great tool to keep consumers engaged. Consumers love to earn rewards and redeem them for other purchases. PayPal recently revamped their rewards program that unifies all PayPal products and offers consumers more ways to earn and redeem. However, since Venmo and PayPal are still two independent platforms, the new PayPal Rewards does not feature Venmo. If consumers are expected to use Venmo for payments, they will expect to be rewarded for such loyalty. Besides Venmo credit card’s rewards, Venmo offers cash back at qualifying merchants on Venmo debit card, but information on that is scant. Venmo needs to make the program more attractive and prominent. Yes, the low interchange rate on debit card transactions makes it expensive to fund rewards, but it’s also expensive, if not more, to acquire new customers and fend off Cash App and a host of other competitors.

Here are a couple of things that Venmo can do. First, link the credit card with the debit card, Any credit card rewards can be turned to cash on Venmo account that can be used to pay friends or purchase at stores with the Venmo Debit Card. This concept is not something new. It’s similar to what Apple has with Apple Card and Apple Cash. By making the credit card rewards immediately available, Venmo would give users a reason to use the Venmo app and debit card.

Second, because Venmo Credit Card is a co-branded card issued by Synchrony, Venmo must receive some compensation, either as share of interest and/or interchange income and finder’s fee for every new account. Financial reports by PayPal indicate that the compensation could run in the millions. Use that money to run marketing campaigns with a celebrity. I’d love to see Venmo try to do what Capital One did with Taylor Swift. Capital One generated a lot of accounts, interest and awareness with this campaign.

In short, Venmo is an incredible asset that PayPal has at its disposal. Investors place a premium on the company’s ability to monetize Venmo, but even the CEO is not happy with what they have done. Compared to Cash App, it’s under-monetized. PayPal needs to start making more progress soon because their competitors don’t stand still for them to catch up.

Weekly reading – 27th August 2022

What I wrote last week

Do as I do

Should you stay at a job for more than 2 years, no matter what?

Business

($) Amazon Adds Revenue Streams as Holiday Season Approaches. I wrote a bit about Amazon’s influence on US-based merchants. Let’s say if these merchants manage to sell 10,000 items per minute on Amazon, the increase in fees will result in an extra $5 million per day for Amazon or approximately around $375 million for the quarter. It’s not insignificant, even for a firm that big. I am curious to see the reaction from sellers. On one hand, nobody likes to see costs rise. On the other hand, can these sellers afford to leave Amazon?

How Amazon’s DSP program has created $26 billion in revenue for owners. Amazon has more than 3,000 delivery partners around the world. It may not sound like a lot, but I don’t imagine it’s easy to figure out the kinks of running a complex delivery system involving the internal operation and that of external partners. VRIO is about finding and cultivating Valuable, Rare, Inimitable and Organized capabilities or resources. This can be Amazon’s one of many such capabilities.

($) Instacart Revenue Growth Accelerates Ahead of Planned IPO. Now is not a great IPO environment for Instacart. Growth yet unprofitable companies have seen their stocks plummet in the past 10 months. It’s very likely that Instacart will be another name in that group. A quick comparison of the quarter ending 30th June 2022 between DoorDash’s publicly reported numbers and Instacart’s numbers reported in this piece – Booking volume: $13 billion for DoorDash vs $7.1 billion for Instacart; Revenue: $1.6 billion for DoorDash vs $621 million for Instacart.

Consumers Are 19% More Likely to Complete a Purchase with Venmo Over Traditional Payment Methods. Venmo is incredibly popular among end users, especially the younger crowds. To merchants, Venmo can be a value add as well. “In another study of more than 300 thousand U.S. consumers and an analysis of more than 3.4 million transactions,1 we found that Venmo users shop over 2 times more frequently than the average shopper and are 19% more likely to make repeat purchases. ” How PayPal monetizes Venmo will play a crucial role in the company’s future.

Secret ‘Batgirl’ Screenings Hit the Warner Bros Lot. Putting away content that took hours and millions of dollars to create just for tax write-down purposes seems a bit extreme.

Amazon bought Whole Foods five years ago for $13.7 billion. Here’s what’s changed at the high-end grocer. One frustrating aspect of following Amazon is that the company doesn’t break out Whole Foods’ financials. It’s almost impossible to gauge the success of this expensive acquisition. Nonetheless, it’s good to read through the operational changes since then.

Microsoft employees love Figma, and it’s testing the company’s cozy relationship with Adobe. Usually, an upcoming challenger is more popular among small companies while the incumbents are favored by big corporations. In the case of Figma, it’s widely popular at a giant shop like Microsoft. It’s good for them, but a warning for Adobe

WhatsApp grocery shopping is already huge in Brazil. One startup wants to take it over. An intriguing concept to use Whatsapp groups for e-Commerce. Trela manages multiple Whatsapp groups, posts weekly deals in the groups so that users can place orders as well as manages orders and deliveries. Merchants save time. Users get informed of the deals and can buy goods conveniently. What concerns me are the management of groups and scalability. First, Whatsapp groups are limited to 256 users. A medium-sized city will require like more than 100 groups. What about a big city then? How does Trela manage the groups, the communication and the orders? Second, people move from one city to another. How does Trela manage the changes? What if somebody leaves the old group but can’t find a spot in any new group?

Other stuff I find interesting

Deep Time Sickness. An interesting long read on Mexico, its history of earthquakes and the consequences.

Fleeing Putin, Russian tech workers find a home in Armenia. Reading this article, I cannot help but feel that Russia is living off only its natural resources and former glory. The brain drain will deplete the country of valuable human capital and innovation; something that is not easily reversed.

France is now offering a €4,000 e-bike subsidy to people who trade in their car. The initiative sounds great on paper: stimulate exercise, encourage folks to ditch cars for e-bikes. The 2nd-order effect will be more space for cities and outdoor activities for everybody. I am sure there will be scientific research into how much this initiative benefits the country and cities and I really look forward to reading such research.

The utterly delightful site dedicated to classifying plastic bread tags. Such a quirky hobby

For Japanese Uber delivery drivers, gig work is working. “The word “freedom” crops up when talking to Tokyo’s delivery drivers. Their full-time employment alternative, after all, is likely an all-consuming office job, involving long, draining hours and a demanding work culture; part-time at a bar or convenience store, they’d face fixed shifts and constant supervision. While the gig worker industry has come under fire around the world for years of shrinking wages and poor conditions, Japan’s experience, so far, is different; in stark contrast to global lawsuits, protests, and strike action, Japan’s workers, by and large, appear content with the rare flexibility their jobs provide. A recent Japanese study, the first of its kind, surveyed roughly 14,000 delivery drivers from major companies across the country. While most of the workers were new entrants — around 60% have been working less than a year, and the vast majority worked 40 hours or less — 63% said they were “satisfied” with their work; 82% reported that they would like to stay in their jobs “for a while” or “forever.”

Stats

35% of Venmo customers are between 18 and 29 years old, versus 23% across the US

‘House of the Dragon’ draws nearly 10 million viewers

Bank of America Clients’ 1 Billion Digital Logins in July 2022

PayPal Q2 FY2022 Results

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.

Venmo TPV
Figure 1 – Venmo TPV

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.

Appendix

PayPal's Active Accounts & Active Merchant Accounts
Figure 3 – PayPal’s Active Accounts & Active Merchant Accounts
PayPal's Transactions Per Active Account
Figure 4 – PayPal’s Transactions Per Active Account
PayPal's P2P TPV
Figure 5 – PayPal’s P2P TPV

Thoughts on PayPal’s latest earnings

What happened?

Last week, PayPal reported its Q4 FY2021 results, causing the stock to reach by almost 25% and reach its 52-week low. Once a $360+ billion company at its peak valuation, PayPal is now worth $148 billion. There are a few contributing factors to this implosion.

The first is the disappointing guidance. A few months ago, the company set the revenue growth for 2022 at 18% which is now replaced by the 15-17% range. The guided Earnings Per Share is $4.67, well below the consensus of $5.21. For Q1 2022, revenue is expected to grow by 6%, significantly lower than the two-digit growth rate usually seen in every quarter since 2019. High inflation, the supply chain issues that have been felt across markets, increased tax rates and tough comparisons to last year’s results are to blame.

Net new active accounts are also a let-down. Total net adds in 2021 stood at 49 million, far lower than the 55 million target reaffirmed in November 2021. This year, PayPal expects to add 15-20 million new accounts. This conservative goal is lower than what PayPal managed in 2018 or 2019 before Covid-19 boosted their business and pulled forward a lot of net new accounts. The management gave two reasons for this muted outlook. First, 4.5 million accounts are found to be illegitimate. Even though the number is immaterial to the overall account base of more than 400 million, it affects the company’s estimate and thinking in terms of net new adds. The second and bigger reason is a new pivot in customer acquisition. Used to plow a lot of money in incentive-led marketing tactics, PayPal is going to abandon low-ROI efforts on low-value customers and instead prioritize high-ROI engagement campaigns which they say have better yields.

Because of the new pivot in customer acquisition, PayPal determined that the target of 750 million active accounts by 2025, which was only set last year on Investor Day, is no longer appropriate. The rumored acquisition of Pinterest a few months ago already called into question the growth outlook. This unexpectedly disappointing development aggravated investor doubt that the management team bit more than they could chew last year and sold investors on unrealistic targets. For me, it is the biggest shock from the earnings call. After Q3 FY2021, I was already concerned about PayPal’s ability to hit its long-term goal, but I, in no way, could expect that they gave up one year into the 5-year plan! Talk about disappointment!

Are the business’ fundamentals still healthy?

Investors are right to be downbeat on PayPal. The announcements on the earnings call gave nothing, but cause for doubt on the health of the business. Nonetheless, I don’t really think that all is lost. The outlook from here isn’t as rosy as we were told before, but one of the most iconic brands in the world can’t just crumble over night. Here are a few reasons why.

The divorce from eBay is strategically essential as it liberates PayPal from the exclusive partnership. EBay is now responsible for only 3% of PayPal’s total payment volume (TPV) and revenue, down from 8% of total TPV and 14% of revenue in the same quarter two years ago. Ex-eBay TPV growth has outpaced total TPV’s every quarter since Q1 2019. This, coupled with the fact that average transactions per active account continues to rise, signals that PayPal’s non-eBay services grew on merit and appeal to consumers.

PayPal's TPV and ex-eBay TPV growth
PayPal’s TPV and ex-eBay TPV growth

Venmo continues to impress with $60.5 billion in TPV and $250 million in revenue in Q4 FY2021. There are 83 million active users in the U.S alone, meaning that almost 1 out of 4 people in the country uses Venmo. The TPV and the popularity are likely to rise with new major partnerships such as the one with Amazon or DoorDash. However, since these partners may command a low take-rate, whether they will help with the monetization remains to be seen. That’s the overall concern with Venmo. Despite the apparent popularity and making up 17% of PayPal’s active account base, Venmo is only responsible for 3.6% of the company’s revenue. The likelihood of merging the two apps any time soon is low. The risk of damaging the Venmo “cult” and taking away its appeal by folding it into the parent app is too big, but at the same time, how would the company entice Venmo users to try out other services? Currently, Venmo is available only in the U.S. What about an international expansion? Investors definitely can use some more disclosures on both issues from the management team.

BNPL is another bright spot. Launched only in August 2020, Pay in 4 already reached $8 billion in total TPV, 12.2 million unique customers and 1.2 million participating merchants. Considering that the parent company has 383 million consumer accounts, 33 million active merchants and 200 markets, there is a lot of growth ahead. As customers who used BNPL delivered 2x average revenue per account, this service will be an important acquisition and engagement tool. Would that translate into money for PayPal? The jury is still out on this question. As there is no fee charged to consumers and no additional service fee to merchants, PayPal is hoping to generate revenue through additional services. This is one of the areas on which I wish to gain additional insights in the near future.

Ironically, I find the new pivot in customer acquisition positive to some extent. While I was disappointed by the abandonment of the 5-year target, I think or at least hope that this is the right move for the business. Let me explain why. I used to receive a lot of incentive-led marketing campaigns from PayPal such as a reward for downloading an app, a discount at a partner store or a chance to win a money pot. As a consumer, I liked these efforts. The investor in me, though, thought that these outreach efforts seemed like a desperate attempt to inflate active account numbers and keep the Street happy with the progress towards the magic 750 million number. But as the active consumer account base grows, you can’t buy cheap engagement forever. Soon, the cost of low ROI campaigns would catch up and it did for PayPal. Therefore, now that the target doesn’t float over their heads any more, the company can be smart about allocating valuable marketing dollars. The next few quarters and the new disclosures on ARPU will be critical in regaining investor trust.

PayPal's marketing tactics
PayPal’s marketing tactics

Competition

Adding fuel to investor doubt is the fact that PayPal has fierce competition in the payment market. The silent killer Apple Pay provides a seamless checkout experience on millions of Apple devices and thousands of online stores. Block/Square is investing and pushing aggressively (such as the acquisition of Afterpay) to gain an upper hand over PayPal to become THE Super App for financial needs. Affirm is evolving from being a pure BNPL player, and adding new capabilities such as eCommerce button, savings and rewards. Additionally, there are Shop Pay and Facebook Pay, native checkout experiences on hugely popular platforms with thousands of merchants and consumers. Last but not least, the rise of real-time payments around the world and in the U.S will also be a threat. Given this elevated level of competition and the sudden change in long-term targets, it’s obvious that PayPal underestimates competitors and overplays their hands. From now on, it’s back to the basics which include constant innovation, addition of value-added services and a firm grip on its engaged and loyal customers.

In summary

The latest quarter is undoubtedly a disaster. There is no other way to describe it. Management overestimated their competitive advantages and consequently set unrealistic goals which led to misguided actions (the rumored acquisition of Pinterest). When such mistakes came into light, the punishment followed, in the form of billions of dollars in market capitalization. But the iconic and trusted brand is still there. PayPal still has incredible assets and millions of active accounts on its platform. The ingredients for redemption are ready. Now it’s up to management to bring about results and restore investor trust.

Venmo’s TPV
Transactions Per Active Account

PayPal Q3 FY2021 Results

The last quarter featured some great developments, acceptable numbers and a couple of concerns for PayPal, from my point of view.

The earning call started with the news that Amazon would let U.S customers check out on their website with Venmo. It’s a great win for the payment company as Amazon is the biggest eCommerce in the U.S, which is PayPal’s main market. The management team didn’t reveal much about the terms of the partnership, but given that Amazon has more bargaining power here, my guess is that PayPal has to offer some sweet economic incentives like a lower rate. In the 9 months ending September 2021, Amazon’s U.S sale was $197 billion, including hardware, physical stores, subscriptions etc. The company doesn’t break down the sale volume for its eCommerce, but for the sake of simplicity, let’s assume that Amazon.com generates around $200 billion in sales ever year. Even if Pay with Venmo processes 1% of that, it will still give PayPal a boost of $2 billion in Total Payment Volume (TPV). Not bad. You may ask given that Venmo TPV for this quarter is $60 billion alone, why is $2 billion lift a year not bad? Well, that’s because Venmo would actually generates money on this $2 billion lift in TPV while the reported $60 billion includes person-to-person (P2P) payments that earn Venmo almost absolutely nothing.

This kind of partnership is possible in the first place because PayPal is no longer constrained by legal obligations with eBay. Hence, we should see the company strike more similar deals in the future. Speaking of deals, PayPal also announced collaboration with Walmart, Booking.com, Fanatic, Phillips 66, GoFundMe and Everlane. At first glance, some of these deals make a lot of sense to me. Walmart is the biggest grocer in the country and a major retailer. Adding PayPal as a checkout option is huge and can help elevate PayPal’s TPV in the same way as Amazon would. 2/3 of Booking.com reservations are online. Since PayPal is already a checkout option, adding Venmo is a logical step to capture more of that payment share. Meanwhile, Everlane, as a fashion retailer, serves as a good case study for Happy Returns, which will be important to PayPal in acquiring and retaining merchants. Last but not least, offering QR codes at gas stations such as Phillips 66 and Valero facilitates seamless payments in a very familiar use case for all consumers.

PayPal Q3 2021 wins
Source: PayPal

BNPL has been an astounding success for PayPal. Launched in August 2020, the service already amassed $5.4 billion in transaction volume, $2 billion of which came in the last quarter alone, 9.5+ million users and 950,000 participating merchants. That’s about 2.5% of PayPal’s consumer base and 3% of its merchant base in only 6 markets so far. The potential growth is enormous. The company is introducing PayPal in 4 in Spain and Italy in Q4 2021 and planning new different flavors of its BNPL in the first half of 2022. I won’t be surprised if PayPal has $8-$10 billion in BNPL volume in the next 12 months (60% or 100% growth).

One of the biggest initiatives for PayPal is the launch of its new mobile app. It’s a major milestone towards being THE Super App for consumer financial needs. The early results, as reported by the company, were great. I don’t take much stock in them, though, because 1/ it’s still early and 2/ I don’t fully understand what all of the reported lifts mean. I’d rather wait for a couple of more quarters to see how the new app fares and hopefully the management team can give more color.

Early results of the new revamped PayPal app

On to the numbers. The last quarter’s TPV stood at $310 billion, a 26% YoY growth. Excluding $10 billion in eBay TPV, which is 3% of the total figure and trending down, the YoY growth is 31%. While eBay is gradually becoming the past for PayPal, Venmo is increasingly looking like the future. Its TPV last quarter was $60 billion, up 35% YoY, faster than the main app itself. Even though it’s only available in the U.S so far, Venmo managed to grow its TPV by more than three folds since 2018. In terms of active accounts, as of Q3 FY2021, PayPal had 413 million active accounts, including 80 million Venmo accounts and 33 million active merchants. Transactions per active account came in at 44.2. Transaction and total take-rates continued to trend down, standing at 1.88.% and 1.99% respectively in Q3 FY2021. As the reliance on eBay tapers off and the product mix is unfavorable (more bill volume or more volume from partners like Amazon that have lower rates), I expect this trend to continue for the foreseeable future.

The decrease in take rates will continue to heap pressure on revenue. Q3 FY2021 revenue growth already slowed down to 13%, much lower than what was reported in the previous four quarters. If we isolate the revenue from value added services which have little to do with the core business of PayPal, revenue growth is clocked at 10%. International revenue only grew by 2% YoY. This is particularly concerning if the management team wants to meet the goal set on Investor Day. To reach $50 billion in annual revenue at the end of 2025 starting with $25 billion in revenue this year, PayPal would have to grow the top line by at least 25%. Growth at the current clip is not going to cut it. On the Q3 Investor Update presentation, PayPal mentioned that the acquisition of Paidy would add 3 million new net accounts in 2021, but said nothing about revenue lift. I suspect that the company will continue to use M&A to aid with the growth numbers in the future. Is it a good approach? It could be, though every M&A carries a certain level of risks and you can’t fault people for doubting your own organic growth if you rely on M&A.

PayPal revenue and growth

Back in Q2 FY2021, PayPal made a major change to their pricing that went into effect on the 2nd of August 2021. Essentially, merchants will have to pay PayPal more in commission when consumers use the company’s branded mobile wallets such as PayPal, Pay with Venmo, PayPal in 4. On the other hand, when consumers key in card information without using PayPal’s wallet options, merchants will incur slightly lower rates. The assumption behind this move is that PayPal is confident in the attractiveness of its own mobile wallets. According to the latest 10-Q, the company claimed that the pricing changes didn’t meaningfully affect revenue. While it sounds encouraging, it has been only two full months. So we’ll have to wait a bit before rendering any verdict.

In summary, I’d give the quarter around 7 out of 10. The numbers aren’t catastrophic. We may just see the effect from a tough comparison from last year and the rule of big numbers. What concerns me more is that I don’t have enough information as of now to believe that they can hit the aggressive goal set for FY2025.

PayPal Total Payment Volume (TPV)
PayPal TPV YoY Growth
PayPal Active Accounts

Let’s talk Paypal. No longer merely a P2P player

The story of Paypal started in 1998 when Max Levchin, Peter Thiel and Luke Nosek founded Confinity, a digital wallet company. They later merged Confinity with X.com, launched by Elon Musk, and altogether rebranded the new entity as Paypal. In 2002, the company went public under the ticket $PYPL. Later in the same year oof its IPO, it was acquired by eBay and became the prominent payment option on the famous marketplace. In 2015, Paypal left the eBay family to become a separate and independent entity. Six years later, it is now one of the most trusted brands in the world, available in more than 200 countries and valued at almost $300 billion.

At the core, Paypal provides payment and financial services to both consumers and merchants. Originally, it used to be one of the primary methods of person-to-person (P2P) transactions. Over the years, Paypal has transformed itself into a more expansive platform. Consumers can now use Paypal to send and receive money from others as well as to pay merchants, whether the transactions are online or in stores with debit cards, credit cards, tap to pay and QR Codes. On the merchant side, Paypal offers a host of solutions, including payment processing, marketing tools and financing options.

Paypal's breadth of services
Figure 1 – Paypal’s services. Source: Paypal

As a two-sided platform, Paypal needs one side to feed the other. From the consumer perspective, they only find Paypal useful when they have friends and families on Paypal network. Additionally, Paypal must be accepted at various merchants, whether transactions take place in physical stores or on websites. Otherwise, what would be the point of having a Paypal account? From the merchant perspective, Paypal’s value propositions lie in their payment solution and the brand name as well as trust cultivated with consumers. If consumers didn’t trust or use Paypal, there would be plenty of other alternatives. But that’s also one of their three moats. It’s super hard to be a two-sided platform because of the chicken-and-egg problem. Not only did Paypal have to solve that problem between consumers and merchants, but they also had to deal with it within the consumer space.

Another moat of Paypal is that the company has cultivated trust in consumers and merchants alike with its track record of security. Even though security breaches are almost inevitable to any company, so far Paypal hasn’t recorded too many incidents. When it comes to handling people’s money, security should be at the top of any company’s agenda. I mean, anyone can boast that they can exercise two hours in a row. I don’t doubt it. But it’s a completely different challenge to exercise two hours a day for 30 days in a row, let alone for years. To replicate such a track record, a competitor needs to invest in security and more importantly, it needs time. No matter what a newcomer says about its own security, only time can seed the trust in the constituents of its network. Unfortunately, time isn’t something that human brains or money can buy. And while a newcomer or existing player builds up its track record, Paypal is not likely to stand still. Just look at their M&A activities in the last few years: Venmo & Braintree (2013), Xoom (2015), iZettle (2018), Honey (2019), GoPay & Happy Returns (2021).

Finally, Paypal is operating at an enormous scale. In Q1 FY2021, it processed $285 billion in transactions, growing at 49% YoY. That annualizes to more than $1 trillion. As you may know, scale is the magic in business. Paypal’s gigantic scale should give the company a cost advantage over competitors. Plus, the breadth of Paypal offerings poses a daunting challenge to anyone wishing to match them. Just look at Figure 1 to see how many services are available, not to mention the acquisition of Happy Returns. It’s hard to spread resources and make investments on multiple fronts when you are on the back foot in terms of unit costs. Just to give you an example of what the scale of Paypal’s existing active account base and its brand name can do, let’s take a look at the rollout of Buy Now Pay Later and QR Code. Paypal introduced its Buy Now Pay Later only in August 2020. As of Q1 2021, its Pay in 4 already had over $2 billion in TPV globally, of which $1 billion came from the US. Pay in 4 also had 5 million unique customers. In addition to its popularity and reach, Paypal offers the service to merchants without charge. Normally, merchants have to pay BNPL providers several times the normal interchange, but Paypal is willing to subsidize merchants to gain market share. Also, the company enabled pay by QR Code some time in the latter half of 2020, but it already amassed 1 million merchants as of Q1 2021 that used the service, up from 500,000 two quarters prior.

How Paypal benefits merchants
Figure 2 – Value propositions of Paypal to merchants. Source: Paypal

How does Paypal make money?

We generate revenues from merchants primarily by charging fees for completing their payment transactions and other payment-related services.

We generate revenue from consumers on fees charged for foreign currency conversion, optional instant transfers from their PayPal or Venmo account to their debit card or bank account, interest and fees from our PayPal Credit products, and other miscellaneous fees.

Source: Paypal’s latest Annual Report

In short, Paypal charges merchants on every processed transaction and for other additional services. On the consumer side, P2P transactions don’t yield much revenue, but if consumers want to have instant deposits or have an outstanding unpaid balance on their credit cards with Paypal or Venmo, then the company earns additional fees and interest on the balance.

Take-rates which indicate what Paypal gets in revenue over the transaction volume depend on the kinds of transactions. Normally, bill payments and P2P transactions have low take-rates. Transactions funded using debit or credit cards are more expensive to process than those funded using bank accounts or balance within Paypal or Venmo. Commercial transactions such as those on eBay or cross-border transactions that require a foreign exchange are more lucrative. Obviously, Paypal would love to maximize revenue and profits, but there is necessarily a balancing act to be had here. Although bill payments and P2P have a low yield, they are sticky. They are what keeps users engaged and in the network. Payments is a highly contested industry. Any transactions processed by legacy banks, other providers such as Square or Apple Pay and fintechs are transactions that Paypal loses. Hence, I think for the time being, it’s better for the company’s future that they are prioritizing the growth of the active account base and engagement.

Venmo and Paypal TPV
Figure 3 – Paypal and Venmo TPV
Paypal's active account base
Figure 4 – Paypal’s active account base
Paypal and Venmo YoY Growth in TPV
Figure 5 – Paypal & Venmo YoY Growth in TPV
Transactions per active accounts from Paypal
Figure 6 – Transactions Per Account

In short, I am bullish on Paypal. The company has a brand name known and trusted in many countries around the globe. It has the expertise after spending more than two decades in the industry and the ability to transform itself into a more expansive and competitive entity. It has a nice track record of acquiring other businesses to add needed capabilities. Currently, Paypal is the only Western company with 100% ownership of a Chinese payments company after it acquired 100% stake in GoPay. Additionally, it announced the acquisition of Happy Returns with the aim of offering merchants as well as shoppers convenient return services. As payments are pretty fragmented, I believe Paypal will not have any trouble from regulators with regard to future M&A. Yes, competition is plenty and stiff, but as you may already see at this point, there are reasons to like Paypal and what they are doing.

Disclosure: I have a position on Paypal.

Weekly readings – 2nd November 2019

How Pizza Hut stopped innovating its pizza and fell behind Domino’s

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An interesting study on how Americans personally view success and perceived success by others

Source: Gallup

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