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.

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