$PYPL (PayPal) - Treading water or still growing?

Continuing the first article in the “Business Analysis” series — $PLTR (Palantir) - America's most mysterious tech unicorn, this week, Viet Hustler sends to readers the analysis of PayPal — the world's leading online payment platform.

Introduction to PayPal Holdings ($PYPL)

PayPal Holdings, Inc., a multinational company headquartered in the United States with operations in most countries offering online money transfer services. PayPal handles payment transactions for online merchants, auction platforms, and many other commercial services

Summary of the history of formation and development of PayPal:

1998:

• Max Levchin, Peter Thiel and Luke Nosek founded Confinity, a company developing security software for handheld devices.

• After 1 year, Confinity pivoted to developing digital wallets because the initial business model was not effective.

• The first version of the PayPal electronic payment system was born.

2000:

• Confinity merged with X.com, an online financial services company founded by Elon Musk.

• Peter Thiel replaced Musk as CEO of X.com.

• X.com renamed to PayPal.

2002:

• PayPal conducted an IPO and raised 61 million USD.

• eBay acquired PayPal for 1.5 billion USD, helping PayPal become popular on the eBay platform.

• PayPal became the default payment method for most eBay users.

Recent changes in PayPal's leadership

1. Alex Chriss - PayPal's new captain

In 08/2023, PayPal announced the appointment of Mr. Alex Chriss as President and CEO, replacing former CEO Dan Schulman.

Chriss had 19 years of experience at Intuit - the world's largest personal financial management software company. Before joining PayPal, Chriss was the director of Intuit's small business division.

Chriss was also behind Intuit's 12 billion USD acquisition of Mailchimp. Under him, annual customer growth and revenue growth rates reached 20% and 23% respectively.

2. Mark Grether - the person expected to bring a new wave to PayPal

PayPal appointed Mark Grether as head of the Advertising division - a newly established division.

• Grether grew Uber's advertising revenue to 1 billion USD/year.

• According to calculations, if PayPal's advertising segment reaches 1 billion USD in revenue with a 40% profit margin, the group's quarterly profit will +10%

PayPal's business model

PayPal is present in every segment of the online money transfer market with many types of products.

• Individuals can use PayPal and Venmo to transfer money and make payments while merchants can use Braintree for card payments

PayPal is essentially a two-sided network (double sided market), similar to Meta - a two-sided network that makes money through advertising.

• In the early stage, the company paid users to use the service and become customers → This created a massive user network.

• Over time, PayPal leveraged this network to attract merchants offering PayPal as a payment method.

• PayPal takes transaction fees between the two sides:

  • Consumers are the building blocks and merchants are the monetizing side.

  • Consumers do not pay fees when using PayPal because the seller has paid the fee

• Today, PayPal has over 420 million active users worldwide.

• While creating a payment platform is not difficult, it takes decades to build a global payment network and attract half a billion users.

PayPal provides services to both individuals and businesses with 3 main business segments: PayPal, Venmo and Braintree

1. Paypal

• PayPal provides payment services to consumers and online sellers, on mobile phones or in stores.

• For consumers:

  • Consumers can pay with PayPal balance, credit card, debit card or bank balance.

  • PayPal's digital wallet allows consumers to draw money from multiple different sources in one place.

  • PayPal usually does not charge fees for withdrawing and depositing money into the account.

  • PayPal also provides buyer protection programs to refund consumers in case of fraudulent activity.

• For sellers:

  • PayPal also provides in-store and POS payment solutions for sellers, similar to Square's services.

  • PayPal provides sellers with value-added services to help manage cash flow, invoice customers, store sensitive customer information and integrate with Braintree.

2. Venmo

• Venmo is a P2P payment app that allows users to send and receive money instantly from other Venmo users.

• Venmo is available for both Apple and Android devices and is linked to the user's email address.

• Transfers within the same country (not using credit cards) are free.

• Venmo allows you to link a bank account or card to pay along with your Venmo balance.

  • Transfers from Venmo to a bank account are completed within one business day.

• Half of Venmo users are young people

• The number of Venmo users is expected to reach 100 million by 2026

3. Braintree

• Braintree provides businesses with the ability to accept online or mobile payments.

• Braintree provides customers with both merchant accounts and payment gateways, while charging fees and settling funds for each processed transaction.

• Braintree is fully integrated with PayPal and other payment types.

• PayPal's unbranded card processing business is growing much faster than its traditional business.

• In the next 2 years, Braintree's payment volume is projected to grow at a CAGR of 22%, while transaction revenue is estimated to grow at a CAGR of 19%.

PayPal's competitive advantages

1. Steady revenue growth thanks to a large user network

PayPal is not a young company; it was founded in 1998. However, it continues to deliver strong revenue growth in its 26th year.

• Over the past 5 years, revenue has grown at a CAGR of 10.9%.

The "toll bridge" function in payments along with a vast customer network makes its business flexible.

• PayPal and Venmo together hold 47% of the US electronic payment market share, far ahead of other platforms like Google Pay or Apple Pay

2. Strategic partnerships with major corporations

• Expanding scope and increasing options for users:

  • Long-term strategic partnership with Visa expanded to Europe and Asia-Pacific

    • => Helps users have more payment options, wider acceptance at points of sale, instant withdrawals

  • Partnership with Mastercard strengthened with the co-branded credit card program - PayPal Extras Mastercard - and expanded to new markets such as Europe, Latin America, Canada, Africa, the Caribbean, and the Middle East, along with the cashback program.

    • PayPal and Mastercard have been partnering for 10 years.

    • Mastercard is a payment option in the PayPal digital wallet.

• Strengthening partnerships and driving growth:

  • PayPal partners with tech giants like Google, Facebook, Pinterest, Alibaba and Intuit, building a favorable position for partnerships with original equipment manufacturers (OEM), tech companies, mobile service providers, retailers, and financial institutions.

  • Partnerships with major banks like CaixaBank, Bankia, HSBC and Barclays Bank help PayPal expand its potential customer base.

  • Partnering with JP Morgan and Bank of America to introduce new services and offers for debit and credit cardholders, attracting more users to the PayPal platform.

3. Product Innovation

• 2024 is expected to be a “transitional year” where PayPal will expand its ecosystem with new features—including FastLane payment service, Smart Billing tool, and Cash Pass rewards program—to increase revenue per user.

  • Fastlane by PayPal is an online payment service that helps users save time and simplify the shopping process by storing their card information and shipping details once, and then the system automatically fills this information into websites accepting Fastlane by PayPal for future shopping.

• Increasing adoption of the company's own PayPal USD cryptocurrency, pegged to the USD price, could make their cross-border transfer operations more efficient.

4. Share Buyback Strategy

According to PayPal's CFO: "$17 billion in cash on the balance sheet. And we have committed this year to allocate more than $5 billion for share buybacks. More than 100% of our free cash flow will be used for buybacks this year."

=> PayPal has excess cash and intends to buy back shares in the future, causing the stock value to increase

Challenges PayPal Faces

1. Competition from Other Payment Services

PayPal remains one of the world's largest digital payment platforms, but the company's advantages are narrowing.

• Big tech companies like Apple and Alphabet's Google are threatening the company's market share with their own payment services

Over the past 3 years, Apple Pay has shown remarkable expansion in the digital payments landscape. Estimated to have over 640 million users by 2024, up from 507 million in 2022

• Apple Pay's transaction volume—this service processes over 1.8 billion transactions per quarter, +40% Y/Y is an impressive figure.

• With 92% of total payments in the US mobile debit wallet industry, this service's dominance is particularly evident.

• Over 90% of US retail locations and 60% of retailers worldwide accept Apple Pay

• Apple Pay's perfect integration with the Apple ecosystem and sophisticated security features—delivering a better user experience—are driving this explosive growth. Ecosystems are the new trend:

  • Microsoft's Office suite with tools like OneDrive and Teams helps Microsoft build a robust environment for companies to boost productivity and collaboration.

  • By linking Prime membership with benefits like Prime Video, Prime Music and faster delivery, Amazon's ecosystem linkages improve user experience and attract third-party providers

• Technological hurdles also make PayPal less able to compete successfully.

  • PayPal has not kept up with these developments, unlike Apple Pay, which provides advanced biometric authentication and a more consistent user experience across multiple devices.

And recently, Apple launched Tap to Pay to easily support money transfers between two users.

2. Competition from Fintech Companies in Payment Processing

• Other fintech companies like Adyen, Block, and Stripe are also trying to capture the payment processing services market

PayPal once enjoyed a close relationship with its parent company eBay, but this e-commerce giant replaced PayPal with Adyen, becoming the preferred payment platform during the 5-year transition from 2018 to 2023.

The payment processing services business segment only accounts for a low growth rate.

• In 2022, PayPal earned 27.5 billion USD, accounting for only 2% of the total transaction volume processed by the company worth 1.36 trillion USD.

• Competitor Adyen earned 1.4 billion USD in revenue, accounting for 0.17% of the total processed transaction volume worth 815 billion USD.

• Stripe earned 3.2 billion USD, accounting for 0.39% of the total transaction volume worth 817 billion USD.

Adyen typically serves the world's largest companies and retailers such as McDonalds or Spain's Mango clothing manufacturer and retailer. Stripe started serving small companies but has shifted to the premium segment. Meanwhile, PayPal tends to serve mid-tier retailers like Casper, Poshmark, and Krispy Kreme.

• Competition among payment processing companies is becoming increasingly fierce as Adyen strives to gain a larger market share in the North American market.

  • Adyen's strength is adapting to the needs and preferences of different financial institutions around the world to achieve high acceptance rates for global retailers.

  • Adyen is trying to leverage its advantage in providing services for international payments to expand relationships while attracting more companies in the United States.

PayPal's response:

In spring 2022, PayPal tried to attract merchants by offering lower prices for Braintree services and then providing them with profitable features like branded checkout, credit products, or PayPal Payouts that help companies like Uber pay drivers.

• Braintree's estimated gross margin hovered around 28% in 2021, but the current low-price strategy has pulled the gross margin down to 23%.

The risk PayPal faces when reducing processing fees is sparking a price war leading to lower quality or lower employee pay. If all three companies cut fees, profits will be affected.

However, since PayPal has many bundled products, profits may be less impacted. Another risk for Chriss is that customers only buy Braintree services and do not use any other PayPal products.

PayPal Q1 FY24 earnings update

• Total payment volume +14% Y/Y to 404 billion USD

• Number of users -1% Y/Y to 427 million

• Transactions per account +13% Y/Y to 60

• Revenue +9% Y/Y to 7.7 billion USD (beat estimates by 180 million)

• Non-GAAP EPS 1.4 USD (beat estimates by 0.18 USD)

• Q2 FY24 revenue guidance +7% Y/Y

• Revenue growth has slowed but recent revenue has reached 30 billion USD

• Costs have trended down in every quarter since early 2023, mainly due to layoffs and improved operational efficiency

• Operating income and net income improved strongly

• EPS has trended strongly upward since hitting bottom in 2022. With the share buyback program ongoing for the next few years, EPS is likely to continue surging.

• PayPal has massive free cash flow thanks to stable and efficient business operations

• PayPal is in a very strong financial position with cash and cash equivalents trending upward continuously except for 2021.

• PayPal has reduced risk in recent quarters as long-term debt is on a downward trend.

• Gross margin has declined in recent quarters but net margin remains high

• ROIC & ROE both trending back up since the low in January 2022.

Conclusion

PayPal is a leading global online payment company with a massive user network, diverse ecosystem, and strategic partnerships. The company has many competitive advantages and strong growth potential in the future. However, PayPal is facing fierce competition and slowing growth in the overall consumer market.

To continue growing, PayPal needs to accelerate product innovation, expand markets, and optimize operational efficiency to improve margins. Recent changes in senior personnel clearly show that PayPal's leadership recognizes the need for change.

For investors, PayPal remains a company with long-term growth prospects plus 5 billion in share buybacks this year. The key issue with this stock is that investors need to feel confident about PayPal's growth potential to elevate the valuation back to that of a growth stock.