PayPal Holdings, Inc. (PYPL) Earnings Call Transcript & Summary

Great. So we'll go ahead and get started. My name is Heath Terry. I cover the Internet sector for Goldman Sachs. Thank you all for being here with us this morning. Really excited to be able to kick off Day 2 with John Rainey, Chief Financial Officer at PayPal. John, maybe just to start things for people here who maybe aren't as familiar with PayPal or who know you best through your services and your brand, what's the right way for an investor to think about what it is that you and the team are building at PayPal as a company?

Sure, Heath. First, let me say thank you for the opportunity to speak with you today and for all of you for attending. I think as context, we are a platform that has a little over 300 million customers. That includes about 25 million merchants and 281 million consumers. And our vision is to be a platform that is a multiple of the size that we are today. We don't think it's crazy to consider that maybe one day we could be a platform that has 1 billion users on it that are engaging with us in some form every single day. And there are 2 or 3 things that I would point to that support that mindset. First though, I think part of the ethos that we have at PayPal is one, where we're trying to promote financial inclusion. And I think that's important because when you look around the world, by some estimates, there are as many as 2 billion people, 2 billion people that are what we describe as underserved financially, meaning that they don't have access to a brick-and-mortar bank or a checking account or a mortgage or something like that. And the unique aspect of those 2 billion people is that about 70% of them have a mobile device. And we have very clearly benefited over the last 5 years from the secular trends of the increase in e-commerce, but also the proliferation of mobile devices. So financial inclusion is something that we think that we can bring. And whether it's helping a merchant with a working capital loan or giving someone access to point-of-sale credit, those are things that have a way of lifting up entire communities and economies. So that's the first thing I would point to. Second, I would say that our goal is to be the simplest, easiest and fastest way to check out, to pay at a merchant online. And that's underpinned by our brand of trust and security. I think when you look at consumer feedback and merchant feedback, people appreciate using PayPal because they know it's reliable. They know what they can expect in the experience. And they know that their data is going to be protected. And then thirdly I would say, as we look forward to the next, call it, 5 years, there's an opportunity for PayPal to participate more broadly in the e-commerce journey. What I mean by that is moving further up into the funnel, into the intent stage of shopping versus just being a payment option when one checks out. Our acquisition of Honey helps us with that endeavor. And we think that, that's a very promising opportunity for us going forward.

How would you describe sort of who the typical PayPal customer is? And I realize there's a spectrum, but both from a consumer and enterprise perspective and why do they use PayPal?

Sure. Sure. Heath, it's hard to sort of pinpoint what the average PayPal consumer is. I can give you a couple of characteristics though. So if you take the traditional PayPal consumer as opposed to Venmo and you just look in the U.S., about 75% of those customers are above the age of 30. Half are women. And if you look at even the component of that, that is underserved, about 1/3 of them are what we call underserved. You contrast that to Venmo. And Venmo obviously skews very heavily towards the millennial demographic. We refer to these as digital natives. They are people that are very accustomed to checking out with a mobile phone or transacting that way. A common theme though among all those customers is that they appreciate the simplicity and ease of use of PayPal and the brand that I just alluded to. If you look at the merchant side, again, the composition is slightly different from what we refer to as our traditional PayPal business versus Braintree, which is a company that we acquired. The traditional PayPal business on the merchant side tends to skew more towards the small and medium-sized business. Braintree is a little bit more in middle market or even large enterprises. But again, when you look at common themes among those merchant groups, they all want simplicity. They all want security. They all want omnipresence. And these are things that we provide and a couple of statistics to support that. So if you're a merchant, like one of your key things that you want from e-commerce is growth. You want to increase your sales. And I think one of the single most compelling metrics to support that is our conversion rate. So meaning when someone puts something in their shopping basket, how often does that convert into a sale? And for us, it's almost 90%. That's roughly 2x the industry average. And so when we go to a merchant and we talk about the advantages of our platform, what we're talking about is much more than payment processing or reconciliation reporting, it's conversion that's giving them growth. On the consumer side because of the things that I mentioned, you see metrics like 54% of consumers are more apt to complete a purchase at an online merchant if PayPal is present. If you just look among our customer base, almost 60%, 59% of our customers have not completed a transaction because PayPal wasn't there. And so these are themes that are consistent across all of our consumer or merchant base, but it's hard to sort of say, this is the typical or average PayPal consumer.

So last year, you grew total payment volume by 25%. You've guided to mid-20s growth again this year. If you look back over the last 10 years, within a couple of percentage points, you've grown payment volume within a couple of percentage points of that mid-20s level. It's an almost incredible level of consistency. How have you been able to achieve that? And how do you manage that into the future?

Sure. Well, I think to be very blunt, we have clearly benefited from the secular trends in our business that I mentioned earlier, the growth of e-commerce and the proliferation of mobile devices, and that unequivocally has helped us. But there are some things that I think that we've done that have also contributed to that growth. One is being an open digital payments platform. That allows us to go partner with people around the world to help power digital payments. And I think that, that has -- well, when we embarked on that strategy, I think there were some cynicism or skepticism about how successful that would be. I think the verdict is in, and that clearly has been successful. And to your point, it has allowed us to continue to grow at a rate that is much faster than e-commerce. But if you look at how we expect to continue that in the future, the strategy is different for what I would call our core markets versus the more emerging or international markets. Within our core markets, we have a much higher rate of penetration among digital users. And so the strategy in that market is not so much getting additional consumers or net new actives, it's more of what we can do to drive engagement. So things like increasing the ubiquity of PayPal, increasing the utility of the wallet, increasing our share of checkout. Those are things that we think can drive a lot more engagement to help on the growth side. Internationally or in more emerging economies, we think there's a tremendous opportunity to just grow our footprint. And so we have, if you just look at markets like China, for example, roughly 1% penetration among the 0.5 billion digital users there. So if we can turn that into 2%, 3%, 4%, 5%, 10% penetration, that gives us a huge opportunity to continue to grow our TPV at that rate. The last thing I would say around this, Heath, is that PayPal is, I think, somewhat unique in this space with a lot of new, fast-growing companies in that not only are we growing at that rate that you mentioned and growing revenue in the range of 20%, but we're very profitable and we generate a lot of free cash flow. We consistently generate free cash flow margins in excess of 20%. And the relevance of that to this is, it allows us to take that free cash and go not only invest organically in our business, but go look at acquiring capabilities to help accelerate that growth. And so examples would be like our acquisitions of Simility and Hyperwallet, which provide great additional features for our merchant base with things like payouts and Risk as a Service. And so it's that growth profile that we have, but also being profitable that allows us to go out and acquire companies that has helped us.

Yes. So you touched on this a little bit just now, but in the same way that you've seen that kind of growth consistency, you have had similar levels of consistency in your profitability, whether on a cash flow margin basis, operating margin basis. What has driven that? I mean particularly given that you've had to obviously deal with pretty material changes in transaction expenses and other parts of the cost structure?

Sure. Sure. Well, it's interesting. I think more recently, the narrative around a lot of the tech companies has been not just growth, but you need to show profitable growth. And we can cite companies, right here in San Francisco that are good examples of the investor focus on that aspect. 5 years ago, we were growing very well, but not all of that growth was profitable growth. And the benefit of any technology platform is being able to scale at a very low marginal cost. And there were periods where we were candidly adding headcount at the same rate as our TPV was growing. And we took some pretty significant steps about 3.5, 4 years ago to, as I describe it, rewire or replumb our business to allow us to grow at a very low transactional cost. And so I'll give you examples in each of the 3 categories of expenses on our income statement. So we have transaction expense and transaction loss, which are both what we group as volume-related expenses, and then everything else which we call non-volume or other operating expenses. In transaction expense, we've consistently held that at a rate of about 95 to, call it, 98 bps as a rate of TPV. And there have been some -- that's related a little bit based upon mix changes in our business, but there was a concern that when we opened up our platform and we allowed consumers to use whatever payment instrument that they wanted to pay that we would see inflation there. And we actually haven't seen that. It's been very consistent. And I think there's actually opportunity for that to come down more in the future. The second area is transaction losses. And so historically, again, on a rate per TPV, we've seen this in the 17 to 19 basis point range. And we've seen dramatic improvements in the last 3 quarters. And so the last 3 quarters, that range in terms of TPV has been 14 to 15 basis points. And that's come through advances in our modeling and what we do around risk. It's also come with the acquisition of Simility, which has helped us take some of their risk capabilities to drive that down further. And so good examples of where we're seeing leverage in our platform on the volume-related side. And then lastly, what we refer to as other operating expenses. This is an area that, I think, gets a lot of focus because it had gotten away from us again 5 years ago when we were growing that at a rate that was not sustainable. And the way that I think about our business is very much in terms of incremental margins. And so as we're growing, what is that incremental operating margin or that incremental transaction margin each period? And a key component of that are the incremental operating expenses. And for us, the right level, I feel, is about $0.10 to $0.15 of operating expense growth for every dollar of revenue. That allows us to see the benefits of the scalability of our platform while also still investing in the business. We could drive it lower, but that's probably the wrong long-term decision because we'd be actually turning off the spigot of investment for a bit. So as we look at our business, we think that there's continued opportunities for us to scale at that low marginal cost. And I think a big focus, if I were an investor, would be on the incremental margins in our business. And we continue to demonstrate that those are accretive.

Maybe to dig into the specifics of growth a little bit more. On the earnings call, Dan was really almost passionate about the likelihood of growth reaccelerating from what we saw in Q4. He spent a lot of time on it. The investors tend to be pretty skeptical when they hear growth reacceleration just in general. What do you see as being the biggest tangible triggers of that growth reacceleration?

Sure. Well, if we contrast the guidance that we gave in the first quarter in January for this year versus where we were a year ago, I think that the first important point to note is that the core business is performing better than it was a year ago. A year ago, we saw some sluggishness with consumer spending in the December time period. We did not see that this holiday season. In fact, we've seen a continued strength as we go through January. Now there are pockets globally which I can refer to later where there are strengths and weaknesses. But generally speaking, we're just in a better starting place than we were a year ago. We started off a little bit in the hole last year. And then directly to your question, Heath, there are 3 or 4 things that I would point to. The first is, we've got a couple, what we refer to as partnerships, like bigger agreements with key partners that are in place and ramping up. The first, and our investor base knows this name well, but Paymentus is someone that provides bill pay that we've partnered with. We are live with them and ramping up merchants each day. So that's something that we're not necessarily betting on [ to come ], it's just a matter of getting to a run rate there. So we feel really good about that and what generally bill pay does in terms of how it bodes well for our business. The second is, among the large partners, I would say is Uber. We've been one of the major payment processors for Uber for a long period of time, but we've expanded that relationship internationally. Some of their largest markets are places like Brazil and India. And so we're doing more of their processing there going forward. A third area I would probably say is Pay with Venmo. Pay with Venmo is -- I know everyone wants to see -- the question I get virtually every investor meeting is, when are we going to see that turn to profitability? Well, Pay with Venmo is a key component of that. And we've got plans about how that ramps through the year that is pretty material to our financials.

Yes. So on the other side of that, you have quantified the drag on growth that your relationship with eBay and that process is having on this year. How do you see that progression, especially now that it seems to be taking longer than they initially expected for them to transition? How do you see that progression happening over the next few years in terms of the impact that it's going to have on your financials and your growth?

Sure. Sure. So as context for everyone, eBay this year will begin transitioning more of their volume to their new payments, their own payments service. And they've had the ability up to now to transition 10% of their volume in 2 geographies. And so we've got pretty conservative expectations about the rate at which they will make that transition. We've said that for PayPal that the impact of that in 2020 is about 1 point of revenue growth, 1 point. And there'll be an additional impact in 2021. And then we can kind of hopefully get back to managing our business and people aren't asking about eBay anymore. But there's a couple of elements that influence that in terms of how we think about the impact of that longer term. One is just how eBay is doing in its own business. We saw, I believe, in the last quarter about a 4% decline in volume in terms of the business that we do with eBay. And it's been declining for several quarters. And so that impacts that. And then the rate at which they actually transition those merchants. Merchants have to elect to go over to their payments system. And it's -- the thing -- the commentary that I've heard Scott and others say is, they're not going to do a knife's edge cutover where they force all of these merchants. I think that would be a bad decision for their business. And so it will take some time. And I think that, that will extend well out past probably 2021. The other thing that is really important to understand about the relationship we have with eBay going forward is we are still a branded payment option in their managed payments experience. And as we said in January of '18 when they announced this, we've gone through that transition with other providers, and we retain roughly about half of the volume on that branded payment experience. Our experience in the 2 geographies where they've launched managed payments, the U.S. and Germany, is very consistent with what we said in that period of time. And in fact, in the U.S., we've seen our share of checkout actually increase over time. And in Germany, we're appreciably higher than that 50% share of checkout. So all of those things together lead us to believe that this is a very manageable transition that will take place over 2020 and '21 primarily.

So this should probably be and you've touched on some of these already, but this should probably be 4 separate questions, but given we only have so much time. When you look at the relationships, the partnerships that you announced last year, Uber, Facebook Marketplaces, Instagram Checkout, MercadoLibre, what are the goals and objectives that you have for that? What role -- for those generally, what role will PayPal ultimately play in those relationships, in those marketplaces?

Sure. Sure. So I'll start with Uber because I mentioned some of the aspects of our relationship with them. They're a huge platform. They're a great company. And there's a stickiness to their payments and their business as well. So when someone vaults a payment method there, they don't tend to change that out with every single ride. In fact, it's almost sort of an unconscious act that they're making. And so we want to continue to process their payments from an unbranded perspective, but also have a branded experience there as well. And so Venmo is a great example where we've seen our share of checkout increase with Uber and other merchants like that where we've had very specific efforts around that. And so they hopefully will continue to be a very important partner, but one that also gives us a lot of geographic reach. And so I mentioned India and Brazil as opportunities there. Those are areas where we're not as strong as in other international entities. With Facebook, we are the unbranded payment processor for their U.S. Marketplaces experience and we also with their new Instagram experience where you have the contextual commerce checkout, where basically, you don't have to go to the merchant's website, we're powering that experience as well. And so we're very excited to be able to partner with them as they launch into these newer areas for their business going forward. I think also very importantly that we are a branded payment option with them as well. And so that is something that we're being patient on, but we think it's great to be able to have a partner like a Facebook that's got the number of users that they have. And it very much helps us achieve some of the goals that I talked about at the beginning in terms of getting to 1 billion users on our platform. The last is MELI or MercadoLibre. We made an investment with them last year. And then right before year-end, we concluded the negotiation for a commercial agreement. And Latin America for us is arguably the geography where we are least strong, but MercadoLibre has something like 200 million customers on their platform. I'm not sure the latest number. But if we can allow those customers to shop with our network of 25 million merchants, 24 million merchants around the world, that's a tremendous cross-border opportunity. PayPal can also be vaulted into the MercadoPago wallet as well. And so there's a lot of opportunity there to expand our footprint in Latin America and help facilitate a lot of cross-border commerce for our mutual customers, which tends from a financial profile to be more profitable business.

Yes. Because it's your most recent, I want to dig into the Honey acquisition a little bit. But maybe before we start, can you just give a little bit of the landscape of how you think about M&A generally? What your process is like from a strategic and financial valuation standpoint?

Sure. Sure. So we firmly believe that there's an opportunity for a company like ours to not solely focus on just organic activity, organic development, but also go look at what some best-in-class companies are doing in the space that provide complementary assets to our platform. And so the 2 examples I mentioned earlier, I think, are really good ones, both Simility and Hyperwallet, providing Risk as a Service and payout. So those are 2 things that merchants want. And when we go to market with those capabilities, it allows us to increase our win rate. So it's things like that, that we think are very important. They're complementary assets. We also look at where we can expand our footprint geographically. We still have white space around the globe in terms of where we are strong. And so we tend to look at those things, but also things that we can do to increase our value proposition for consumers. We've done a lot historically on the merchant side, iZettle, Hyperwallet, Simility, Braintree. But our focus, I think, is shifting a little bit more to the consumer value proposition. And that's where you see the Honey acquisition come into play there. And we are extremely excited about the acquisition. It's a great team and they've got great technical capabilities there that, again, are very complementary to what we're doing. And so there's some obvious quick wins related to that acquisition. One is if we can cross-sell Honey to the 281 million PayPal consumers, that's a big opportunity. And we're extremely encouraged by just what we've seen in basically a month since we've closed the acquisition. Right at the date of the announcement, we were -- basically allowed our customers to go log in at Honey using their PayPal credentials. Just as an example, that's something that took us about 9 months to do 4 or 5 years ago when we acquired Xoom. But that's a big opportunity. There's also the opportunity to have PayPal as a payment method in that checkout experience for Honey and then obviously cross-sell that to our merchant base of 24 million merchants. But the area that I get excited about here is what we can do with data to tailor individual experiences to shopping experiences to customers. And so I'll give you a data point and maybe this will help understand why we're excited about this. But when we look at our consumer base today, they obviously don't use PayPal every time they can. And in fact, sometimes they're only using it about half the time. And if you're a PayPal customer, you probably recognize that when you go to checkout and PayPal is an option, you click it right there, the one-click checkout, that's where our value proposition shines. It removes any friction and you can check out seamlessly. There are other integrations where you still have to enter in shipping information or other information and then you get to a set of payment options, of which PayPal is one. And in that case, our share of checkout is lower because our value proposition is a little more watered down. And so an extension of that is the further up into the shopping channel that we can get, the more likely we will increase our share of checkout. And so what's exciting about Honey is being present at the very intent stage of the shopping journey. And if we can be there then and we can help provide things that are relevant to consumers, that provide incrementality to merchants, we think that we can dramatically increase our share of checkout, which gets back to your question earlier about, what are you going to do to continue this rate of growth with TPV. That's a vehicle for increasing engagement with our consumer base.