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

Welcome back to Evercore ISI's Fourth Annual Payments & FinTech Innovators Forum. Delighted to have with us, PayPal, John Rainey, Chief Financial Officer and Executive Vice President of Customer Operations. Welcome, John.

Thanks, David. It's good to be here.

Gabrielle Rabinovitch, Head of Investor Relations; and Amanda Miller. So thanks so much. We appreciate it.

So just to start off with, John, 1 week ago, you reduced your first quarter 2020 revenue guidance by 1 percentage point, both on a spot and FX-neutral basis for the negative impact from COVID-19. Can you elaborate upon the factors within your cross-border business that slowed substantially? And any cost measures you took that allowed you to actually maintain your EPS guidance for the first quarter?

Sure, sure. So I'll start with the fact that our core business has been performing very well. And I think that offsets some of the impact when you look at what we shared in terms of the impact of COVID and how that relates to our first quarter guidance, still coming in within the range that we provided. But specific to coronavirus, obviously, the topic of the day here. But things like this are, at best, difficult to forecast. And we've got a vast cross-border business that extends pretty prominently into Asia and China as well. And so the impact that we've seen has been really concentrated up to the point of our guidance in that region: China, Hong Kong, Southeast Asia. And specifically, what we were seeing is more on the Chinese seller side. So demand has held up pretty well, best we can tell. But certainly, I think there's been an impact more on fulfillment with Chinese sellers. And so that's what we saw that was related to our guidance. We're obviously keeping a close eye on this, just like everyone else. I would expect there to be some impact to our business if it continues to spread, but the duration and magnitude of these things are very difficult to predict. And I think you obviously see that manifest in the wild swings in the stock market because of the trepidation that exists out there. But we have experienced things like this before, be it H1N1 or SARS. Fortunately for me, I work for PayPal now and not in the airline business when I was previously when those have occurred. But we've got a durable business. And e-commerce trends are strong, and we still continue to gain share there. So we'll weather this and get through it. But certainly, I think there's going to be some impact that prolongs into the second quarter and beyond. And as we get to our first quarter call in April, we'll talk more about that.

In terms of the factors that enabled you to maintain your first quarter earnings guidance, you called out underlying strength in the business. Were there any specific cost measures you're taking to actually hit the guide?

Yes. So we've continued to see really good leverage opportunities in our business. And I'll kind of walk through the P&L because it's not specific necessarily, David, to one area. So I'll start with transaction expense. We've consistently been able to maintain a transaction expense in terms of a rate of TPV in that 95 to, call it, 98 basis points and the mix in our business, the growth of Venmo, those -- that allows us to kind of manage that over time and mute some of the more inflationary pressures in that expense side. The one item that I think stands out more than others in more recent quarters is transaction loss. And so if you think historically, going back over the last 4 or 5 years, the transaction losses in our business have been in that 17 to 19 basis point range as a percent of TPV. And in the last -- the more recent, call it, 3 quarters, we've been around 14 to 15 basis points. And there's always risk pressures that come in that area. But the benefit that we've shown there is really more related to improvements in risk management capabilities, actions that we've taken that, I think initially, when we started performing at this level, I was a little guarded about the sustainability of that. I feel pretty comfortable right now though that what we're seeing is a durable trend in our business, and again, gives us tremendous leverage opportunities. And so those are the 2 what we refer to as volume-related expenses on the P&L. Everything else is -- we sort of generically referred to as other operating expenses, and that runs from product development, to finance, to customer operations. And in every single line item, we've seen opportunities there. We continue -- like, you take customer service as an example, we continue to make improvements there, both in the number of contacts that we get from customers but also in the cost of those contacts. And so let me expand on both those for a second. So if you think about the last 3 years, we've grown our transactions roughly 25% a year. Over that period of time, the absolute number of contacts that we received from customers has actually gone down. So growing volume 25% a year and our contacts were coming down. This is by improving experiences for our customers. So one of the key metrics that we look at in our business is the contact rate or the number of contacts that we get divided by the transactions. But the cost of those contacts is also coming down because we're doing things like focusing on chat, asynchronous chat experiences for our customers. In many cases, they'd rather be serviced that way than speaking to someone on the phone and potentially having to wait in a queue on the phone. That's a lower cost service channel for us and has also the ability to -- for a teammate, one of our customer service employees, to handle multiple chats at 1 point in time, which brings down that cost per contact. We still have a tremendous opportunity here. So we get 60 million contacts a year from customers. Still today, 70% to 75% of those are handled via phone. And so as you think about our business going forward and the ability to continue to show strong incremental margins in our business. This is one of many examples that we have.

Great. Well, just segueing a little bit into 2020. So on the fourth quarter call, you achieved a 35% incremental margin as you continue to scale the business at low incremental costs. That being said, for 2020, you've guided to flat EBIT margin. You've called out 3 points of acquisition dilution from Honey Science and GoPay, together with investments in Venmo and China expansion. So as we look at these acquisitions and investments, do they extend the duration of your current kind of midterm guidance model in terms of revenue growth? Or do they potentially give you an opportunity to accelerate growth over time?

Well, let me divide that answer in 2 aspects: One is just pure math and the other is like what's happening in our business. And so if you look at -- and as a reminder, our medium-term guidance is 17% to 18% revenue growth compounded annually and approximately 20% EPS growth over that 3- to 5-year period of time. What we've demonstrated is 27% EPS growth over the last 4 years. So significantly above that 20% threshold. And if you dissect our revenue growth into 2 areas -- you just look at the rate of growth of eBay. That's been a drag on our business. It's been growing in low single digits whereas, like merchant services volume is north of 30%. And so as we transition over the next 2 years off of eBay and more of our business is related to these faster-growing marketplaces and technology platforms, you'll actually see an acceleration in growth. That's just pure math. But if you look at what's happening in our business, there's a lot of opportunities that support just the organic growth in the business. And so you've alluded to a couple, but we're expanding with Uber. It's one of our largest partners. And the nature of our relationship is expanding into international entities as we look at places where we've got more white space in terms of our presence, and they have a bigger presence, India, Brazil, examples like that. That's a big opportunity. And then Paymentus something that we've talked a lot about, but bill payment, we think, is a very complementary service to what we provide today, and there's a huge addressable market there. And so we're looking forward to expanding there. But there are other merchants like, Live Nation, it is something that we've expanded and moving forward with them. These are all big opportunities for us. But then you look at even some of the acquisitions that we've made. And so I'll take 2 examples, one of which relates to growth, one of which is not TPV growth. And so in the former example, GoPay in China. China is the significant opportunity for us. We're very excited to be the first company to be granted a payments license there. China is expected to be, by some estimates, as much as 40% of cross -- of worldwide cross-border TPV by next year. And we have a very low penetration rate among that 0.5 billion users in that market. The opportunity for Chinese consumers to now shop using PayPal at our network of merchants of 24 million merchants around the world is significant. So that's a growth vector that we're pretty excited about. But I also would emphasize it requires significant investment in China, and that's what we're undertaking this year. But as we look out into next year and beyond, we think that's a big opportunity. Honey is another one. So our acquisition of Honey is something that we're excited about. To be clear, though, that's not counted as payment volume growth today. And so that's more of a revenue opportunity, but we think it's -- there's an indirect benefit to moving further up the funnel to the intent stage of shopping to where customers will shop more with PayPal.

If we look out to 2021, should we expect to see operating expansion resume at the historic cadence which has actually been quite strong?

We haven't guided to 2021 yet, and we certainly have 1 more year of impact with -- from eBay. And so, we feel confident about our ability to weather that. And to be clear, like what we're seeing today in the 2 geographic entities where eBay has launched their managed payments, being Germany and the U.S., were maintaining a significant share of Checkout with our button. And that's consistent with our historical experience, where we've gone through this before. And so we've actually increased our share of Checkout in the U.S. with PayPal since it's been launched and it's approaching 50%. In Germany, it's well north of that. So these are things that, I think, will mute that impact. But as we get out beyond 2021, there's significant opportunities to continue to expand margins in our business. You referenced it in your previous question, but the 35% incremental operating margin that we had in the last quarter is, I think, indicative of the type of opportunities that we have in our business to continue and grow and scale, but do it at an expanding operating margin.

Shifting gears for a minute. You exited the fourth quarter with Venmo at a $450 million annualized run rate. Can you walk through the current monetization strategies for Venmo, new avenues of growth and what the path to profitability is?

Sure, sure. So let's have -- let me provide some context here. We have over 300 million customers on our platform today. Venmo has over -- at the end of the last quarter, got over 52 million customers on that platform. We continue to be very focused solely on growth right now. It's a pretty precious opportunity for us, and it's something that, that customer base really covets the opportunity to use it whether it's in a P2P application or the ability to shop at a merchant, either online or in store. So as we look at the opportunities to monetize that, one that stands out that is the bulk of the monetization opportunity thus far is the instant withdrawal product. And to be very clear, that has exceeded our expectations in terms of how that's gone. We also have a Venmo card, a Venmo debit card. That's going very well. And later this year, we'll launch the Venmo credit card. And so those give us opportunities in the off-line space to use a traditional card. But I think importantly, if you go into the Venmo app today, you'll see the QR code opportunities more prominently displayed. And that's an opportunity that we think is pretty significant. If you look at the regions of the world where mobile pay has been rapidly adopted, it's been more with QR codes. And so China is a great example. You can go to a street vendor in China, and there's a placard with a QR code out in front there. We want to give our customers the ability to use us in whatever form they want. And so whether that's using a QR code or tapping a phone with a Samsung or an Android device using NFC. Those are big opportunities for us as well. And then lastly, and I think probably most importantly, is the ability to use Venmo to pay online. This is a well-worn path. We did this with the PayPal. We understand what it entails. But we have had some bumps in the road on this, to be clear. Now when we launched this, the -- things have changed since then. So significantly, the use of cookies in the browser and the app have impacted our ability to launch this at the pace at which we wanted. We have workarounds for that, but it involves -- it's slowed us down from our original timing. But where we do have integrations with Venmo like you take an Uber, for example, we see our share of Checkout increase. And again, we hear loud and clear from our Venmo customers, they want the opportunity to use the money that they get in a P2P application to go shop online or in-store as the case may be. And so we're excited about this opportunity going forward.

Could you talk a bit about the TPV trends within the business. Q4 '19 came in at 22%, but you pointed to a reacceleration in 2020. What are the major drivers behind that?

Yes. So there are 3 or 4 that I'd call out. Some we've already sort of touched on, but we've got -- we're expanding with Uber, that's one. We've got a couple of significant partners that we're launching with, Live Nation and Paymentus or others. And I think Paymentus, just the addressable market around bill payment is a pretty big opportunity. It's not unreasonable to assume that Paymentus will one day be much larger than what eBay is. And so we're very excited about that. But also Pay with Venmo, that's something that we expect to have more acceleration in, in the back half of this year as we launch some of those experiences. And so all of those things, combined with some of the acquisitions that we've made, give us the opportunity to accelerate TPV from where we saw in the fourth quarter. But David, I want to point out because some look at the headline TPV numbers and some of the trends there and draw conclusions that can be incorrect for what's happening in our core business. And so one number that we look at internally is what's happening with our TPV once you exclude P2P and eBay. And that trend has been very consistent even in the fourth quarter, we saw it north of 20%. And that really demonstrates what's happening in our core business. And so there are comparison difficulties from one period to the next when you lap acquisitions or things like that. But our core business continues to perform very well and we continue to gain share.

Just shifting gears to eBay for a minute. End of the operating agreement in July 2020, do you see the end of the operating agreement as more of a risk? Or an opportunity when you balance the potential for a decline in eBay revenue with your ability to do business with previously restricted marketplaces?

Yes. So as a reminder, we guided this year that we expect there to be about 1 point of headwind to revenue growth related to eBay. And as we transition off of eBay midyear, the rate at which they sign up merchants and how their core business is performing, can't influence that number. But we feel like we've got a pretty good handle on what the impact of that is. And so if I had to err to 1 side, I would say it's probably more conservative than not. We feel pretty good about that. And of course, we'll have some impact in 2021 as we have the full year lapping of that event. But looking at other opportunities, certainly, we don't have to wait until we reach that point where we transition or eBay transitions away from us to announce something. But those things take time, too. They don't just happen overnight. And so we are continually involved in discussions with large technology platforms and marketplaces and look forward to the opportunities that are presented once we move past eBay.

Should we think about those large margin -- marketplaces having a much increased willingness to do business with PayPal once the eBay OA ends? So just putting aside the contractual restriction you've had, does the new relationship with eBay, post the end of the OA, actually make some of these big marketplaces more willing to use PayPal?

Well, we've had contractual restrictions, as you noted, and that has been the major impediment. But I do think -- my perception is that as we continue to grow, as we continue to diversify, we continue to have complementary services that we provide to our merchants like risk-as-a-service or like payouts. Those are all things that any merchant, irrespective of the size, will want. And so I think we -- as we continue to expand our value proposition, that probably has a more prominent role in the desire of some of these merchants to work with us than simply moving past this time period with eBay. But I think it's very important too to note that we bring to these merchants a 2-sided network. We have over 280 million consumers that are using PayPal and using it at an increasing rate each period. And so that's something that, as you look at some of the competitors that are out there, we have -- it's a very big differentiator with us.

You referenced the Honey Science acquisition a little earlier. Does Honey Science help you kind of achieve the long-term objective of really helping both sides of the network communicate a little more? So for example, if we look at the 24 million merchants for whom you do acquiring and then the 281 million consumers in the wallet. Will you be able to at one point offer, like seamlessly offer like products and services from the merchant side to the consumer side? Or is there more you need to do from a product and technology standpoint to really seamlessly link?

So what you're describing is one of the more appealing aspects of this acquisition for us. Honey has a relationship with both merchants and consumers. And when we think about the overlay of that on our platform, it's a tremendous opportunity. So there are obvious synergistic benefits to this acquisition. So just simply putting PayPal as a payment option in the Honey wallet is one of them. But expanding the Honey offering to our network of merchants is a tool for those merchants that allows them to go acquire a business or acquire customers, in some cases, that is pretty unique. And by being present at the intent stage of the shopping journey and seeing SKU level data, we can tailor offerings from merchants to consumers that are relevant to them. So to use as an example, David, like if you've been wanting a pair of Nike Vaporflys and you haven't been able to find your size or your color, you can keep that as a saved item. And when that goes on sale or comes in your size, that's then brought to you and targeted at the beginning of your shopping journey. And what we see at PayPal is to further up the shopping journey that we are present, the greater share of checkout that we have. And the opportunity to use that data and provide tailored offerings to consumers is, I think, pretty unique in terms of what others are doing in the ecosystem. But think of it from a merchant's perspective. You can elect to spend $10 million in a quarter to drive some incremental sales by having a banner ad on a website and hope that you can get click-through. But if we actually know that we have 100,000 consumers that want that size 11 in Nike Vaporflys, Nike could elect, or whatever the merchant is, whoever the merchant is, to actually lower the price or do some offering that could generate sales with a very high return on investment versus something that is much lower than like a banner ad or something. So this is where we think this offering is really appealing to merchants, but also consumers as well.

Does that capability give you the opportunity to do more differentiated pricing? So for example, if you can drive a lot more revenue to the merchant by having that SKU level data and having a sense of customer demand, does that give you more flexibility on pricing?

Yes is perhaps the short answer. But the way that we're thinking about that right now is the take rate model with merchants would not change, but there's -- as exists today, a commission-based structure related to what Honey does. What's appealing to us is that the incremental monetization opportunity can actually be used, it could fall to the bottom line or it could be used to drive increased engagement. So they have a loyalty program, Honey Rewards. And one of the aspirations that we have is to have our customers using us every single day in some form. And this is yet another example where we can drive some of that loyalty. If you're earning points, not only with your issuer if you're using a credit card, but also the opportunity to sort of double down and earn points with Honey or now PayPal, that give you a discount of future purchases. And so that's really how we're thinking about that today, but I'll say just generally speaking, with respect to pricing, that's a pretty complex and sophisticated part of our business. And if you think about who we are, we're in 200 markets around the world with over 100 different products. And so there's a lot of different ways to think about pricing. But inherent in all of that thought is this notion of driving value for our customers, whether it's the merchant or the consumer. And I think that's important to distinguish because depending upon the product, it may be priced for the merchant or for the consumer. And in certain instances, we can elect to drive more volume with lower pricing. In other instances, we might be driving more value and can price to that and take that to the bottom line.

How do you think about competition in the space and how it ties into your thoughts about pricing?

Yes. Well, there's -- unquestionably, this is an exciting business that draws a lot of competition, right? And it's something that we're very, very familiar with. And given the diversification of our portfolio of products, whether it's unbranded, P2P, remittances, the branded button, competition comes in many forms. But again, kind of going back to something I said earlier, we are very different than a lot of others in that we have a 2-sided network at scale globally. And so if you're thinking about what we bring from a merchant -- to a merchant, we're not just doing payment processing, reconciliation, things like that. We're actually bringing incremental sales to that merchant. One of the things that we really focus on is what we refer to as our conversion rate. So when a customer goes and checks out and puts something in their shopping basket, how often is that completing -- is that generating the sale? Our conversion rate is 89%. I don't have the latest data on the industry, but it's roughly 2x the industry average. And so when you're talking to a merchant and they're seeing more of their business go online, their focus is increasing sales, the discussion is a lot more about conversion rate and incremental sales versus basis points on payment processing. So that's something that's very different that we bring. On the consumer side, we've got a network of 24 million merchants around the world. We want to be ubiquitous. We want to allow our customers to shop anywhere they want, and that includes both online and off-line. And so that's a big opportunity for us. And on the off-line point or in-store, this is something that we're focusing a lot more on this year. I've talked about the focus on QR code. But this is still roughly what, 85%, 90% of worldwide commerce is done off-line. So we want to be present there.

So just segueing into off-line a little bit in iZettle. Where do you stand with integrating iZettle more into kind of core PayPal? And how are you thinking about bringing iZettle back to the U.S.? Or is it mostly still focused on international?

Yes. The focus for iZettle thus far has been in the markets where there's been the most need. And specifically, where card acceptance is not as common as where it is in the U.S., for example. And so we're in a lot of these -- you might call them secondary type markets in some cases. But it's where the value proposition really shines for that small and medium-sized merchant. With the integration, we've integrated with PayPal in 4 markets thus far and expect to round out the bulk of those in the near term. But ultimately, we will bring it to the U.S. It's a complementary part of our off-line strategy to allow merchants to be able to accept cards in-store.

Great. Just shifting back to KPIs for a minute. We touched upon your thoughts around kind of TPV growth improving in 2020. Can you talk a little bit about KPIs? What should we expect from KPIs in 2020 in terms of net new account growth, engagement? You had a nice jump in engagement to 10% transaction per account in the fourth quarter.

Yes. So the 2 key metrics that we really focus on are those: Net new actives and the level of engagement of those customers. To your point, we were over 40 transactions per active in the last quarter. And just by comparison, when we separated from eBay, that was in the mid-teens. And so we continue to see higher levels of engagement among a growing consumer base. With net new actives, we added over $37 million last year. We've guided to $35 million this year. Again, $305 million on our platform. But our focus or our strategy, I should say, is slightly different, depending upon the region of world that we're talking about. And so among what we refer to as our core markets, which are the U.S., Canada, Germany, U.K., Australia, markets like that, we have a much higher rate of penetration among digital users. And so by extension, the opportunity to continue to grow net new actives is less in those markets than in some of these faster-growing markets like Southeast Asia, for example, or China. And so the customer acquisition should come more from the latter. Some of those markets like China. With engagement, we actually think that the opportunity is more in our core markets, getting people -- like expanding the Honey offering, right, or getting people to use us in an off-line setting. And so that's where the focus on engagement will be more, is in the -- in that core markets.

Can you talk about your strategy in Brazil, especially given your recent acquisition in MercadoLibre? How are you working with the Brazilian acquirer to grow in Brazil?

Sure. So we made a small investment or, I guess, some may say a large investment, but about 3/4 -- or about $750 million of -- into MercadoLibre. And if you look at our footprint around the globe, and where we're strong and where we are less strong, Latin America stands out as an opportunity for us. And so MercadoLibre and MercadoPago, we think are an opportunity to really accelerate our presence down there. And so the commercial partnership that we've launched with MercadoPago -- or MercadoLibre, I should say, gives their customers the opportunity to shop at our network of merchants around the world. It also allows PayPal to be in the MercadoLibre marketplace and allow their customers to shop with PayPal in Mexico and Brazil. And their customer base is a couple of hundred million. I don't know the latest but, call it, 200 million. That's a significant opportunity for us to also grow our customer base as well. And again, given the integration that we have with a set of merchants around the world, this is a big value proposition for their customer base as well.

Great. Let me just pause there and see if there are any questions. Shifting to capital allocation. You laid out a framework at your May 2018 Analyst Day. We've got an Analyst Day coming up around the corner. Can you just touch on capital allocation priorities and where you -- whether you expect them to change, let's say, in the next couple of months?

Sure. Want the precursor? We feel pretty good about our capital allocation, the way that we've let it out. It's a very balanced approach that allows us to invest organically in the business, return cash to shareholders and also go acquire companies. I don't expect that to change, but we'll certainly update that if needed at our Investor Day in the coming months. I think what's important about our business, and I think, well known, is not only are we growing north of 20%, but we're generating cash flow margins north of 20% as well. And so that gives us the ability to reinvest in growth, and that investment can come organically or inorganically. And that is, when we look at how we think about the opportunities and -- just take inorganic opportunities for example, growth is a primary focus. We want to continue to take the profits that we make right now and be able to find vehicles to grow 2, 3, 4, 5, 10 years from now. And so Venmo is a great example, right? And that's an organic one. But Venmo, if we were solely focused on profitability, you actually might starve yourself of some of the growth opportunities there. That's not what we're focused on right now. And fortunately for us, we've got the P&L architecture to be able to not only grow margins but make those investments in the business. And so you take our cash-generating opportunity and then the fact that we've got a very strong balance sheet. We'll continue to allocate capital in the same manner that we have.

Great. Perhaps just to close, coming full circle to where we started on your commentary on the first quarter. To the extent we remain in a more uncertain environment with coronavirus, how should we think about the durability of PayPal's business model, your ability to sort of power through what could be a tougher environment this year?

Yes. Well, so e-commerce trends are, I don't think necessarily are going to be substantively changed based upon an exogenous event like coronavirus. In fact, some hypothesize that if people are staying at home, you might even see e-commerce trends increase. And so the demand side has still been there. It's the supply side, it's what the sellers and the ability to fulfill those orders that have had more of an impact on our numbers. But we've got a durable business. We've got a multifaceted portfolio of products. And we're in all the regions, major regions of the world. And so I think it's certainly reasonable to assume that if there is a prolonged and material impact from coronavirus, there's going to be some impact on growth. But we've got a very profitable business model that is showing strong incremental margins. And I don't think that, that's in question based upon what is hopefully maybe a more transitory event.

Understood. Well, John, thanks so much for being with us here today. We greatly appreciate it. Thanks so much to Gabrielle and Amanda as well.

Thank you, David. Appreciate the opportunity.