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

Good afternoon, everybody. I'm Jason Kupferberg, the payments processors and IT services analyst at Bank of America. Thank you for joining us for our Global Technology Conference virtually. And we're very excited to have the CFO of PayPal, John Rainey, with us. John, we appreciate you joining, and I hope you're staying well.

Thanks, Jason. I'm happy to do it and look forward to the conversation.

Well, terrific. Let's jump right in. I wanted to get just some feedback from you on what kind of spending themes that you're seeing emerge as some countries, states have obviously been moving along with the reopening process. Has there been any significant reversal in the e-commerce behavior so far as people are actually going out and about more because it seems like that's kind of one of the biggest unknowns or the main point in your business?

Sure, Jason. So I think that is the, perhaps, multimillion-dollar question for all of us is how much of what we're seeing are sustainable trends. Clearly, we benefited from the growth in e-commerce that we began to see towards the tail end of March and very clearly in our results in April and as we move through the second quarter. And we have been closely watching this by both vertical as well as region of the world to see or assess the sustainability of these trends. And a couple of the markets that we had a keen eye on are some of the markets that relaxed their shelter-in-place measures earlier than others, so examples would be Austria or Germany. And at the sort of -- if we look at like April results, the growth rates in those countries were 2 to 3x what they were going into the period right before coronavirus. And we're still seeing, even in these countries and as we look at states across the country, we're still seeing elevated levels, much more elevated levels of e-commerce activity. And so it's -- whether it remains at this level, I think that sort of remains to be seen. But I think, certainly, we recognize that some of these shifts are likely to be permanent. As people are experiencing things like purchasing groceries online for the first time, and they realize that that's not a bad experience at all. Or they're venturing into things like buy online, pick up in store, and those are things that are just simply more convenient for customers. And so we do expect to see higher levels of growth than perhaps what we saw going into this. And I think, in some ways, this may have accelerated some of the trends that we were seeing in e-commerce by, quite candidly, maybe a number of years.

Yes. Well, that's a good segue to my next question, which if we think about -- speaking of number of years, your medium-term guidance, which you framed as a 3- to 5-year type of time frame, has called for mid-20% overall TPV growth. And certainly, on the earnings call, it sounded like COVID effectively can be driving some upside to that target because of this structural acceleration that you're talking about. So should we think about there being a modest amount of upside or potentially something more significant relative to what those medium-term targets have historically looked like?

Sure. Well, I do recall you asking the question on the call, and I believe I was pretty emphatic in my answer in terms of we definitely think that there are some structural changes. I believe that was the nature of your question on the call. And so maybe just a little bit of context about sort of what we're seeing here. Clearly, there's some benefits to our margin profile right now related to just the growth in what we refer to as branded transactions. And by the same -- and that's both on the revenue side as well as the transaction expense side. And again, I go back to my answer on the first question, like I think that we are seeing some shifts in e-commerce that I think are here to stay. But at the same time, like we've got great opportunities with just the scale of our platform to continue to grow at a very low marginal cost. And we've demonstrated that in our performance historically. So I think it's probably a little bit early to make any declaration around the change to our medium-term outlook, but there's some very, very encouraging trends that we're seeing in our business. And when we get a sense of the sustainability of this, when we get out of these compulsory shelter-in-place measures that have taken place and get back to some degree of normalcy and see how those trends are sticking, and the extent that they do, then we can certainly update our guidance at that point in time. But there's very clearly some encouraging trends in the business.

Yes. No doubt. No doubt. And certainly, the whole e-commerce category has obviously seen a big boost from COVID. I'm wondering if there are any data points you might point to suggesting whether or not PayPal's market share has increased at a faster rate than what was already happening pre-COVID.

We do see that in our numbers that we look at, but I think it's important to understand that part of the PayPal value proposition, if you will, is we've been a trusted source and solution for digital payments. And that trust and safety and security really come through during this time. And maybe one of the best metrics to look at is just our customer acquisition. So we talked about this on our earnings call, but an average day in 2019 and even in 2020 prior to coronavirus really spreading outside of the China region, we would see about 100,000 net new customers come to our platform. And we've been seeing 2 to 3x that since then. And we talked about almost 7.5 million net new actives in April alone. Honey, the company that we just recently acquired, had almost as many net new actives in April as it did in all of Q1. And so I think if you look at -- like just take our TPV composition for a second. We were -- we had growth of 22% in that period, and that's when the travel and event vertical was declining 80% to 90%, and that's almost 10% of our volume. So it shows the strength in our business. And we highlighted that May 1 was the most transactions that we've ever had on our platform in our history in any one day. And so there's -- I think there's a lot of really compelling data points. But one of the things we're looking at very closely is that continuing trend of higher -- much more higher-than-normal net new actives in our business and the engagement of those net new actives as well.

Yes, do you want to comment a little bit just on the engagement there? I think you had given a couple of metrics on the call. And just remind us kind of how you measure those engagement levels when someone joins the platform.

Sure. So one of the things that we look at is daily active users, and we noted that, that was up appreciably in this period versus normal levels. But one kind of specific measure we look at is when a cohort or a new customer comes to us and they have 3 transactions in a 10-day period, it's one of the indicators that we have. And we look at that, the growth in that versus prior cohorts. And that 10-day activation rate was up 30% and has continued to be up in that range. And so that's encouraging for us because we're seeing not only people that perhaps would historically maybe come to PayPal and be a one-and-done type customer, maybe use us on a website where PayPal was the only option, but they're understanding the value proposition there and are using us and not only at multiple merchants but in many different applications that include things like P2P to pay friends or loved ones. And so that benefits us from a sort of a short-term perspective just on the P&L. But to the extent that these customers stay engaged, that's less churn that we have in the future that keeps that customer there, and there's more durability to the earnings stream associated with them. So very, very encouraged about the level of engagement or transactions per active that we're seeing in addition to the overall elevated level of net new actives.

Anything notable just in terms of the average transaction size you're seeing from these new cohorts, just in addition to their underlying engagement level?

So if you look at it in total for the -- for all of PayPal, there's not an appreciable change, although there are pockets where we do see some change. And so like an example would be with Venmo. We talked about Venmo. Obviously, its use case is centered around social interactions. People will split the bill for a meal at a restaurant or they will pay one another for tickets or things like that. And certainly, as we got into March with things like March Madness being canceled, we saw a decline in the overall level of Venmo volume. But volume is a function of both average transaction size as well as number of transactions. And as we got towards April, what we saw was overall volume came back up because the average transaction size was increasing. And that's, in part, Jason, because we were seeing what I've referred to as this silver tech demographic. The fastest-growing demographic in terms of growth of our net new actives were those over 50. And that demographic tends to be a wealthier demographic, and so we're seeing higher transaction sizes as it relates to them. But again, probably not enough to change the overall number for PayPal, but that is one pocket where we are seeing the use case change a little bit.

Interesting. Just one more on the net new actives. I know you've talked a bit in the past about the mix by product, brand, demographic, you just called out. But when you think about the 7.4 million you put up in April, and obviously, you're targeting the 15 million to 20 million for the second quarter, geographic mix, are there any interesting call-outs there?

Well, it's really pretty broad-based from a country perspective. We've got, at least certainly when you look at where our footprint is in our core markets, but like if you just take Italy, for example, which was one of the countries that went into lockdown a lot earlier than the rest of the world, we saw about a 75% increase in net new actives in March. And those came primarily through P2P flows. So -- but again, like it's really kind of across the world where we're seeing a lot of this growth by market. Certainly seeing new customer acquisition come through certain verticals, like as people were confined to their households, we saw verticals like home and garden, office supplies, grocery, even media increase. And that's a great customer acquisition channel for us with many of those merchants, and then they go on to transact at other merchants as well. But it's -- there's not necessarily one thing that I would just call out. I would say it's very broad-based.

Okay. So maybe just switch gears a little bit. I mean one of our biggest takeaways from your latest earnings call was the accelerated investment pivot that you're making into the in-store market. We at least thought it was important enough to publish a report on that yesterday. And I was hoping you could maybe walk us through a little bit more detail on the go-to-market strategy there and how it may differ between the small merchants and the larger merchants.

Sure, sure. So there's been a lot of questions for many years about an off-line strategy or I guess, just more generally, the use of contactless payments in a physical store. And there are markets in the world where that has really just become ubiquitous. But certainly, in the U.S. and some of our other core markets, it's been much slower to take hold and maybe in part because it's, at least in the past, maybe been described as a solution in search of a problem because carrying a plastic debit or credit card to a store and swiping that has not really been that much of a friction point for consumers. And when we assess the situation that we're in today though, it's a very different situation with very real problems, where people have concerns about health. People don't want to go into a store and handle cash or don't want to go into a store and touch the keypad on a POS device. And so we think that this is perhaps a fundamental shift that allows us to accelerate the strategy and probably by a number of years. And so we pivoted some of our priorities internally for 2020 to capitalize on this, to basically provide our customers, both on the consumer side as well as merchants, the ability to handle a transaction without someone ever needing to touch anything other than their mobile device. And the receptivity from merchants has been great. And look, we probably all see that from our own personal experiences, where now you go into stores and you see separations between the consumer and the merchant and people not wanting to...

Yes. The plexiglass.

Yes, exactly, plexiglass. And so we've had conversations with several merchants around the ability to provide that offering. And look, so for us, we're going to start with QR codes. We think that that's something that is very easy to do. It's available in both the PayPal and the Venmo app today. And it's aligned to our strategies around increasing digital payments and I think fundamentally replacing cash. We have to remember that we talk about the competitive landscape that we're in, but the single greatest competitor is probably still cash, where something like 70% to 80% of all transactions still take place. And we've got a partnership approach on this. And when we look at our partners like Visa and Mastercard, Amex and Google, we're all focused on very similar strategies. And so we're not endeavoring to replace contactless cards or other methods, but rather provide alternatives for touch-free payments that are available to all consumers and merchants. And so with the QR code, which we've launched in several markets already, that's really focused towards this SMB segment. So think of it as like a farmer's market or a yoga instructor or someone that has some small business, where now with their simple mobile device, they can have someone scan a QR code and be paid that way. We would like to see that expand as we go forward to be in some of the large enterprises. But this is a kind of a measured pace that we'll go through this. And look, Jason, I don't expect that we're going to look up in one quarter and see that everyone's doing it. So this is still going to take some time, but we believe that now is the time to capitalize on this. And very clearly, we see interest from consumers and merchants.

So on the larger merchant side, I guess, what's the characteristics of the larger merchants who have at least expressed interest? I know you had touched on 1 or 2 of them on your earnings call, which were overseas. And I'm just curious if you're having similar conversations with merchants like that, that might be in the U.S.

We are. And we're targeting the types of merchants that are everyday use-case-type items. So think of grocery stores, pharmacies, things like that, where we can habituate customers through that and then as that takes hold, then expand that further. And we're also, at least initially, having a geographic-specific target, and this is new territory for us. And there have been plenty of examples with PayPal and others where they've had kind of a checkered past in terms of the success of this. And so we're going into this very thoughtfully. But what it is, for us, I think, a pretty material investment opportunity and hopefully, something that we'll see take hold here in the future.

Yes. Yes. Well, yes, I remember going to Home Depot back in 2012 or so and trying it the old way with PayPal, and this seems a lot sleeker. So what can you tell us about what the unit economics might look like on these in-store transactions? I mean I'm kind of guessing that there would be a difference between the smaller sellers and the larger merchants.

Sure. Well, to get some traction here, we're having this introductory period with pretty much free economics to get it launched. But as we move forward, our take rate is planned to be 1.9% plus $0.10 or its equivalent in the market. And it's -- I think -- we think that's a competitive rate. And again, there's a huge value proposition to the safety and security and ease of using a PayPal or a Venmo. And with over 300 million consumers that we count as active customers, that's a pretty large market for merchants as well. And so we're, again, looking forward to this, and -- but it is early on.

How long do you think it might take until there is, I guess, what I'll call, maybe a meaningful amount of volume and/or revenue to start materializing? I mean is this measured more in years than in quarters or...

I think we should exercise some patience here. I think to get to a point where it's meaningful, it's certainly more than a year. But we're early on and we will certainly report out as we have results that we can share. But I don't anticipate that we're going to see dramatic changes in consumer behavior overnight. And again, it takes us some time to build the other side of that network. The fortunate thing about our e-commerce business is that we do have a 2-sided network at scale. What we're talking about now is basically a one-sided network when you consider that we don't have the merchant side. And on the one side that we have consumers, they're used to using us online but not in-store. And so there is this period where we have to educate all of our consumers as well. And so I think this will take some time, but we're very encouraged about the opportunity.

That's good color. Let me move over to margins for a minute. And the midpoint of your EPS outlook for the second quarter implies operating margins around 25.5%, call it. And we know you've been experiencing some real mix benefits in transaction expense, which you touched on briefly before, so maybe some of that ends up being transitory. But aside from that, would there be any other reason that your margins can't maintain that kind of level that we're expecting for the second quarter as we start to think about potential outcomes in the second half of the year?

Sure. So Jason, I think there's kind of 2 elements to this. The first is just the natural leverage we have in our business at our scale. And then the second is something that is maybe more transitory, maybe has some permanence though in terms of the increase in branded transactions. So with the first of those, we've been able to demonstrate continued margin expansion here since we've been a public company. Our guidance initially this year was that we said we expected essentially flat margins as there were some headwinds in some investment that we had. Last year, we expanded margins by 160 basis points. But going forward, like just the natural sort of leverage we have in the business, we would expect to see some increase of margins, and that still allows us to invest appropriately for future growth. But to the point of your question, certainly, we're seeing margin expansion that is greater than normal right now because of the increase in the branded transactions that we have. And to the extent that these trends persist, it's certainly going to be accretive to our margin profile. And we do think, as I noted earlier, that some of those trends will be there for a while just as we're seeing an acceleration in e-commerce growth prior to what we were seeing going into that. But we have -- there's tons of opportunity in our business as we think about just even the cost side. You mentioned transaction expense. Well, part of the growth in branded transactions is those tend to have a lower overall transaction expense that helps our margin. But even on the nonvolume-related sides, as we are seeing things -- just people aren't traveling this year. They're not recruiting as much. Those are real costs that we incur. Even customer support, by rapidly moving our teammates that support the operation to a work-from-home environment, there's a lot of efficiencies there, too. So one of the things we looked at is our number of contacts that we can complete in an hour. And that's at record levels for us right now. We changed the channel, that a lot of those contacts are starting to be more chat versus voice, and that's a more efficient channel as well. So I guess, I'm just citing these as examples, that there's a number of tailwinds that we have to increase our margin profile in our business.

On the customer support side, is some of that structural? In other words, post-COVID, you can leverage more work-from-home and continue to drive these metrics better and better while increasing the use of tools like chat.

Yes. It's a great question because in a customer support or maybe better said, in a call center-type environment, the challenge is always matching the resourcing to the call volume coming in and getting to what is schedule optimization. And many times, you have these peaks in a day of contact volume that may last for an hour or 2. And it's very difficult to schedule that perfectly efficiently because you don't want to bring someone in to work for 1 or 2 hours and then have to go home. And so you tend to see an avoidance of things like split shifts or very short-duration shifts. While in a work-from-home environment, that's not a problem. It's okay to schedule someone between 8 and 9 in the morning when they don't have to commute to and from work. And so one of the learnings that we're seeing or taking from this right now is that whenever we get to the other side of COVID-19, we will still keep a very large work-from-home environment for our customer service employees because for many of them, it's better for them, and it also allows us to schedule more efficiently. So that was something that we were attempting to do last fall, and we were piloting a program. And I would have said that this was several years down the road before we had gotten to where we really needed, to a point that we could do that sustainably. And in a 3-week period of time, we were able to do that with almost the entirety of that workforce. And so we will definitely keep that, at least to some extent, for some part of the workforce going forward.

Interesting. Interesting. So if I think back to the beginning of the year, let's say, back on your Q4 call before the world changed, there were a whole bunch of partnership and product initiatives on the road map for this year, Paymentus, Uber, MercadoLibre, the Venmo credit card, Facebook, China UnionPay, a long list. So can you give us just your perspective? Do any of those stand out as having either speeded up or slowed down materially because of COVID?

I would say there's -- that we don't expect any significant delays in any of our partnerships as we see things right now. That said, everybody is sort of adjusting to this new situation, this new normal for a while. And so that may have some impact, but there's nothing to call out as it would at least impact the way that we think about our own financials or the benefit that we would receive from that. Maybe the one that I think is perhaps more prominent is just around bill payments and specifically Paymentus. We continue to be on track with our expectations around that integration and think that bill payment more broadly is a real opportunity for us. A lot of the focus that we have right now are on things that are -- maybe you could refer to it as stickier in payments, so things like subscription services, things like bill payments, but those things that you tend to kind of put on autopilot and almost are done sort of without thought each month. And to the extent that we can do that, there's a lot of benefits that come from that. As just -- I mentioned earlier, decreased churn. If someone has us as a -- they're using PayPal for a bill payment that happens each month, then that's a transaction that continues to happen and we don't have that customer churn. And then they're likely to use us in other ways, too. So nothing overall to say that there's any material change in the partnerships, the product initiatives that we had in 2020, but very encouraged about some like bill payment.

Does COVID make it more or less likely that we'll see increased M&A activity from PayPal this year? I mean clearly, you're looking at this market from a tremendous position of strength.

Well, we do think that we are looking at this from a position of strength, and I think there's a couple of elements to that. One is we've got an exceptionally strong balance sheet, and we continue to generate significant free cash flow. Going into this, our medium-term guidance was that we basically were expecting about $0.20 of free cash flow for every dollar that we brought in. And in the first quarter, we had a record amount of free cash flow of $1.3 billion. And so as we see these encouraging trends in our business, they also benefit in terms of our cash generation. And so as we assess the landscape and think about capital allocation broadly, there's no change to our capital allocation plans. We will expect to continue to invest in the business, continue to buy back stock and continue to invest in other companies. And those opportunities, we have to continue to assess. I mean valuations have been affected for some companies. But you also want to make sure that you're acquiring companies that really complement your platform and what your overall strategic goals are. And so we'll continue to assess the landscape. I suspect there will be plenty more opportunities out there for us, and we'll look at these like we always do, in terms of what is going to get -- provides the highest return for that dollar of capital allocation.

Makes sense. So one topic that, I guess, for a change, didn't really come up on your earnings call was Venmo modification. So I wanted to see what updates you could share there and whether or not COVID has had any kind of positive or negative impacts on any of the 3 legs of that stool, if you will.

Sure. So Venmo, in the first quarter, at least from a volume perspective, grew almost 50%. I think 48% was the number. And it was certainly doing better than that prior to March. As Venmo, as I noted earlier, as it is used in social context with the inability for many people to do that, we saw some of the volumes decline. That has come back to more normal levels since then. And I would say that, generally, the monetization of Venmo has kind of tracked what we've seen with volume. And so I think we're very much on track with many of our initiatives. One of the things that I know you're aware of, Jason, but we're launching the Venmo credit card in the back half of this year. And so we continue to work closely with Synchrony on that, and I think the ultimate launch date is somewhat dependent upon how things develop, but we certainly expect it to be in the second half of 2020. And so when we think about the 3 legs of that stool, they're all very much in place. But one of the things that we've really tried to emphasize this year is allowing Venmo users who want to have their payment protected or maybe are in a business and selling a good or service, to have that capability as well like PayPal customers did. And so that's an additional sort of monetization avenue for us that we're pretty excited about and we'll continue to focus on going forward.

Terrific. Well, this has been great. Unfortunately, we're out of time. Really appreciate all the thoughts and the insights, John, and continue to stay safe.

All right. You do the same, Jason, and I appreciate the opportunity. Okay. Bye.

All right. Take care. Thank you. Bye-bye.