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

Hello. I'm Bryan Keane, Senior Payments Processors and IT Services Analyst at Deutsche Bank. And we're super excited here to have John Rainey, CFO, EVP of Global Customer Operations at PayPal, to do a fireside chat today. It's going to be virtually, obviously, now given the time. So format of the call will be chat with John. I'll ask the questions. [Operator Instructions] So with that, John, I know you're really busy. We only have about 350 questions. We've pared it down to 250. So I know we only have 35 minutes. But thanks for joining us. And hopefully, you're staying safe there in San Jose.

Yes. Thanks for having me, Bryan. And I hope you're doing the same as well as all of our audience.

So John, I wanted to jump in. When I looked at other e-comm players, they saw the slowdown in June and July. But for PayPal, the growth kind of accelerated in June, and it was equally strong in July, and that kind of surprised us and some analysts. So what do you think the difference is in the models that's caused the acceleration versus the deceleration that some others saw?

Well, Bryan, I think we -- we're probably at a tipping point for e-commerce and for specifically our business. Some of what we've seen, we think, are fundamental shifts in consumer behavior. People just don't want to handle money anymore. And what has probably gone from initially what would be described as pantry packing and staining less checks, we think, has become a much more profound and durable shifts in consumer behavior. And one of the reasons we think that is because in areas where some of the shelter-in-place or social-distancing measures have been relaxed, we're still seeing much more elevated levels of e-commerce activity. And for us, there's a couple of data points that, I think, maybe justify sort of different trends versus everyone else. One is, we've seen that in terms of the new users on our platform, the single-largest demographic in terms of growth has been what we're referring to as silver tech. They're now my message, people age 50 and over that, in many cases, are coming to e-commerce or coming to PayPal for the first time and used cases like buying groceries online. And just last week, you're hearing the CEO of Kroger talk about how they believe that the fundamental shift in consumer behavior, where people will continue to do that. And so I think part of this is just our relevance has never been greater than what it has been now. And I think second to that is the scale and perhaps corresponding network effects of our platform. We are one of the largest players in digital payments, particularly when you look at our penetration among the merchant population. Today, we have 26 million merchants that provide PayPal as a form payment on our platform. And so this just gives us a level of ubiquity that provides customers an option to pay with PayPal almost wherever they check out online. And so I suspect some of those items perhaps maybe influence some of the trends relative to others in our industry.

We saw recent data from Visa and Mastercard from August, and it still showed really solid debit and card-not-present trends. And I guess, I was a little surprised because I thought it would maybe take a little bit of dip as there has been less stimulus. So I'm just curious, have you been surprised by the strength of the consumer?

It's -- well, first, I should start by saying, when we were in the March -- late March, early April time frame, it was an unprecedented time. And it was difficult to really predict what would happen. And certainly, relative to that period of time, I've been extremely pleased with the strength of the consumer. I think part of it certainly is stimulus checks that have gone to people's bank accounts. And that's influenced perhaps some of the shift to owned money versus owed money. And -- but it's been sustained at higher levels. And I don't know if that's maybe in part sort of behavioral shifts of people sort of in the period of time that we are maybe with macroeconomic uncertainty, maybe using their money differently, but it stayed at an elevated level. So we -- it's been a nice thing to see because we certainly benefit from that on our transaction expense.

You mentioned some of the customers and net new adds, I think it was 10 million per quarter, and I think it was as high as 20 million in the second quarter, including 3x the typical merchant adds. How sustainable is the accelerated adoption of that consumer and merchant side from what we're seeing?

Well, we've been extremely pleased. In fact, I would say, probably the single item that I'm most pleased about has been the growth in the net new actives. And we guided on our call that we expect to have 70 million net new actives this year. And just, again, it underscores the importance and relevance of our platform. And I think we all agree that when people are lacking mobility and the ability to go purchase something in a physical setting, we're going to see heightened levels of e-commerce trends. And certainly, I think what follows is new customers. And so I think it's maybe a stretch to say that this is the new norm, 70 million customers per year. I think we'd all agree that that's probably not a reasonable way to think about it. But predicting how sustainable it is, it's somewhat false precision. We're still only 6 or 7 months into this. But here's what we do know. We know that PayPal is more relevant than it's ever been before. We're providing more used cases than we have before. They're better experiences. And we're extending our product offering to things like Pay in 4. And one of the things that we're keenly focused on, as you think about sort of the composition of that number of net new actives, it includes activations, reactivations, and then it's reduced by churn. And given our size and scale, we churn a material number of customers each year. That's been where a lot of our focus has been in these early months, is driving consumer experiences to influence behavior that will reduce churn. And I'd say, we've been quite successful with some of the early trends that we're seeing. And we talked about that on our last couple of calls, where we talked about the 10-day adoption rates being appreciably higher than what they've been for previous cohorts. And these are defined as a new customer coming to PayPal and using us 4x within a 10-day period. We want to continue those kind of trends. And we believe with the movement to off-line, with the expansion of things like Pay in 4, many of the other services that we'll be providing in the digital wallet, we've got a really good opportunity to influence that outcome.

One of the big drivers has been the growth in PayPal Checkout experiences, which remain elevated. I think it's up over 40% year-over-year in 2Q '20. What's the historical growth rate of that? And what's driving such an increase in the PayPal-branded?

Well, this is certainly higher than what the historical growth rate has been. Also, the PayPal-branded experiences have grown sort of commensurate with the rest of our business. Some of the faster-growing parts of our business, like Venmo P2P and maybe Braintree, things like that, have outpaced the PayPal-branded experiences, but we've continued to see through the entire 5 years as an independent company, but good growth there. But to be very clear, like this is an appreciable increase in what we've seen historically. And again, I think it just shows our relevance, shows the convenience and ease of use of our experience and demonstrates the ubiquity that we have with the side of the network with the merchants just being so expansive.

When you listen to some of eBay's comments, it sounds like they want to move away from PayPal Checkout, and obviously, the contracts now changed here. So can you talk a little bit about that transition from eBay on the impact it might have on volume, take rate and margins?

Sure, sure. Well, first, I'd start with what's -- this transition that's happening with eBay right now is not a surprise to any of us. This is something that we've been planning for, for 5 years. And during that period of time, we've continued to expand other parts of our business at a much faster rate than what we've done with eBay. And just by comparison, Bryan, in 2014, when we were still a part of eBay, PayPal is doing roughly 1 billion transactions a year. Last year, we did over 12 billion transactions. And so we've continued to grow these -- the part of our business that is not eBay at a much faster rate. And just to give you an example, on a compounded annual growth rate, the TPV growth over the last 3 or 4 years has been about flat for eBay. I think it's up 1%. While our merchant services growth has -- on a compounded basis, has grown roughly 30% over that same basis. I think the exact number is 29%. And so we've continued to prepare for this period that we're in right now. But that said, we think that the effect of this transition from an economic perspective is quite manageable. eBay has to have their merchants opt in to this new managed payments experience. And that doesn't happen as a nice etch. I think their own comments have suggested that this will -- this transition will take place all the way into 2022. And even then, we remain a branded payment option in that experience. And I think the best examples are ones in the 2 entities where they transition first, which were Germany and the U.S., where we are at roughly 50% of the payment volume or appreciably more in one of the markets in the case of Germany. So we would expect to continue to retain that branded part of the business. And so as you look forward, pick your 1, 2, 3, 4, 5 years, I don't expect that there's going to be any sort of appreciable difference in our economic profile versus what it is today. Certainly, eBay has a higher take rate than, generally speaking, the rest of our business. But one of the benefits of the meter transition of this is it allows us to scale to other growth companies and other marketplaces. And I think we can look to the most recent couple of quarters and see the benefits of scale on our platform, where we've had some record margins for our business by being able to grow and do it at a very low marginal cost. And so take rate is not something that we think is a way to manage our business or even, quite frankly, a health indicator of our business. We certainly look at the absolute margin dollars and the growth of those dollars as the best indicator for our success.

One of the drags on the business has been the ticketing events. It was down 60%, I think, in second quarter, which is probably a slight improvement from the trough there. Can you just talk about what the outlook is on that? Will that just kind of gradually improve, probably still stay negative until we get a vaccine?

Yes. This has been very clearly, I think, a part of our business that has suffered the most. And it's -- as we said on the last call, it's roughly 10% of our overall volume. And we saw sort of the peak level of decline right in the early periods of April in terms when everyone was locked down, shelter in place, everybody had stopped all travel. We've seen some resurgence since then, things like Airbnb, which we include in that vertical. People are doing more regional drive where they may drive 2 or 3 hours and stay some place. And certainly, Uber is, I think, rebounded from the early period as well. Where we continue to see some pressure is really in the live events and ticketing. And you can probably get a good indication of that just watching the U.S. Open this last weekend or any of the football games and see the sparsity in the sands. And I expect that that's going to take a while to come back. These are long lead time-type items, like if someone is going to host a concert and sell tickets to that, there's a certain amount of planning that goes into that. If someone is going to take a vacation overseas, that's not something that you basically plan in a couple of days and then fly out that weekend. It's -- there's a period of time where you have to plan for that. And so this would be the part of our business that I think will probably take the longest to recover. And it's anyone's guess as to when that would be. I think, certainly, it will be probably closely tied to a remedy for the pandemic that we're experiencing right now.

John, when you look at the split on international to U.S., I know international was stronger. In the past quarter, it grew 36% on 30% volume. So just curious on that delta there, the stronger revenue growth versus volume. And then on the U.S., it wasn't quite as strong. I assume some of that was a drag from OVAS. But is there anything else drag in the U.S. to grow the same way international has?

Sure. So you're right, with international, we've seen good growth in our cross-border corridors, which tends to carry a higher margin. And so we certainly have benefited from that. And in comparison to others that have talked about their cross-border business, remember, our cross-border business is entirely e-commerce. And so we're not dependent upon a business person traveling to Europe and then spending money while they're there. And so we've seen continued elevated levels of cross-border strength across virtually all of our corridors. In the U.S., you're right, the disconnect between TPV and revenue growth was almost entirely related to other value-added services, which is there's really 2 components that are worth calling out there. One is lower credit income as we had lower originations, customer relief actions. We even lapped the period last year where we received money for servicing the Synchrony portfolio. And that loan was over $50 million last year in the second quarter. So all of those things contributed to pressure on other value-added services revenue. The other item is lower interest income, as globally, interest rates have come down, and we carry an appreciable balance of merchant and consumer money on our balance sheet. And with lower interest rates, we benefit less from that. I think worth noting, though, Bryan, offsetting some of that was the inclusion of Honey in the quarter, which contributed over $60 million in revenue.

Got it. Wanted to turn to the margins. I know incremental margins were up 70%, and transaction margins spiked, which is leading to the higher investment. You guys talked about the $300 million in the second half '20. Are these additional investments onetime in nature? Or do you expect them to continue at this elevated level in fiscal year '21?

Well, the answer to that question, I think, is really, one needs to understand how we think about managing our business. And we believe that we can continue to invest for future growth while still expanding margins in our business. And we've demonstrated that, I think, quite well over the last several years. Certainly, we recognize that this is a seminal moment in our history and perhaps e-commerce overall, and we need to invest into this. Things like the expansion of QR code, Venmo acceleration, even expanding the digital wallet, things like buy now, pay later. All of those things, we're investing heavily in, in the back half of the year because this is, I think, an important moment in time where there are some fundamental shifts, and we want to take advantage of those consumer shifts despite doing that $300 million of investment, which I should say, will be a little more weighted to the fourth quarter versus the third quarter. Despite that, we still expect to expand margins by over 100 basis points this year if you look at sort of the guidance that we've provided. But I think the question of why now? Well, what we've long talked about the ability to use digital payments or contactless payments that more accurately in an off-line setting. And that's probably one of the single-greatest areas of investment for us in the back half of the year. And this has been -- at least in the U.S. and arguably, in maybe some of our core markets, this has been a technology that has really been a solution in search of a problem for many years. It just, quite frankly, has not been that difficult to carry around the debit or credit card and pay that way in store. And what we clearly see and hear feedback from our customers, both merchants and consumers alike, is that now, this is a technology that is solving a problem. And you can either observe your own behavior or see it in stores, where people just don't want to touch a point-of-sale device or a keypad on a point-of-sale device. So they don't want to handle cash. And we've benefited in other ways from this, just in like the growth of new users of Venmo and PayPal that are doing P2P. And we can provide an option for customers and merchants, where if you're a small or medium-sized merchant and you just want to print a QR code and have it on a placard at your checkout register or even if you're a farmers market, you can have it on a lanyard around your neck, you can scan device. You don't even have to open your phone. You simply click the picture button on your home screen and you scan that QR code, and it takes you directly to the PayPal or Venmo app where you check out seamlessly in the click of a button. If you're a large enterprise, we're integrating with existing point-of-sale devices to where you can simply scan your phone right there at the register. So for us, it doesn't require any type of significant software, no hardware investment. So this is really -- the investment around this is very much an engineering one as well as a go-to-market and marketing one. And we just think that this is a very important point in time. So the question of sustainability of that, that remains to be seen. I think it's reasonable to expect that we'll have elevated levels of investment for a period of time of maybe not at this 300 million run rate number. But again, we think that we can manage that while still growing margins and focusing on growth for the next several years.

On take rate, transaction take rate was up significantly, and it helped by branded. I think it was only a 2-basis-point decline. What does that look like going forward? I assume you still see strong branded growth, yet maybe ticketing and event comes back, which might have a lower take rate. How do you think about take rate -- transaction take rate going forward, John?