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

Thanks for joining us at the virtual edition of the Morgan Stanley TMT conference. We're very excited today to have with us John Rainey, CFO of PayPal. Before we get started with John, I do have an important disclosure to read here. For important disclosures, please see morganstanley.com/researchdisclosures. So as I said, I'm James Faucette. I'm the Head of U.S. Payments and Fintech Research at Morgan Stanley. Very pleased today to have John Rainey, CFO of PayPal, joining us. Clearly one of the highlights of the conference for us and just in the market in general. And today, John, we have roughly 30 minutes. I have enough prepared questions that we could do a 4-hour Joe Rogan-type podcast, but we'll keep it to 30. And for those of you that are joining us on the webcast, I mean if you do want to submit questions, please feel free to do so, and I'll try to incorporate those as we go along.

So John, let's start with like the most pressing current business question, and that's COVID recovery. Can you give us kind of an update or recap on the latest trends that PayPal has seen? You had a really strong 2020. How has spend on the platform trending in '21? And what kind of consumer usage are you assuming for this year?

Sure. Well, James, first, let me say, it's a pleasure to be able to join you today and looking forward to the series of questions. I guess I'll just start with the macro statement that we clearly see that consumers and frankly, businesses of all suffices, are adopting this digital-first mindset where it's really erasing this distinction between the physical world and online. And it's not just us PayPal saying that, but you see this with one merchant after another adopting these digital-first strategies, whether it's reconfiguring storefronts or the way that they're serving our customers. And this plays into our strength. And as we said, we believe that the e-commerce trends have been pulled forward a number of years. How many years, I think, is probably not as meaningful at this point, but it's certainly a number of years. And so we expect these trends to continue. I think importantly, as you touched on in your question around the overall level of engagement, this is something that we expect to persist. And so the overall level of engagement that we had measured by transactions per active in the fourth quarter was just north of 40. And I remind you that we've added Honey year-over-year, and that lowers that number, that average a little bit. But adjusting for that, basically, the year-over-year increase in engagement is double digits. And it's that level of engagement that we expect to see continue going forward. If you just take the fourth quarter, another metric that we look at for engagement is daily active users. That was up almost 30%, 29% to be precise year-over-year. And as I talked about at Investor Day, I would characterize the last 5 years of growth for PayPal as really about increasing distribution. The next 5 years will be much more about increasing the experiences that we provide our customers that contribute to this overall level of engagement, things like crypto, buy now pay later, QR code and many other things.

So John, as you kind of touch on those incremental services, et cetera, at the Investor Day a couple of weeks ago, the team laid out PayPal's ambitions to grow into, a term that many use, which is financial super app. How would you characterize where you are on the path to becoming a platform for payments, financial services and commerce? It seems like you have a lot of these different solutions already and in some ways, maybe functioning a little bit in isolation. But how do we start to bring them together? Where do you think you are? And what do you feel like -- how much more do you feel like you need to add incrementally?

Yes. So let me start at a high level here, James. And that is, at the end of the day, we're dealing with people's money. And that requires a level of trust that is second to none. And simply, we are in the business of trust. The safety and security of our customers' money and data is a primary reports. And you see this through various sort of third-party surveys. Like as an example, there was a survey that came out that said, "Which technology platform or financial institution would you want to use if you were to buy or sell crypto?" And PayPal was #1. This was before we launched this. And I think that demonstrates the placements that we have in the ecosystem and the level of trust that is conveyed. And so another internal metric that we speak to is that 54% of PayPal customers say that they are more likely to buy something when PayPal is present on the website. And so I think one needs to start with this overall brand of trust to really sort of explore where we can go in the financial ecosystem. And as we've said, like we're going to be adding additional services to our app that really complement what we do around payments today. Those may be commerce-related. They may be things where we get into financial services, investments, things like that. And I think it's important to note too that we can do this while partnering with others in the ecosystem. I think the sort of -- the thing that stands out to me about fintech is there are so many people that participate in this space, and they have complementary assets. Now we want to take the best of what we provide and the best of what others provide and really go after this huge addressable market. And so as we think about being a destination app or a super app, I think that we have a right to play in that space as much as anyone. And to build out that experience, I think there's really -- it's twofold. One is we need to add additional services and experiences that customers want. We also need to improve the overall app experience to make it more intuitive. And we highlighted that's one of the things that we plan to add later this year. But to be very clear, that is not a one-and-done type approach. This is an iterative approach that will continue to evolve. And I think one could look at the PayPal app today. And say it's a little tired. It needs a refresh, and we recognize that. And so we're really excited about the app launch later this year that not only includes an intuitive app experience, but also adds additional functionality and capabilities.

So when you talk about having a right to be a player in that space, the thing that jumps out at me is like you've already got 400 million active users, right? And compared to just about any other aspiring player, your miles ahead. And not only that, but you -- at the Analyst Meeting, talked about getting that to 750 million on the platform by 2025. Where do you envision these users coming from both geographically as well as demographically? And how much of this is growth on the Venmo platform versus PayPal versus other services? And I guess one of the go-to questions is, how much of that ends up being double-counting versus how do you think about it?

Yes. Yes. Well, clearly, I think the plan that we laid out that doubles our customers over the next 5 years is something that we're very excited about. And it really comes through multiple forms. I'll start with one of the big efforts that we've made related to the increased engagement is to see a reduction in churn. And so by extension of that, I mean some of the new customers that we're growing are where our core markets are today, where we have those customers. And so that's something that I think is going to drive or contribute to a lot of that growth. Second is we have white space in certain markets around the world, like we're really in heavy like 7 or 8 markets around the world. And so there's some huge opportunities for us. And Asia is a great example. I'll just spend a moment on this, James, but like take Japan as an example. Japan is, I believe, the fourth largest e-commerce market in the world. And we believe that our capabilities, our technology, our scale really play well and fit well within that market. And so that's an example, Brazil, Mexico, others in Latin America, where we can really bring the best of PayPal to those markets and generate a lot of new users. And Asia, to me, is like it's a shining example because in many ways, they are far ahead of the rest of the world in digital payments. And you just take the Asia broadly, 40% of in-store payments are done with the digital wallet. In the U.S., that's less than 10%. And so not only is there a lot of addressable market or opportunity in Asia. There's even more in the U.S. in some of our core markets. So this is where we see a lot of that growth. Lastly, demographically, the area that stands out to me where we have more opportunity is a group that we call value seekers, which -- like if you take the Venmo demographic today, those tend to be slightly more affluent than some of their peers. They tend to be more millennial-based. And what the services that we're providing these -- especially as we get into other financial services, they really address the need of the value seeker demographic. And so this is an underpenetrated segment that will also contribute to this growth going forward.

So John, when you look at the potential there, what kind of other financial services do you and the team envision at PayPal? And I guess along those lines, we've seen some of the other fintechs pursue different types of banking charters, et cetera. Is that something that will make sense for PayPal? Do you have to get to a point that you're offering, like FDIC-insured savings accounts or other accounts? Like how are you thinking about that evolution of both services and other requirements that may go along with that?

Sure. Well, this is a journey. I mean it's an evolution. And as we see things today, that could change in the future. Our current expectations are that to provide the services that we want for our merchants and consumers around the world, we don't need to be a bank, at least as it pertains to the United States. We do have a banking license in Europe, and that allows us to provide the services that we want in that region. But this is where I think we can partner with many others, whether we're talking about crypto or high-yield savings account or even financial services, and do it in a way that provides best-in-class experiences that are frictionless to our customers and gives them all the protections that they need to take advantage of those various services. But broadly, I would say that as we think about the future, I put it in 3 categories. One is payments, which is certainly our core. The second would be commerce. And this is where the addition of Honey comes into play. And thirdly is financial services. And again, as I noted earlier in my previous response, I think that we have a right to play here because of the trust of our brand, because of the digital-first experiences that so many are looking for today. And it really plays into what people are looking forward, and we've got a suite of services that is top-notch and will be improving.

So let's turn to talking about services that you have today. And I think what caught a lot of people's attention, in the last little while in the earnings release as well as the Analyst Day was "buy now, pay later" stats that you provided, and those seem to be really impressive. And I guess, maybe can you provide just some clarity for investors? The question we get a lot is, do you need a merchant to enable "buy now, pay later" for you to make this a payment option? And what is the path to enabling "buy now, pay later" options for the entirety of your customer base?

Sure. Well, let me start with the fact that what we've seen with "buy now, pay later" is a great demonstration of the benefit of our scale. When we launch a product, that becomes available to almost 400 million customers around the world. There are very few companies, very few companies that can top that. And so this is like when you go to a merchant and you say, "Look, if you integrate Buy Now, Pay Later, we're going to bring 377 million-plus customers that can avail themselves of that option." That's a lot more attractive than maybe a smaller start-up that doesn't have the distribution that we do. And so this is, I think, a great example of one of our competitive advantages in this business. And you know as well as anyone, James, that the benefit of having 2 sides of the network at scale. But specific to your question, Buy Now, Pay Later, we've only launched it in 3 or 4 markets thus far. And we anticipate to continue to expand that to the other markets that we serve. And there are nuances to each of those markets from a regulatory perspective, which really plays into the cadence of how we launch that. But generally speaking, the way that's presented today is if a customer opens their app, they can -- they have that option there. There's nothing that they had to do. There's nothing that the merchant had to do. They can pay that way. I think what's probably really driving your question is, "Well, what does it take to get upstream present so that when a customer is at that merchant's website, before they even go to checkout, they've got that Buy Now, Pay Later option?" And clearly, this is important to us because we see a 10% -- a 10% increase in share of checkout when that's provided. That does require some integration effort on the part of the merchant. It's not as seamless as just providing in the digital wallet that we do. It's very low integration effort. But again, if you think about the trade-off of that from a merchant's perspective, you integrate that into your app, you see a higher sales conversion, you bear no risk with us. You've got 377 million customers that want to use it. And importantly, it's free.

And on that point, so look, I think that the pricing and your ability to kind of take on that credit risk, if you will, given the short duration and ticket sizes makes a lot of sense today. Like that to me is clear and can provide value for lots of different types of customers. But how do you see that evolving? You do have an existing PayPal Credit product, and that's offered in conjunction with partner, Synchrony, at least in the U.S. And then in other places, that can be structured a little bit differently. But does Buy Now, Pay Later migrate up into bigger ticket, longer-duration type loans or transactions? And what are the implications for pricing and who takes on that risk? And how you work with PayPal Credit and Synchrony? Can you just kind of walk through how you're feeling about those different aspects today?

Sure. Well, let me start with pricing. We've had no discussions around ever-increasing pricing. That could change in the future, but that's not something I anticipate that what we want to do is monetize this through an increased level of engagement. And an example that I'll provide you. We talked about this at Investor Day, but 40% of U.S. customers that have used Buy Now, Pay Later have come back for 2 subsequent transactions. And when you can provide a seamless, frictionless experience, that's the kind of behavior that it will drive. And so we want to monetize this through increased share of checkout, which is good for everyone around. Consumer is getting what they want, merchants getting what they want. And we monetize that through the traditional take-rate model. So we don't have plans to raise this in the future. That's not the way that we expect to monetize this. In terms of the evolution of where this could go. Certainly, these are sort of baby steps for us. We're making our first foray into this, and we're learning from this. But I think importantly, the risk around this is relatively minimal for us because with most of these customers, we already have a risk profile on them. We know whether it's a good customer or a bad customer. And so the extension of that credit also being short duration, it bears very little risk for us. And so the trade-off there is something that we happily accept. I think, James, there's certain proclivities among the younger demographics out there where they don't have the same relationships with traditional financial institutions, like revolving credit or even many don't have a checking account in a bank. And they prefer the sort of onetime installment pay-type option. And so we will provide that to them, if that's the only credit that they ever want. But it's also reasonable to assume that as people move up into their financial lives and maybe you get married. And now it's time to buy a washer and dryer and you want something that's more than installment, you want revolving credit, that's something that complements this product so easily, and we can provide that to our customers. And so having this, again, the suite of diversified products is good for our customers. It's also very good for us because we're not solely dependent upon one aspect.

Got it. Got it. Like I said, there's lots of time that we could spend on this, but given everything we'd like to get to, let's move on to Venmo. You laid out $900 million of revenue target for '21 and -- which is a combination of Pay with Venmo, instant transfer, debit card and the credit card. Can you give us a sense, at least roughly of the relative size of these different products and how they're contributing to $900 million for '21? But really more importantly, how are you envisioning this Venmo developing? Do you think that Pay with Venmo still becomes the largest source of revenue? Or how has that changed, if at all?

So I do anticipate over time that Pay with Venmo will be the single largest contributor to how we monetize that. But I think importantly, as you noted, sort of in your question, we've got a diversity of products that we provide to our customers, which, again, is good for our customers. It's also good for us, so that we're not solely dependent upon one aspect that maybe becomes more competitive or the way that that's monetized has competed away over time. And so providing things like the ability to use Venmo in an offline world with QR code, or if you're a small business, you can now have your own business profile, so you don't have to co-mingle what's happening in your personal line with your business life and importantly, provide the protections that businesses want by having that business profile and then lastly, to complement some of the things that we're doing with cards and other things, having that option to Pay with Venmo online. And so over time, I would expect Pay with Venmo to be the largest contributor of all those buckets. But as we sit here today, we've got pretty good diversity among the various funding sources, whereas early on, we were more dependent upon that instant cash withdrawal fee. But certainly, as we move forward, we expect to rely on that less and less.

And when we look at some of the other acquisitions, obviously, Venmo came in quite a few years ago now via acquisition. One of the ones that more recent, at least that's higher profile that you mentioned earlier in our discussion, was Honey. How is that integration going? You, the management, have laid out ambitions to integrate this into the POS and within PayPal and Venmo apps. What should that user experience be? And what kind of relationships is that allowing you to develop with the merchants?

Sure. Well, we're very pleased with the technology that Honey brings to our platform. And we've launched several new experiences this year with Honey including expanding in certain other markets where they weren't previously. But as we move forward, I think the power of having sort of personalized wish list, if you will, for customers that merchants can tap then to effectively, every individual customer has their own demand curve. And from a merchant's perspective, this gives them like very high fidelity at how they're spending their marketing dollars rather than spending money at the end of the quarter for a banner ad, I hope you get some click-throughs. You clearly see what consumer preferences are, and you get a much higher ROI on that investment. So it's great for merchants from that perspective. But again, it allows consumers to have a more tailored shopping experiences for the things that they care about. And so this combination of data that Honey has, combined with the scale of our platform, I think creates a tremendous opportunity for us going forward, and one that hopefully, merchants will see as a great alternative to how they're spending some of their marketing and advertising dollars today.

Let's talk about another acquisition, iZettle. You've mentioned that you had launched iZettle in the U.S. How do you think about your small merchant offering today? And what kind of demand do you envision for iZettle? And maybe you can help contextualize that with how iZettle has been performing in other markets and how you would expect it to perform in the U.S. relative to those markets?

Sure. Well, iZettle, like others in the space, have not been immune to the effects of businesses shutting down or not having the same in-store presence. And so it's clearly had some impact there. But I am personally very excited about the launch in the U.S. of iZettle because I think it will really show and demonstrate the capabilities and why iZettle was so attractive to us. Again, iZettle is in multiple markets around the world, which shows sort of the nimbleness of their platform and the way that it's easy to integrate with merchants. And when we launch it in the U.S., we'll certainly target those PayPal customers. But I think the real opportunity for us is where customers don't have a relationship with PayPal. I think it's something like 50% of SMBs have no online presence. And so that's really what we're targeting is this backbone of America, which is the hair salons, the restaurants and things like that, that we can go in and have iZettle be sort of a single platform that integrates into things like QuickBooks or BigCommerce, which so many of these companies have. And it's that interoperability of that platform, which makes it so great. And so I'm quite excited about this, and I think that it represents a big opportunity for us. And I think investors will begin to see as we move this into the U.S., why this is such a coveted asset for us.

And on acquisitions, generally, like they're no longer part of the formal forward guidance from a revenue and revenue growth perspective. But nevertheless, it seems like acquisitions still form a key part of your strategy. Is there -- how should do we think about acquisitions, both in terms of strategy? And is there a basic algorithm that you're looking to use for that, whether it be a percentage of free cash flow or some generally targeted level of inorganic contribution? What is the role of acquisitions in your kind of long-term view for developing PayPal?

Sure. Well, a couple of points there to start with. One is the last Investor Day that we had in 2018, I think we were, call it, roughly $100 billion market cap. And we're obviously well north of that today, over $300 billion. So to drive that incremental growth given the size company that we are, it requires a much bigger acquisition. And so we had said previously that we were expecting $1 billion to $3 billion roughly annually, and we were less specific this time. And it does not mean in any way that our appetite for inorganic growth has diminished in any way. But it's -- I think we're less reliant on it, given where we need to go. And we have the luxury of being more disciplined and opportunistic. And so as we think about our free cash flow allocation, certainly, a lot of that will be spent towards organic investment. We've noted or earmarked that 30% to 40% will be spent towards returning cash to shareholders. And we've got the balance to go out and acquire companies if we want. But again, these are sort of rules of thumb or averages over this 5-year time period. If there's a larger acquisition that we think is important to our platform, we've got the ability to kind of pivot and do that 1 year to maybe ratchet back in one of the other areas because the thing that I keep going back to is there are a few companies of our size and scale that have our growth rate but also generate our free cash flow. We noted, like we expect to generate $40 billion in free cash flow over the next 5 years. And as you think about the landscape in which we operate, the other companies that are out there, they have nowhere near that cash flow. And so this is a competitive advantage for us. I keep saying this. It's another arrow in our quiver as we go out and compete in this landscape. And so we're less specific, but it doesn't mean that our appetite has diminished. I think we can just be a little bit more selective and opportunistic as we move forward.

So let's wrap up the last few minutes we have here, John, talking about what ties into that free cash flow, and that's the economics of the business. Take rate is compressed, in part due to business shifts as Venmo, P2P grew, eBay has rolled off. What do you think we should be thinking about as a more normalized cadence of take rate compression, especially since eBay is largely behind you, Venmo monetization is still underway, but new products are starting to roll in.

Sure. Well, I guess, I'll just start with some high-level numbers. We talked about 20% compounded annual revenue growth. And so I think if you did the math, that gets you to like $53 billion and change maybe in 2025. We also talked about $2.8 trillion in TPV. So if you take those numbers that implies take rate compression of around 40 or 50 basis points from where we are today. And so you can see that, that level of decrease, we expect to compress over time or decrease less than what it has over the last several years. And that's a result of a lot of things that are happening in our platform, mix in our business. Certainly, adding Bill Pay, which is a lower take rate, but also lower funding cost that depresses that number, but we begin to monetize Venmo more. And then I think importantly, we get asked a lot about transaction expenses and transaction losses. And we expect those to stay at lower levels than what we had entered -- where we entered the pandemic. And so all of that contributes to margin profile that I think is quite attractive in the business. It allows us to take that transaction margin growth combined with the operating leverage we have in the nontransaction-related expenses and grow our margin over time. Now there are some nuances to that. As we think about, well, our tax rate is we are expecting to be a little bit higher going forward. We also earn a lot of money on interest related to customer balances. The forecast that we had and the numbers that we shared at Investor Day are basically kind of the forward curve, a flat interest rate environment. And so to the extent that we see interest rates go up, that creates a little bit more opportunity. But I think, really, very importantly, that we focus on the absolute growth or the growth of the absolute transaction margin dollars or operating margin dollars in the business. Again, this goes back to the cash flow that we generate. And there are very few companies that have our growth profile and our cash flow profile that generates the kind of outcome that we're talking about.

And on that point and on the bottom line margins, if you will, or the operating margins, your EPS growth CAGR targets versus revenue, implying margin expansion, I think you've also talked about levers that you can pull to manage that depending on the environment, et cetera. Where do you have flexibility? And where is kind of the -- how do you walk that prioritization tightrope between margin expansion and growth and investment right now?

Well, it's a great question, James. And I would expect that there are -- in all the people in your audience, there's probably -- we're split in terms of half want to see that greater margin expansion. The other half probably want to see higher growth. And we feel like we've done a good job threading that needle and achieving both. And the plan that we laid out contemplates that as well. I think that the scalability of our business, the way that we can grow at a low marginal cost makes those margins want to go up. But at the same point in time, we're not just focused on growth in 2021 or '22, but we're thinking '27 and '28, and we have to invest in the business. And so I think we're striking that right balance to be able to grow our margins and at the same time, continue to achieve these high levels of growth. I'll point you back to the last guidance that we gave at our previous Investor Day in 2018. We outperformed our revenue guidance by, I believe, about 100 basis points and almost a 700 basis point outperformance in earnings growth. And yet here we are at this latest Investor Day, increasing the metrics around revenue growth and earnings performance. So I think this really speaks to the model that we have, the scalability of the financial architecture in terms of being able to grow at a low marginal cost. And I think lastly and importantly, the diversity of products that we have. And this is really unparalleled in this space, and we're quite excited to go execute on this over the next 5 years.

Well, John, I think that lots of people share your excitement and enthusiasm, but -- and we're really thankful for you to -- for joining us here at the virtual Morgan Stanley TMT conference. Love the messaging and everything else, but more than anything, really, I'm sure there are lots of people that have appreciated support during the pandemic and look forward to all the things that you do going forward. Thank you very much to everybody for joining us, and have a good day.

Thank you, James.