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

Hello. My name is Bryan Keane, and I'm the senior payments processors and IT services analyst at Deutsche Bank. And we're excited for our next fireside chat with PayPal's John Rainey, who's the CFO and EVP of Global Customer Operations. As you recall, there is a portal down below where you can ask questions, and we can hopefully get to a few of them. But with that, John, hey, thanks for joining us.

Yes. It's a pleasure to do it, Bryan.

So I know we're 18 months out since the pandemic. How would you characterize the sustainability of the strong e-comm volumes as we anniversary some of the more tougher comps? Does growth remain elevated over pre-pandemic levels? And do you expect that to last going forward?

Sure. Well, we're continuing to see e-commerce spending remain well above pre-pandemic levels. And it's quite exciting to see in our business. Even as markets have reopened, we're seeing levels of e-commerce growth at far in excess of what we saw prior to the pandemic. Now that said, as the sort of COVID has unfolded and we've seen the economy reopen in fits and spurts, certain verticals have changed. And so early on, we saw verticals like home furnishings, consumer electronics that really had strong growth, obviously, alongside of groceries and things like that. And as we've gone through the pandemic, we've seen a shift away from some of those verticals like electronics and home furnishings. And even at the beginning of the summer, we were seeing travel when the bets picked back up. And so it's one of the great benefits of the diversification of our platform, that we have exposure to so many facets of the economy and insulates us whenever we do see maybe a softer performance in one of the verticals. But the main thing that I would want this audience to take away is that we have a strong belief and conviction that we're going to continue to see these elevated levels of not only e-commerce, but just digital payments. I think that's an important distinction as well because we've certainly seen a movement away from cash during this time period. And we believe that's a trend that's definitely not turning back.

Did you -- I know Visa came out with some August numbers. But have you seen much of a move since the Delta variant has become a little more prevalent?

Yes. We've seen, in pockets of our business, some effect from that, probably most notable in travel events. And if you follow the news today, you've noticed that many airlines have taken down some of their third quarter guidance because of the impact of the Delta variant and the expectation of softer performance. So as we've seen a shift away from that -- those travel and even event verticals, we also see the pickup in some of the more traditional verticals that we benefit from the online shop.

Got it. Lots of interest in the take rate last quarter since it dropped more than, I think, expected. A lot of that was due to eBay, hedges, FX spread and then the Braintree mix picking up. Why will take rate accelerate sequentially getting better in third quarter and then I think it improves again in the fourth quarter?

So you certainly called out the notable drivers of the performance in the second quarter. We said -- on the last call, we said that our expectation was that, that rate of decline would decrease in the third quarter and even more so in the fourth quarter. And the reasons for that are meaningful, one of which is we're simply lapping some of the payments volumes, which carry a lower take rate but also a lower transaction expense. We begin to lap some of the eBay migration. And then we also see some of the benefits from the pricing change that we -- that went into effect at the beginning of August. So all those things will cause that rate of decline to decrease somewhat. But if you look further out longer term, and I can point you to the guidance that we provided at our Investor Day earlier this year, we suggested that TPV would grow in the mid-25% or the mid-20s, call it, 25% range, and that revenue would grow approximately 20% over the next 5 years. And so that contemplates a modest decline in take rate over that period of time. But to be clear, I think I always point back to same-store sales, and our take rate on same-store sales is not declining, that the declines are truly either transitory or something like the effect of mix in our business like shifting off of eBay and many things that we're doing like the monetization of Venmo and a lot of these other verticals where we're beginning to monetize that more will help mute any decrease in take rate over time.

Got it. I believe the majority of the recent PayPal-branded price increases, I've seen The Street estimate anywhere from 2 to 4 points annual positive impact to revenues. I think most of those price increases were implemented in early August. So just curious if you've seen any pushback from that SMB base? And then secondly, is that something that you could also branch out internationally eventually?

Well, we don't just sort of capriciously change prices. And arguably, given that it's been 2 decades since we changed our headline price, it was slightly overdue. But we put a lot of rigor and a lot of testing, a lot of thought into the price changes that we make. And one of the important elements is just what you asked about, what is the effect from those that are on the receiving end of that price change? And so we look very closely at merchant feedback, merchant call volume as it's coming in, perhaps complaining about the change in prices. And that informs our point of view on whether or not we expand that or how we might expand that. And the early response has been surprisingly well and that there's not been a lot of consternation around this. And I think in large part because merchants understand that we're pricing to the value that we provide. Arguably, we provide more value today than we ever have versus the landscape of competitors that are out there when you consider things like buy now, pay later that's being offered to merchants for free. And so we'll take all this feedback. We'll continue to monitor this over the coming months, and that may inform a decision to expand that to other international entities or even expand it into larger-sized merchants if the need may be. But I think fundamentally, what I want to say is that pricing for us continues to be a strategic lever and will be over the next several years as we continue to price to the value that we provide.

Got it. Given net adds are expected to be at the high range in fiscal year '21, by my calculation, that leaves about $80 million annually for the net adds for the next 4 years to hit your $750 million net add target. So the question I often get from investors is what drives that acceleration to be at that $80 million run rate over the next 4 years?

Well, I think it's important to step back and think about the composition of net new actives. And so net new actives is a function of 3 things. It's new activations plus reactivations, and then we subtract up churn and improving a lot of focus on new activations. And we saw that during the height of the shelter-in-place during COVID early last year. But a lot of our focus, a lot of our rigor, the data science that we provide around this is around reactivations and churn. Reactivations are actually a great opportunity for us because we already have that customer's payment credentials vaulted with us. And so there's a lot less friction in reactivating the customer versus activating a new customer. On the churn side, look, it's not something that we disclose, but you can make your own assumption. With 400 million customers around the world, the churn numbers can be pretty large each year. And so a lot of the focus that we have, not only this year but going forward, is to keep those customers engaged and allow them to use us in many different ways, many avenues that they haven't before to diminish that chance for churn. And so as we look forward over the coming years, as we add capabilities into the digital wallet, things like crypto, things like investing, buy now, pay later, all of these things are key drivers that increase in engagement and therefore, decrease churn. And so I'll give you a couple of examples of that real quickly, Bryan. Like crypto is one of the things that we talked about. When we launched that last year, in the months that followed, the adoption or the customers adopting that product, roughly 50% of customers came to our app on a daily basis to check their crypto balances. That's precisely the type of engagement that we want. And we see that in other areas like buy now, pay later or QR code as well, where there is as much as 15% to 20% increases in engagement or TPV among those customers that have adopted those products. And so as we continue to add capabilities to the wall, to add new product features for our customer [indiscernible], all of these things will drive engagement, which, therefore, in turn, will also diminish the chance or likelihood that someone will churn. I'll also add, I'd be remiss not to also mention the opportunities we have internationally. We certainly have a lot of focus in our core markets right now. But as you can see, with the recent announcement of the acquisition of Paidy in Japan, Japan is a big market for us. So a big opportunity for us. I think it's estimated to be the third largest e-commerce market in the world. And so this gives us an opportunity to have a 2-sided network in a very coveted market where, arguably, there's not an entrenched competitor already. And so this is an example of an international opportunity for us that we can add to our net new actives over the coming years. And then also, we talked about, lastly, expanding Venmo internationally over the coming years. And that gives us even more opportunity in that area as well.

Higher engagement is a key metric that we look at. And we saw in 2Q results that 11% growth number in transactions per active account, especially those using PayPal core experiences has gone up. Can engagement growth rates continue to increase? Is that one of the key drivers that you watch as well?

Yes, it absolutely is. And one of the things that I really focus on when we launch a new product, a lot of times, we're looking for the synergistic benefit or the halo effect of that product. So QR code is a great example, where we've talked in markets like Germany, where someone uses a contactless payment in store. They have a significant number or a larger number of transactions with us online, as many in excess of 50 in some places. And so I definitely look at engagement, and I was exceedingly pleased with the performance there in the second quarter. You noted the 11% increase. That was actually the highest increase in engagement that we had on our platform going back to, I think, the first quarter of 2017. And quite frankly, given some of the mix changes in our business, it really -- notably, I've talked about eBay. That obscured some of the overall performance. If we excluded eBay, our engagement actually went up 20% in the second quarter of this year. And so I think that really shows the improving value proposition that we're providing to our consumers, giving them different ways to use us than they haven't before. And all of these things will drive engagement, which ultimately, where that matters is that translates into a higher average revenue per user and more revenue and more profit fall into our bottom line.

Got it. I want to ask about transaction margins. I think they'll be lower heading into fiscal year '22. And I believe you stated before that you expect nontransaction expenses to increase mid- to high single digits going forward. So putting those two together, just trying to figure out adjusted operating margins in fiscal year '22 might be a little bit tough to expand like the typical PayPal model, given some of the pressures and the higher expense that you're expecting?

Well, we're not guiding 2022 yet, but I'll give some -- I'll give a little bit of flavor to how we're thinking about this. First, I think we need to recognize that we're a company that is growing TPV this year in excess of 30%, growing revenue 20%. And that's versus the comp of our strongest year in our history. And so this is exceptional performance, and it would be foolish for us not to invest heavily into this. We've said repeatedly that this is a seminal moment in our industry's history. And we don't want to just sit back and be the recipient of some of these trends that are happening, we want to shape the outcome and influence the future. So we are investing heavily into that. Next year, there's a couple headwinds that we'll face. There'll be a little bit of a tail from eBay as we feel the effect of that. We also have the credit reserve reversal next year. We're seeing the reversal this year. We've got that comp against it next year. But to be very clear, I want everyone to understand this. This is entirely within our control. When I say this, I'm talking about the expansion of operating margins. To have this kind of growth opportunity in front of us, we want to invest in this. And despite some of the headwinds that I just called out, our operating margins are going to expand over the medium term. And it's just a function of the scalability of our business and the ability to grow at a very low marginal cost. But we also want to balance that with appropriate investment to enable us to continue these rates of growth into the future.

Great. I wanted to ask about an update on the launch and timing and features of the destination app. I know some people are calling it super app, but I think you prefer destination app. Can you just talk to us about what -- when can we see more of that functionality in the timing of that launch?

Sure. So we'll be rolling that out in this second half of the year, the coming quarter here. And this is something that is going to happen in phases. As Dan noted on the last call, we're effectively code complete, but that's sort of what the base functionality. And what this platform allows us to do is it's much more nimble going forward, where we can append these various services and products to it that all allow our consumers to easily and securely manage their daily financial lives from consumer financial services to P2P, even to commerce. And so these are all products that we'll be rolling out. And moreover, the app uses AI to actually tailor some of those experiences to your personal preferences to the way that you shop. And so this is not necessarily, Bryan, going to be a big bang, where we have everything coming out at once. But instead, it will roll out in phases, and those phases will span over the next several years. But you will see a lot of additional functionality here starting this next quarter, but also going into next year.

Next quarter, you mean starting in the fourth quarter? Is that when the phase roll out?

Yes. The exact timing, I'm not precise on. It would be either later this month or into the fourth quarter.

Got it. Got it. And investments, that's been a topic of potential for you guys for a while. I know you've talked about that in the investment Analyst Day. Is that something you guys would buy, build? Or is that a partner scenario?

I think we're open to all of that. We're in that stage right now where we're evaluating each of our choices there. And keep in mind that they're not all mutually exclusive. In many cases, we -- like with crypto as a good example, we did a partner/build approach to that. Where we think about an inorganic effort is when we can really accelerate some of our efforts there. And frankly, I'll point back to Paidy, the acquisition in Japan, is a good example of that. And I think a lot of focus is on installment pay or buy now, pay later with that. But really, I think the major takeaway there is the accelerant that, that provides for us with a 2-sided network in Japan. And so all of those things we'll evaluate with investments and other product features that we roll out. And it's tough to say at any point in time what the best avenue is. Certainly with buy now, pay later, we look to -- we canvas the landscape of the companies that were out there, and we elected to build ourselves, and we did that in record time. And again, those payment volumes are doing exceedingly well for us being so early on there. So we'll avail ourselves of these different options and see what's best for us as we go down this path.

Does that likely mean that you don't need to buy additional players of BNPL in the U.S. market because that's a market you can already offer the product?

Yes. That's -- I would say that's probably not on our radar right now for BNPL because we've got a great product there in not only in the U.S., but in a lot of our core markets. And again, it's doing exceedingly well. When you just look at the roughly $6 billion of annualized payment volume that we reported in the second quarter, given that we're only a couple of quarters into the launch of this product, I'm tickled with how this launch has gone. And again, it's extremely relevant to our consumer base. If you look at markets like Australia, this is in double digits, this being installment paid broadly, not just PayPal. But it represents double digits in terms of percentage of e-commerce. And so I think that's a harbinger of what's to come in other markets that are maybe less established or there's been less of that history there like the U.S. And so we're extremely excited about what that bodes for the U.S. and other of our core markets.

Yes. I was going to ask on BNPL, how fast can you grow this? I mean can you -- you look at some of the public players and some of the private ones, you guys obviously are coming at it with different size and scale. I mean the growth has been a bit -- has been obviously very solid, but I wonder if there's a step function change where this can even get that much bigger?

Well, with a lot of our credit products or products that involve risk, we tend to take a metered approach to sort of calibrate risk models, understand the riskiness of that product. And we've done that with installment pay. And even then, we'll do over 5 billion or roughly 5 billion of payment volume this year with that product. And if you look at our credit portfolio, that's where most of the growth is coming from on our balance sheet right now. And so it's something that we're kind of wading into the pool on and taking it slowly in a measured fashion. But there's obviously opportunity there as we can expand the opportunity for people to increase their average order size and things like that, which others have done, which will drive more volume in the future.

On BNPL, there's a lot of interest in potential players disintermediating the networks and using ACH or balances to fund transactions. I think for you guys, it's about 70% of BNPL is funded through debit. Do you see that as an opportunity to lower cost by going more ACH and balance routes?

So for us, we're probably 80% of the funding around BNPL is either ACH or debit, so lower-cost funding instruments and the balance being credit. We launched the ability for our customers to use ACH as a funding mechanism in the U.S. earlier this year. And I think that makes up roughly 30% of our volume today. So that has a very low funding cost. And as a reminder, the way that we monetize this because we don't charge merchants for it is through increased TPV, increased conversion. And all those things are picked up in our transaction revenue. And so this is a product that bears very low risk to us. There's a very low funding cost to it. There's no cost to the merchants. And we continue to see increases in engagement, increases in TPV among those customers that are using this.

Yes. That's what I would think is that if you don't have to pay out any interchange or you don't -- the cost of funding for ACH and -- or balances eventually could be a cheaper cost of funding for you guys.

Absolutely.

The -- I wanted to ask about Venmo. I know the target is for $900 million in fiscal year '21. And I'm still curious on Pay with Venmo, in particular. I know we've talked about this throughout the year. So I feel like that could potentially be a big tipping point when that starts to take off because then growth rates could really exponentially go higher. Can you just talk a little bit about Venmo's growth rate, in particular, when Pay with Venmo might have a positive tipping point?

Sure. Well, I always like to step back when talking about Venmo because I think sometimes it gets lost in the overall numbers of PayPal. But when you step back and you think about the most recent quarter, we've got 75 million customers in the U.S. that are using Venmo. Its TPV was close to $60 billion in the quarter and growing at almost a 60% rate. And if you compare that to where PayPal was when we spun off of eBay 6 years ago, and keep in mind that Venmo is just U.S., it is comparable in size. And so we are very happy about this product, about the engagement that we see among our users and eager to monetize that in future ways like Pay with Venmo. And so we talked about in this year, pay more or Venmo broadly being transaction margin positive and also having about $900 million in revenue. Next year, we would expect it to be in the black. And so actually making money on an overall operating margin basis. And the large part of that is the expansion of Pay with Venmo. And so we're launching that one more with more merchants and eager to be able to demonstrate to all of you where PayPal or not PayPal, but Venmo is going to show up as a payment option here in the near future.

Got it. Wanted to ask on QR codes. I know it's not material today, and I know that this is not going to be something that happens overnight. I think you've said that before. But the strategy, obviously, is important to get more into in-store. Can you just talk a little bit about what could be the inflection point to get more scale in store?

Sure. We've been really pleased with the receptivity of merchants that are wanting to have this option. It's certainly been -- there's been challenges. And like one of the things I've noted as early on, we recognize that employee awareness. And I mean, employees at those stores is important to the experience for a consumer coming and wanting to use that. And so we put more focus on employee education as well as consumer awareness going forward. But look, I think I've said this multiple times. This is going to be a long road. We're effectively changing consumer behavior, and that's a hard thing to do. But we certainly believe that the tide is changing, and we're beginning down a path where consumers aren't going to turn back. And you can look at established markets like China as a great example. And I hate to keep going back to that, but I think it's such a perfect example of the ubiquity of that in that market, where you literally, you go to a train station, you're paying with a QR code. You go to a vending machine, you're paying with a QR code, the grocery store. Even like when I was there a couple of years ago, a street vendor was selling her food with a QR placard in front of her little stove out on the sidewalk. And so this is truly, I think, the beginning of a moment where in a lot of these markets where you've had maybe less of a need for this because of the ubiquity of credit card acceptance, digital wallets are going to take over. And I think that's fundamental to our 5-year plan and how we think about the future, and that is the ascendancy of digital wallets. There's simply nothing about handling cash that makes it easier or safer or more convenient. And so as we continue to add experiences, we continue to add merchants breadth and consumers become more aware of the ability to use this, you'll see more penetration into the offline market. But I think very importantly for us is that is not the end by itself. A big part of our strategy here is as customers are using this in their everyday financial lives, use it as offline, use it as for bill payment, things like that. They're much more apt to use us online, where the unit economics around that transaction are more appealing to us. And so this is a strategy that is going to take some time. But we're investing heavily into it and fully believe that this is a trend that is going to take hold.

Got it. Wanted to ask about the strength in OVAS. And to be honest with you, OVAS is one of the line items that's the hardest for me to model. So I knew it grew 40% in the second quarter. Trying to figure out what the go-forward growth rate should look like because I know there were certain fees that were waived during the pandemic and then the loosening of the credit box, driving more originations. How do we couple all that up and try to think about the right growth rate for OVAS?

Sure. Well, in the second quarter, we were lapping a period where we had really tightened originations. And so we saw outsized growth there, 40%, I believe, is the number that you called out. Looking in the back half of the year, for the third and fourth quarter, it will be -- the growth rate will probably be roughly half of that. Tough to say at this point, but you don't have some of those same lapping effects. But the biggest drivers there are the resurgence in credit as well as what we're seeing in our Honey business, which is recorded in other value-added services revenue as well. And just another reminder, I know there's a lot of focus on buy now, pay later, but that credit product is not monetized. We don't report on that through the value-added services because of the way that we monetize that through increased conversion and things like that comes to transaction revenue. So the single biggest driver for OVAS right now is credit. And as we are seeing a bit of a resurgence in credit, we'd expect that to normalize from the slower period of originations last year.

I know we have 2 minutes. The one question I did get was just asking about the affiliate model in Honey and the growth of BNPL and advertising. Will that be a big push for you guys going forward here?

Well, certainly, Honey opens up a lot of opportunities for us just for commerce in general. And that will include both online and offline and encompass not only tailored offerings to customers, but the ability to utilize rewards, use those as currency in ways that they shop. And so we are very pleased about what that means for us going forward. It's a high-growth part of our business, and we're very excited about what that means going forward.

Got it. All right, John. I'll get you out on this question that I ask you pretty much every year at our conference. But historically, PayPal has given high-level next year fiscal year guidance on the third quarter earnings call. Is that the plan again? And I know, is there any other besides eBay and the headwind that it had versus the tailwind this year? Is there any other high-level considerations that we should be thinking about?

Well, I will correct you, Bryan. We've done it a few times historically. We did not do it last year. In fact, it [indiscernible] the lack of visibility over the next 15 months. And look, we always balance transparency with the accuracy of that information. And we're still in a fairly unprecedented time right now in terms of really understanding how the pandemic unfolds, what the recovery is like. And so it's very possible that we'll take the same path that we did last year and just give some qualitative color, a flavor of how we're thinking about the next year to help investors understand that because we don't want to put information out there that we don't think is reliable. And even today, as we sit here, we're one of the few companies that is providing guidance as far out as we have been. And as we've said, it's a little tricky right now when you've got the Delta variant and sort of the fits and spurts of different verticals in the economy accelerating and then decelerating. And so we want to be responsible with the information that we provide. If we feel like we can do that, give that medium-term guidance, we will. But it's entirely possible that we'll take the same path that we did last year.

It will be good to get the eBay, the majority of that 7-point revenue headwind and the profit headwind behind you. I assume that will be a nice spring effect into next year.

Well, I think, just looking forward, growing at the rate that we are, even with this headway -- this eBay headwind is pretty remarkable. When we get past that, and you're really just looking at this core performance of our business, it certainly, I think, bodes very well for our business. And we're quite excited about what that means for our future.

Got it. With that, we can leave it there, John. Thanks so much for joining us. We appreciate it.

Thanks, Bryan. It's always a pleasure.

Bye-bye.