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

Good afternoon, everyone. I'm Ashwin Shirvaikar, Citi's Global Head of FinTech Research. We're on Day 3 and starting off the afternoon session of Citi's 11th Annual FinTech Conference, and really happy that you're with us. [Operator Instructions] But with that said, let's get started with the next session. Super excited to have PayPal. And from the company, we have John Rainey, who is CFO and EVP of Global Customer Operations. John, welcome, and good to see you again.

Good to see you, Ashwin. It's a pleasure to be here today.

Absolutely. Yes, yes. John, I don't normally start these sessions with like earnings and model questions, as you know. But the recent earnings, they were quite eventful, had a stock reaction. So I'd like to, if you don't mind, just start off with a few related topics.

Sure.

I think the first one is take us through what you saw in the quarter itself in Q3, how that was relative to your expectations and how that shaped your outlook for Q4. So more of a setup question.

Sure, sure. Happy to. Well, I feel like I have to start with eBay. It seems to be the elephant in the corner of the room, but eBay actually came in very close to our expectations for the third quarter. That said, for the full year, the pace of their migration has happened quicker than what we expected. And we've talked about the roughly 700 basis point headwind that we have for the full year. But that shaped up pretty much as we expected. When we started the quarter though, travel -- the travel and event vertical was actually performing pretty strong. And we had an assumption that, that was going to persist throughout the quarter. And what we saw is when we got into the tail end of August and certainly into September, that really slowed quite a bit. I think that's when we saw a lot of the concerns around the Delta variant tick up. And so that came in less than what we expected for the quarter. We also had an expectation around stronger back-to-school shopping than what we experienced. And so September was -- it was a really odd month. I described it as sort of this September malaise because there were a number of factors and even the consumer confidence reading came out that month that was very weak. And that was disappointing to us. It certainly came in less than what we expected. But as we launched into October, we actually saw a resurgence in some of our core trends. And that's persisting today. So we're excited about that, but we're also measured in that excitement because we recognize that with all of the concerns and press that we see around supply chain issues, labor market issues, things like that, that there could be some pull-forward from holiday shopping. We certainly -- we're counting on continued strong e-commerce growth in the holiday season. But I think it's reasonable to believe that if consumers are following the press, then they're likely responding to a lot of these offers that merchants are putting out there. But that said, when you look at whether it's Adobe or Mastercard and some of the e-commerce projections for the fourth quarter, we're still projecting to grow roughly 2x what the rest of the market is. And so the balance of the year is shaping up more or less as we had planned, particularly with respect to the number of initiatives that we launched and talked about in the last call. But we just -- the starting off point was a little bit slower or less than what we had expected.

Okay, okay. Got it. One positive surprise was OS grew 50% in the quarter, certainly significantly ahead of what we were expecting but also what you were expecting. And we get this question a lot from investors, how do you model OS? What are the contributing factors? How do you think about growth rate for Q4 and next year?

Yes. It's -- I appreciate the question because it's something we probably don't give enough guidance on or enough color on to satisfy the investor community. But it did grow faster than even what our expectations were for the beginning of the quarter, and I'll talk about some of the reasons why. But first, as we think about the fourth quarter, I would expect that growth rate to slow to roughly half of what we saw in the last quarter. It would be a more normalized growth rate for that part of the business. But the contributing factors are really around credit. Credit continues to perform very strong relative to last year. And there's really 2 factors that I'd point you to. One is strong growth in the Synchrony loan portfolio. And I think that, that's an important point to mention, particularly as we think about the trajectory into next year because what we're seeing right now is with all of the stimulus that's been injected into the economy, loss rates are really performing very well. And our agreement with Synchrony is a profit-sharing one, so we recognize it as revenue but it's basically a profit contribution from that portfolio, which is inclusive of revenue minus losses. And so as losses have performed better this year, we've seen stronger performance there. Going into next year, I would expect that in the absence of stimulus, to normalize a bit. And so we would expect OVAS overall next year to grow quite a bit less than what we expect the rest of the PayPal portfolio. The other contributing factor in the quarter though was the acceleration of revenue recognition related to the PPP loan portfolio. And so we do certain services around origination of those activities as well as servicing those activities, and we recognize that revenue over the duration of the agreement. And as our partner there, WebBank, actually sold part of that portfolio, we have to then accelerate the recognition of that. And so that was also a contributing factor in the quarter, which we should not expect to continue into the fourth quarter and next year.

Right, right. And when I look at sort of nontransaction-related OpEx grown 25% year-over-year for the first 9 months, how are you thinking about that in Q4 and next year?

Yes. So we've really sort of seized the opportunity in front of us and invested a lot into this current environment that we're in. That said, we are going to have an operating margin this year very similar to what we had last year, which was a record year for us. And so we're able to do those investments while still seeing our margins climb like they have. But a lot of the investment that we're making, Ashwin, is like in permanent heads, like these aren't sort of necessarily like onetime costs that we incur in one quarter and out the next quarter. We're -- we've become a lot more -- a lot better and a lot more efficient at our own organic development, our own engineering resources and the yield that we're getting from that. And so we've added more resources there. The reason I described it that way is we're growing roughly 25% this year. We grew roughly 25% next year. Those costs that we've added aren't going away, so we have those engineering resources as we go into next year. I don't think we're going to grow 25% next year. In fact, we guided to something that is sort of the high single digits. And I think that's an appropriate level of investment for us that still enables us to capitalize on the opportunity while not being spread too thin and focusing on too many things. And so we'll get to what is next year probably a more normal expense growth rate similar to what we've seen prior to the pandemic time period.

Okay, okay. Got it, got it. I want to get back to what you call the elephant in the room, eBay. Obviously modeling it had been -- modeling the deceleration has been a challenge for many. Where do we stand now -- 4Q, just to be clear, was that the last part of the decel? Or has the timing changed? And then I want to make sure that everyone gets the tough comps part of it right for next year. So can you remind investors of how to think about 2022?

Sure, sure. So I'll start with the fact that our business ex eBay is the best proxy for how we're going to perform going forward. And implicit in the 18% -- roughly 18% revenue guidance that we've provided for next year is 22% revenue growth ex eBay. And we're at a point where eBay is roughly 3% of our business and we would expect it to stay in that range for the foreseeable future. That said, to your point, we sort of saw the brunt of that impact this year and we're going to lap that next year. But the eBay migration was effectively complete at the end of the third quarter. And so what's happening to our business right now is not the continuing decline, it's simply the comparison of the performance in one period to a period in a prior to a quarter or a year that had that eBay impact. And so for us, the first quarter is going to have the most acute pressure from a year-over-year perspective, and our growth rates will probably look pretty similar to what they are in the fourth quarter. The second quarter will be a little bit less of an impact than that, and the third quarter, even less than that. But by the fourth quarter of next year, we're getting to what is a normal sort of apples-to-apples comparison of our performance where the mix of eBay in our business is not changing or the composition of that is not changing year-over-year. And so as we noted, we expect to exit next year at an overall growth rate for PayPal that is in line with or higher than our medium-term guidance.

Okay, okay. Got it, got it. And just to be clear, when you said eBay is now stable, in dollar terms, it's stable? Or as percent of rev it's stable? How did you mean?

Yes. So really, I'm talking about that in terms of their overall migration. So they've effectively migrated 100% of their merchants, and so there is not another shoe to drop. And so our business going forward will be really retaining our share of checkout with those merchants, which we've said is approximately 50%, 5-0 percent of that. And so we would expect that to be very consistent over time based upon our prior experience. What is harder to gauge is sort of like how eBay overall does. They are a lower growth business so we're not necessarily expecting anything different than that as we move into the future.

Got it, got it. Okay. And just getting more eBay questions. So eBay take rate, is that also stable going forward?

Yes. So a year ago, the eBay take rate was roughly 4% in our business. And I believe if memory serves me correctly, in the last quarter, it was 2.37%. There is a little bit more of a decline that we'll see there. But because it's such a smaller part of our business right now, it really won't have the more pronounced effect that we've seen in the last 2 quarters where roughly half of the decline in our take rate has been a result of eBay. So we do expect a little bit of compression there, but overall, our take rate should -- or the rate of decline in take rate should abate from what we've seen in the last 2 quarters.

Right, right. Okay. And I don't want to kind of ignore or forget an important thing you've said in there, which was ex eBay, I think you're growing 28%?

This year, yes.

This year. And you're basically thinking of low 20s, 22-ish next year. Is that sustainable going forward? And the point of this is the most frequent long-term investor question I get is how do you think of whatever has happened in 2021 in the context of your medium-term outlook, right?

Sure. Yes. I'm happy to -- go ahead, I'm sorry.

Yes. Can you talk about like how year -- at this point, year 1 is kind of in the books, sort of. Year 2, you kind of talked about, but years 3, 4, 5, is it like 22-ish?

Yes. So our medium-term guidance that we laid out always contemplated that 2021 would be the most difficult year in terms of the impact of eBay and then we'd lap some of that in 2022. If you step back and you think about where our latest guidance is, and look, I'm disappointed to be lowering guidance for the fourth quarter, but the full year guidance that we've given right now is basically right where we expected to start the year when we gave our guidance on the first quarter call. And so things are on track, right? And that was just a couple of weeks before our Investor Day where we gave that medium-term guidance. So a different way of saying that is that was the basis for the medium-term guidance that we provided, and we are exactly where we expected to be. And so those -- that medium-term guidance always contemplated that we were going to have this lapping impact from eBay, where in the earlier years or earlier periods, you'd see the pressure on growth rates from eBay as it being a larger part of our business at that point in time. And then you see an acceleration from there. And I think that really points to the tremendous opportunity that we have not only in the space that we operate in, the industry that we operate in, but the tremendous opportunity that we have at PayPal. And that's why we focus so much on some of the things like improving our checkout experiences, the experiences associated with the digital app, and then further down the road, even international expansion that becomes a bigger impact. And so I think anybody probably listening to this recognizes and appreciates that we operate in a space that has a tremendous amount of growth potential. And you see that in our ex eBay numbers. And our focus at PayPal every day is how we continue to see those trends continue or even accelerate from there with additional experiences that we're providing.

Okay, okay. And again, you touched on a couple of areas, and I'm getting a lot of questions also partly related to certain other comments out there in the space today. But when you talk about international growth, cross-border growth, you kind of mentioned the point on that part doing better in the future. You also talked about e-comm and e-comm market share is obviously a factor you have to think about. Can you talk about those factors sort of kind of pulling it all together, if you don't mind?

Sure, sure. Well, to start with, I know that from the feedback we've received from many investors, the international growth numbers in the quarter were not all that impressive. But when you look at it on a currency-neutral basis, actually, the decline in international was fairly similar to what we saw in the U.S. We have to remember that international last year, particularly in Europe, performed very, very well. I can't remember the exact growth rates, but what I want to say it was high 20s percent like 28%. And that was, we were seeing sort of a second or a third lockdown during that period of time. There was a resurgence of some of the virus, and so that contributed to a lot more people doing things online versus in person. So we were lapping that experience. Exacerbating that impact is this year, we see a lot of the supply chain issues that are out there, which are more acute in the APAC or the Asia region. And so I think the double whammy of that provided numbers that were not in line with sort of the overall growth trends of the business. But that said, international is a tremendous opportunity for us. And like Japan is the example that I have to start with because we just made the acquisition of Paidy there, which is a great platform with a 2-sided network, doing installment pay there in Japan and really caters to some of the predilections of consumer behavior there. And so if you think about Japan, you step back, it's a market with 120-ish million digital users. And we're excited to have this as an accelerant to our growth there. But even more broadly than that, if you think about Mexico or even South America, you've got roughly 0.5 billion, I'm rounding up a little bit, but call it roughly 0.5 billion digital users there. And arguably more white space, where you don't have an entrenched competitor like maybe you do in the China region or something like that. And we think that our capabilities and product features really cater to some of the consumer demand there. And so our focus may be slightly different in the past where we were casting a net very wide and trying to kind of do all things for all regions of the world. Our focus internationally is much more targeted now to execute in areas where we think that we cannot just have a right to play but a right to win, where we can truly be successful. And so you see that in Japan, you see that in Mexico and South America. And then eventually, we look forward to the opportunity to expand Venmo internationally in one of the existing core markets that we have today. I think all of that is a tremendous opportunity for us as we look out over the next 4 or 5 years.

Got it. Okay, okay. And judging by the frequency of what types of questions I'm getting here, I do want to kind of change the order of what I intended to ask and talk about, let's call it, button wars if you will. And look, I mean our point of view is kind of... [Audio Gap]

Hypercompetitive environment. I joined the company in 2015. And at that point in time, the questions around competition were more with the traditional players in the ecosystem, maybe you'd throw in Apple there. And the list of competitors has changed over time. I think maybe some of the concerns around that existing set that I said have abated some and/or maybe we've allayed the concerns that are out there, but now it's a new set of competitors. And so that's what motivates us each day to wake up and try to thrive in this market. And I think it's also why you see some of the valuations in this space because the addressable opportunity is so large. And I've never really held the belief that this is going to be a space where there is a winner-take-all. I think there's plenty of room for a few players. I think over time, those few players, though, will be ones that have great digital wallet experiences because I do think that consumers are going to habituate to that, and merchants are going to respond to that habituation with some of what they're doing both online and in-store. So I think that there's a tremendous amount of opportunity in that space. But look, if we look at our own share, as an example, Ashwin, and we compare our market share relative to the entire ecosystem, what we've seen is that, yes, some others are gaining share but not at our expense. What we're actually seeing is that the -- typing the debit or credit card in the browser is actually the one that has seen a decrease. And so you continue to see players like PayPal continue to maintain their market share or even grow it in certain cases. But for us, like we need to nail checkout. That is like -- one of our single greatest advantages is the scale that we have and the 2-decade experience with our customers with a brand that's built around trust and security. That really, really matters. But we can't just sit on our laurels and expect that, that's going to be the recipe for success in the next 2 decades of experience. And so that's why we're so focused on improving checkout and providing these experiences to our consumers. And so I'll give you one last sort of data point to close out this answer. But when we look at the behavior of our consumers today that use PayPal, roughly half the time that a PayPal consumer has the opportunity to check out with us, they actually do. And so that's -- there's 2 ways of looking at that. You can say, well, gosh, that's not very good, but you can also say that's a huge opportunity. And so said differently, we could double the size of our business without ever adding another customer if our customers that we have just use us all the time today. And so that, to us, points to like we have opportunity because when we look across our breadth of over 30 million merchants and we analyze our share of checkout at each of those, it actually varies quite significantly. In some cases, it's 100%. In some case, we're not getting our fair share. And so like Walmart is a good example. Historically, at Walmart, if you wanted to pay with PayPal, I think you had to go to the third page of payment options. Well, let's be frank. I mean, no one's going to click 3x to use PayPal, including probably PayPal employees. It's just too much friction in the experience. And so what we're doing is working with merchants to improve those experiences where we don't have that high share of checkout so that we can get more of what we think is ours to win. So there's a tremendous opportunity in this space. It's competitive, certainly, but I like our assets relative to anybody else's.

Okay, okay. And a few of the points that you made there, one part of it is that the competition doesn't actually have to start and end at checkout. It can -- you can bypass that with BNPL. You can bypass that with money. So that's one part of it. The other part of it is you are working with merchants to improve sort of your positional advantage or relative advantage, if you will. That's sort of what I heard. So from an engagement perspective, is it possible to maybe quantify both the customer and merchant side because that becomes important to get to a more holistic answer, if you will?

Yes. Well, it varies greatly, depending upon merchants and consumers. Some use us all the time. Some are sort of only when they have to. But I'll point you to our engagement numbers in the most recent quarter, which were our highest ever. And the overall sort of headline number of a 10% increase in engagement really, I think, belies what's happening to the rest of our business because, again, I sound like a broken record here, but if we strip out eBay, our engagement grew almost 20%, and so -- 18% is the actual number. And so that's a great indication that a lot of the things that we're doing in our business and adding some of these experiences with the digital wallet, the growth with new merchants, that it's really having an effect and having the effect that we wanted. And so as we think about how we achieve our revenue aspirations over the next several years, it's a combination of both growing net new actives but also increasing the overall engagement. And so the more that we can get people using us all the time, the more that we can increase that share of checkout, the better it is for our business.

Got it, okay. And certainly during the pandemic, PayPal Credit was really not a big part of your toolbox. You're ramping it up again. Can that help engagement? And then to complete the answer on PayPal Credit, it does help downstream P&L impact, so could you talk about those, including tax and so on from just credit normalization, if you would?

Sure. Well, Credit for us is a very complementary part of our business. It's something that is another opportunity for engagement, like we see our customers that use PayPal Credit as well as the existing checkout button are much, much more engaged with us. It's also something that we want to be balanced in, in terms of how far we lean into that because we don't want to, as I've said in the past, like go through a credit cycle and have our earnings deteriorate to the point that people think about the durability of those differently and put a different multiple on us. And so we have very clear and careful guardrails in terms of our overall Credit business. Now that said, the latest sort of incarnation of this is installment pay, and that's on the tip of everyone's tongue and there's a lot of new firms in the space that are playing in this space. But it's a great opportunity for us because it has very low risk characteristics. In fact, today, only about 15% of the funding of our installment pay is done with a credit instrument. The rest of it is either ACH or debit. And so that has low risk characteristics. But at the same point in time, the value proposition to merchants is tremendous. We're not charging anything for this. We've got over 430 million customers that have this product and the merchant bears no risk. And so it's another sort of flywheel effect or engagement opportunity for our customer base. And it will probably be the largest growth area in our Credit portfolio going forward. But that said, as I started the answer, like we're going to be very careful around our dependence on Credit so that it doesn't change the economic profile of our business.

Okay, okay. Got it. Is there, at this point, I mean, almost a year, I think it's about a year since you announced -- formally announced BNPL. What's the overall market feedback that you get, particularly as so many other options have shown up?

Yes. Well, it is sort of like we talked about earlier, it's a crowded space, right? There are many people playing in the space. And we were later to the party than others, right? The others had a head start. But if you look at the overall volume that we're doing on our platform right now, roughly $8 billion annualized, it's on par with what anyone else is doing in this space. And to me, I could point to a lot of other metrics but that is sort of the point to the scoreboard type metric, like we are getting tremendous amount of volume in this because there's a huge appetite from not only consumers to use this but merchants to have it as a payment option because they recognize the increase in conversion, the increase in average order size, the increase in engagement that comes from this. And so again, I think our value proposition is second to none. I think our experiences are very good and there's a tremendous appetite for this right now. And so it's something that we're really excited to add to our portfolio. And this quarter, we'll be adding it to 2 other markets in Spain and Italy, and we'll continue from there.

Okay, okay. Got it. I do have one little quick question going back to the midterm guidance and more clarification question that I have from an investor, which is, is formerly is Amazon, is that included in your midterm or was it always included? Or is that incremental?

So if you go back to wherever it was, February of this year at our Investor Day, I can't say that specifically Amazon was included, but we did have an assumption in there around a number of different large merchant deals that we now have the ability to do since we're freed from the operating agreement with eBay. And so a different way of saying that is there should be no change to our medium-term guidance simply because of Amazon as it exists today. Now over time, if that turns out to be much greater than what we expected and we get a lot of traction there, that could change. A number of other factors could change our guidance as well because there's just a huge opportunity in our space. But at this point in time, all of that was, call it, roughly included because we had assumptions in there around merchant growth.

Got it. Okay, okay. One of the questions that may be a little bit less frequent now, which is kind of noisy but we did get a lot of questions, was with regards to interest and that's kind of the desire to do larger M&A, if you will, broadly speaking. On your earnings call, you mentioned a higher hurdle rate for larger M&A. Kind of if you think of the strategic question, though, of what attributes of criteria do you look for, for M&A? Is it geo expansion? How important is the underlying model? I mean, will you step into advertising-based models, for example, considering you have many clients for whom it's core? Any incremental color around that would be helpful.

Sure, sure. Well, can't imagine why that's been a question. But I'll start with the point that I think is a really important one is that we are a business that generates a tremendous amount of cash flow. And that allows us the luxury of being a very acquisitive company. I don't -- I can't sit back and say that there are holes in our portfolio or needs that we have to achieve our 5-year plan that we need to go fill through acquisitions. I think that's entirely an organic plan, but there's always opportunities to complement or accelerate what we're doing with acquisitions. And historically, those have been of a smaller variety in terms of overall dollars, call it $1 billion to $4 billion, $5 billion. And that's generally the way that investors should think about our business going forward, that, that really fits our model a lot more. But that said, I mentioned this, like for every deal that we announce, there's 100 that we don't look at. And the opportunity in front of us is so expansive. We don't want to kind of put our head in the sand and not explore certain other things. Now look, I mean, we're not going to go like buy a railroad. I mean, we're not going to go that far afield, but there are certain technology things, whether it's ad tech or what we can do around commerce that certainly are not too far afield from what we do and we have to explore. In this particular situation that was speculated about and rumored, it would have been a much bigger deal and really kind of point to one of those directions that I just referred to. But we elected not to do that. In fact, I think we actually weren't even that far along in the process there. And so there was a little bit of reading into that, but we're always going to explore deals. I think, Ashwin, that's sort of my job as a fiduciary and sort of steward of the resources that we're managing that are the investors' money, right, is how do we create more market value? And as I look at our organic plan today, I think we have the same opportunity or greater that we've experienced or realized over the last 5 years. We have that over the next 5 years. But that may not be good enough, right? Maybe there's other opportunities that if we were to really nail some other vector that even create more shareholder value. Now that said, I mean, stating the obvious, there's execution risk with all of these things. And that plays into our calculus on this. So as you asked about sort of the metrics or sort of analytics or the way that we look at this, I mean, execution risk is a huge thing. Like we don't want to get so distracted that we stop running the company and start running a merger. And believe me, I come from a background where that happened to me with the merger of Continental and United, and there's some real scar tissue there. So I'm very cognizant of the effect that, that can have on the business, but I want the investors to know that our core business is doing fantastic. Set aside sort of some of the comp numbers that we're dealing with right now in the current quarter, but our core business is doing fantastic. But we also have opportunities that we need to explore from time to time. Our model going forward should be pretty much, from an M&A perspective, what you've seen in the past. But we also have to explore some things. And maybe 1 day, one of those works but it's not as if we have $20 billion that is burning a hole in our pocket and feel like we have to go spend that.

Yes, yes. No, that's a fair answer. I want to close out, I mean, there's a lot to talk about but we are kind of coming up on time. I want to close out with maybe a last question on super app rollout, how should investors think about it? Is it helping engagement? Is it doing what you thought it would do? I think that can feed into that overall answer with regards to competition as well.

Sure, sure. So the early returns are very encouraging. And we talked about a lot of those on the call, like discoverability has increased 25x. We're seeing increases in engagement among a number of things like crypto as an example. First-time users were up 15%. And so each of these things, while very early on, these are the sort of the seeds of growth that we're very focused on to make sure that we're getting the type of results from an engagement perspective that we expected. And there's so much more to come. We talked about a lot of the things that we have on our road map. And there are many things that we haven't talked about yet, some of which for competitive reasons. But I think right now, like it's too early to extrapolate the trends that we've seen just in a month or 2. But as the CFO, as someone that's sort of laser-focused on how the yield is for these investments that we've made, I'm very, very encouraged by what we're seeing. And this is the foundation for how we're going to grow going forward. Again, I think the ascendancy of digital wallets is something that is going to happen over the next several years. It's just -- it's fundamentally better and easier for consumers. And so we're going to invest into that, and we expect to see a lot improvements in engagement from those additional products and features.

Great. That's actually a very good note to end on. John, I want to say thank you very much for your insights. Great conversation as usual, and I really appreciate you being part of our conference.

Well, it's always a real pleasure, Ashwin. Thank you very much.

Thank you.