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

Welcome back to Evercore ISI's 6th Annual Payments & FinTech Innovators Forum. I'm David Togut, payments processors and IT services research analyst at Evercore ISI. Delighted to welcome John Rainey, Chief Financial Officer and Executive Vice President of Global Customer Operations for PayPal. John, thanks so much for being here today, greatly appreciate it.

It's my pleasure, David. Thank you.

Over the past few months, many payments and fintech stocks have been hit hard, and PayPal is no exception. You did lower your 2022 outlook and announced a change to your user growth strategy. Do you think the market overreacted to or misunderstood anything about the 4Q print and 2022 outlook?

Sure, David, happy to address that. We still saw attractive growth rates in the fourth quarter. We did exit the year at a slightly lower growth rate than what we had expected. We talked about that. But if you step back and look at the core business, and what I'm referring to is like ex eBay, we grew north of 20%, 22%, I believe, in the fourth quarter. And on a 2-year basis, it was a compounded rate of 25%. And you can look at other metrics too like transactions per active account, something that I know there's a lot of focus on right now, grew double digits in the quarter. But as we looked at the outlook for 2022, we did see the impact or the expected impact from both macro and supply chain. So we gave a little softer outlook than what we had originally anticipated. But I think very importantly, as we go through the year, we expect to have accelerating growth rates. And hopefully, this will give investors more comfort about the health of our core business as we move through the year. I know there's been a fair amount of questions or confusion around the strategy with net new actives. And I want to emphasize that we still see an opportunity to add new users going forward. It's not as if we are pivoting away from growth. It's simply that when we consider the best return for our investment dollars, we think that we should focus more on the quality of the users versus the overall quantity. And in 2022, because of that, we're going to see a more elevated level of churn. But going forward, we would expect to see something that's more normalized.

Understood. With PayPal's recent strategy shift toward growing client engagement over net new actives, the midpoint of your 2022 revenue guidance for 15% to 17% growth implies a double-digit increase in ARPA or average revenue per account. What will be the biggest drivers of low teens ARPA growth and are you seeing any initial traction year-to-date toward your 2022 ARPA target?

Sure. Well, again, I'll point to ex eBay because the metric we use for engagement at this point is transactions per active, TPA. And if you look at the fourth quarter, the TPA was up about 18%. And I believe it was up the same amount in the third quarter as well. And I point to that because it really shows that we're having a really strong impact in some of the things that we're doing there. eBay was a significant drag last year. It was almost $1.5 billion of drag on revenue. And it's roughly $600 million which is concentrated in the first half of this year. But among the initiatives that we're really focused on, there are several to call out, but the primary ones would be the increased focus on checkout as well as digital wallet. And digital wallet is really important because when someone downloads the app and they begin using PayPal in other forms besides just checking out online, we see about twice that or 2x the value of that customer over their lifetime. And so that's really important for us. About 50% of our customers or PayPal customers, sort of different from Venmo, have downloaded the app today. The entirety of the Venmo base has. But if we can move that up to 55%, 60%, 70%, 80%, that has the potential to have a meaningful increase in the average revenue per user.

Got it. Great. So just as a segue, online checkout has always been an important part of PayPal. With the branded PayPal button share of online checkout hovering at 50%, what are the major initiatives to innovate, to improve the customer experience at checkout and increase your market share? And I know you wear 2 hats, both as CFO and Head of Customer Ops, so you have some unique insights into this.

Sure, sure. Well, I believe we described this in our last call as checkout is our legacy and our future. And I think that's very important. This is an exciting business, an exciting industry where there's so much opportunity. The total addressable market is probably not quantified yet. But the fact is, what is core to our business and core to our future is checkout. And if you look today, we are accepted at roughly 75% of the 1,500 largest online merchants across North America and Europe. That is like unparalleled among other payment players online. No other digital wallet has that level of acceptance. But it's not to say that we don't operate in a competitive space. I think we recognize that as consumers, right? We see various checkout options, and we need to continue to innovate, to provide better customer experiences, to optimize our presentment with merchants. That's really important. The better presentment that we have, the better share of checkout and fundamentally remove that friction for consumers. I'll give you a stat here, David. Roughly half the customers at PayPal that churn in a given year have had a login failure in the last 6 months. And so you can, and I'm sure some people have probably even experienced that. But if you can do better things around authenticating customers and things like that then you remove that possibility for them to churn and increases the likelihood that they would use us at checkout, which was a significant opportunity for us.

Great. And just as a related question, PayPal uses a lot of device-level recognition. Is there a way to continue to innovate in that area to improve the experience at checkout?

Absolutely. Our risk teams are continuing to evolve not only in ways that remove friction for customers, but also address what regulators want, too, that provides safety for customers. And so you can think about authenticating a customer in many ways other than having them login with a password. You can send them a text with a passcode, among other things. And in a typical PayPal transaction, we do about 200 risk checks in the milliseconds that follow to authenticate or make sure that's a legitimate customer. And so we continue to advance here, and you see that with record low transaction loss rates on our platform right now.

Great. Just digging into the first quarter to fourth quarter 2022 growth bridge, what are the steps that you either have the most visibility into or are within your control and which steps are more difficult to predict?

Sure. Well, to start with, we clearly need to demonstrate to the market the power of our business and the power of the franchise. And that said, it has been a difficult market to forecast it. And some of the things that we called out or even before sort of the events that are going on with Russia and Ukraine right now, and tough to say if there's any kind of spillover effect from that. But as we look into 2022, things that are a little bit easier to predict, one is eBay. That's a known thing for us now because they effectively completed their migration by the end of the third quarter. So we're no longer predicting like how much they're going to migrate on the platform. It's simply comparing to a known number the year before. And for us, we called that out as it being a drag in the first half of the year. But as we get to the second half, it's an apples-to-apples comparison. And so that's one thing that I would call out. The other thing is that there's a number of initiatives that we have. And this is the same for any year. You've got a host of initiatives that you're launching in the year, and they have a different ramp-up rate throughout the year, and there's expected benefits to all of them. In any year, David, some of those come in better than what we expected and some come in not as well as what we expected. So we're doing a better job today than we ever have at organic development. And you can see that in things like our buy now, pay later launch, with our crypto launches on both the Venmo and the PayPal platform. But I think overall, the thing that sort of worries me the most is just the macro environment because that is difficult to predict in any certain period of time.

Understood. We have some incoming investor questions, so I'll turn to some of those. While you're focused most on transactions per account, should we expect to start seeing growth in account balance per user to indicate traction and engagement?

Sure. That stands to follow, right? If people are more engaged, then they're more likely to keep their funds within the PayPal ecosystem to use it there. And so we have been seeing that. You see our account balances are at all-time highs right now. And that's very much a good thing. It has offsets too that like take, for example, instant withdrawal, like we charge for that today. That could go down if people are not moving that to their banks. But frankly, we'd be just fine with that because it shows that they're keeping those funds in the ecosystem, reusing them, and that comes at a very low funding cost when it's from balance. And crypto is a good example here, David, because we see among those customers that sell crypto, there's a very high degree of reuse or respend within the PayPal Wallet, which is great for our business.

Understood. Another incoming question, as a result of IDFA changes, advertising at small e-commerce companies has been disrupted or reduced over the last 2 quarters. Is this part of the weakness that can be explained in PayPal TPV growth, that these smaller e-commerce companies are being affected, i.e., traffic is slowing at some of these businesses?

Well, let me describe this more broadly and answer the question that way. So we have seen changes in advertising with SMBs. It's more difficult for me to determine what the direct cause of that is. Certainly, it could be what you're describing. I think it's also likely supply chain issues, right? Customers aren't going to advertise their products if they don't have product to sell. And that's been most acute in some of our cross-border international markets like China as an example. And so we have seen, on the margin, some changes there.

Got it. Understood. Incoming question about capital allocation. How are you looking at share repurchase today with your stock at current prices versus acquisitions in terms of, do you have a lot of attractive opportunities in the acquisition pipeline?

Sure. Well, I'll start with, we take a long-term view when it comes to capital allocation. And the goals that we put out there, as a reminder, like allocating 30% to 40% of our free cash flow to returning cash to shareholders in the form of share buyback, those are multiyear goals. And we may deviate from some of those goals from 1 year to the next. But over the long term, we think that's the appropriate way to allocate capital in our business that both returns cash to shareholders but allows us to invest for growth. And that invest can come organically or inorganically. So at this moment in time, certainly, with what we believe is the dislocation in our stock, it's fair to assume that as you've seen in the past couple of quarters, we've been a little more aggressive on the share buyback front. I also think it's safe to assume that from an acquisition strategy, M&A strategy, at least in the near term, we would expect to, if we did anything at all, to be kind of right down the middle, probably lower dollar amount. And certainly, the events of last year with the rumors around Pinterest are not lost on myself and the management team. And so I think we're being appropriately disciplined in that area. But we also have to recognize we're a growth company, and we're going to continue to invest for growth. And we're not going to walk away from opportunities that make sense for PayPal.

Understood. For this year, you've guided 15 million to 20 million net new active accounts. What are the most important areas you're focused on to drive gross account adds, either new geographies or demographics, and have you seen any progress in reducing customer churn?

Sure, sure. Well, as we've talked about on the last call and some of the meetings that followed, we're still focused on growth. And if you look at the geographies where we operate, like take the U.S. as a primary example, we're only about 1/3 penetrated into the digital users there. And so focusing on those more quality net new actives that have the propensity for higher engagement will likely be in the markets where our value proposition shines the most. So think of markets like Australia, Germany, U.K., U.S., Canada and others like that, more of what we refer to as kind of our core markets. But we're also focused on international expansion, but that international expansion is just, it's not as simple as casting a net and sort of catching everything that's out there. It's more targeted. And I would call out the countries where we have a more targeted focus as being, in no particular order, Japan, Mexico, China are the 3 that really stand out. And in Japan, obviously, we made the acquisition of Paidy there, which is an accelerant to our strategy in that market. It's the third largest e-commerce market in the world. You don't have the same level of entrenched incumbents like you do in China. And we think it's a great opportunity for us and has a lot of similarities to the core markets that I mentioned. And so that's where we'll focus. And then even within some of the core markets like the U.S., something that I'm quite interested in is expanding our reach into youth or teen accounts. As someone that has a couple of kids that fall into that category, I see how they want to use PayPal. I see how they want to use Venmo, how they transact with their friends. And I think it's important to capture the engagement of those kids, if I can call them that, at that point in their life and then mature with them through their financial life cycle.

Great. For 2022, your guidance incorporates 10% e-commerce growth. Through early March, are there any market indicators you've seen to reinforce or to challenge that planning assumption?

Sure. So it's playing out about how we had expected, just going back to the last earnings call. But if you look at what's happened in the pandemic, you've seen, obviously, a shift away from spending on services to spending on goods. And we've seen a little bit of that revert back, right? And where that actually levels out remains to be seen. That's one of the areas that we have to make assumptions about in our forecast. But by the same time, you see more spending shifting back to in-person and again have to make assumptions about where we land there. But I think longer term, the secular tailwinds of our business have not changed. We are blessed by the pull forward in e-commerce and this growing digitization of payments. But in any period of time, there's going to be like assumptions that we have to make around what consumer behavior is. I think importantly, when we look at our business versus maybe some of the banks or even the networks, we tend to, relative to those businesses, skew a little bit more towards discretionary type items. And so you see some differences in what each of us are talking about around consumer behavior right now.

Understood. We have an incoming investor question really on the same topic which is, you already have high market share in e-commerce payments and there's plenty of new competition. Why would you continue to be able to grow faster than e-commerce as a whole or should we expect you to grow more in line with the e-commerce market going forward?

So you should expect us to grow faster than e-commerce. And you could have made that same statement 6 years ago. And we've continued to grow faster than the market over the last 6 years that we've been a public company. And this is part of the network effect of our business. We've got a great value proposition for merchants and we have over 30 million merchants on our platform around the world. By the same token, we've got over 400 million consumer accounts. And the relevance of PayPal, I think, is greater than it's ever been as we sit here today. And as we continue to improve checkout experiences for consumers and merchants alike, add features like savings, high-yield investments, these give our customers opportunities to use us in more ways that are more relevant to consumers. And so here is an example of the opportunity that we have. When we look at our customer base, our PayPal customer base, roughly half the time that a PayPal customer has the opportunity to check out with PayPal, they actually do. And you can look at that cynically and say, well, that's not very good. But opportunistically, you could say, we can double the size of our business without adding another customer if they just use us when they can. And so our team is very focused on completing that vision, that journey, helping to change the experiences so that the value proposition shines in the best way when one goes to check out versus maybe not having the best integration or the best experience or presentment to where the value proposition is maybe a little more watered down. And so we're very focused on checkout.

Is there a way we can think about what your targets for share of online checkout might be over time? I mean, do you have specific goals for how much you want to move up from 50%, for example?

Well, look, we'd love to be at 100%. That's not probably realistic, but we think that we can move it appreciably higher from there. And I've highlighted many things that we're doing to do that. Presentment is something that's very important to us, very important to customers. When you have that option to select PayPal right there at the beginning of the shopping journey, that's where we see the highest share of checkout. And in fact, the further up that shopping journey that we are, getting all the way to the intent stage, we have a correlated increase in our share of checkout. And so it differs, David. With some merchants, we're going to be 100% share of checkout, like we're a sole source provider. With others and particularly around some of the larger enterprises, there are other payment options that are always going to be presented there. But I think very importantly, in a competitive environment that we've always operated in and find ourselves in today, when we are side by side competing with someone else on an apples-to-apples basis, we like our position in that game. We fare very well.

For this year, you've discussed 50% growth for Venmo monetization. Can you dig into the key drivers of Venmo monetization growth? And how much do you expect Venmo's acceptance at Amazon to generate?

Sure. Well, Venmo continues to just perform amazingly well. In 2021, we had almost $0.25 billion in TPV. We've got over 80 million accounts, Venmo accounts right now. And that's obviously just in the U.S. But the revenue streams are more diversified than what they have been historically. We're continuing to add the ability for our customers to check out with Venmo online. You mentioned Amazon, something that we're really eager to launch later this year. But it's other things as well, things like business profiles or the Venmo credit card or more options around goods and services protection, even crypto. Things like that where those users can have a more, a broader suite of services to use Venmo in ways that pleases them, but at the same time allows us to monetize that. And so over a year ago, at the end of 2020, we talked about expecting to get Venmo to $900 million of revenue last year. And we were very pleased to achieve that. We think that we can roughly have about a 50% increase on that this year through the more diversified ways that people can monetize Venmo.

Is PayPal a net beneficiary of inflation when considering a rising average ticket size, stable funding expense at least from the ACH and stored balances point of view, partially offset by wage inflation?

So if you look at the unit metrics of our business and that model, certainly, because we are a take rate business, and we take a percentage of the overall transaction, that would stand to reason that in an inflationary environment we're going to see a benefit there for revenue, particularly when we're not a business that has inputs or cost inputs into our business that are like feedstocks or something that also go up with inflation. We have seen inflationary pressures in wages, but that is true for virtually every company in the U.S. right now. But we can't ignore the impact that higher prices have on consumers. And so when you simply look at the unit metrics around the transaction, yes, we benefit from inflation. But as I noted earlier, our business skews a little bit more to discretionary type items versus others. And so the elasticity of demand is such that, particularly with our user base, that with higher prices, you're going to see less purchases in some cases. And so net-net, it's nothing that I would call out as an outsized driver to any improvements in our business. The one thing I would say that is sort of separate from that is just the interest rate impact of that. And so with higher interest rates, we certainly benefit from that because we're in a net cash position. And so the interest on customer balances is actually a component of our other value-added services. We've seen that come down a couple of hundred million dollars over the last few years in a lower interest rate environment. And so in a higher interest rate environment, we could see that go up. And I think very importantly, when we had our Investor Day, we noted that we are not assuming any increase in interest rates over that period of time.

Two more incoming questions. The first, can you talk about your expectations for transaction expense this year? With credit spend normalizing for the U.S. consumer, why shouldn't that tick higher?

Sure. So we've said that we expect transaction expense to be in that mid-80s basis point range. And to be a little more precise, I'm not simply saying 85 basis points. I mean, there's a range there, call it, 83 to 87 basis points or whatever. There is some inflation there, for sure, as we've seen credit normalize more. But by the same token, we have offsets in our business that mute some of that inflationary pressure in transaction expenses. Venmo is a great example where the funding cost around Venmo is appreciably lower than the overall PayPal transaction expense because that skews more towards balance and ACH. Bill Pay is another example. Bill Pay has a lower take rate, also has a much, much lower transaction expense. And so when we look at all the puts and takes in our business around transaction expense, I think for the near term, we would expect it to stay in the range that we see right now.

Incoming investor question on competition, especially for the lower-end consumer versus Square. I think you called out on your earnings call some pressure on spending trends in some lower income cohorts. So the question is, do you think you're maintaining market share in that cohort or are there increased competition issues that you're honing in on?

Sure. We do think that we're maintaining market share. I'll elaborate on that in a second. But certainly, when we see the impacts around the various cohorts by income group, lower income, middle income, high income, the effect that we see is more isolated to the lower income group. I would be led to believe that competition would have an effect that would be more consistently distributed across income groups. And so I do think that these are more macro factors. But we continue to see, to maintain share of checkout very favorably with the competition. But I know this is a concern among investors, and so maybe I'll expand on this because I don't want to suggest that we are immune to it, right? As I noted earlier, side by side, equal presentment, we really like how we fare there. But it's also reasonable to assume like if you've got a buy now, pay later option of a competitor that has upstream presentment and the PayPal option is buried a page back with other payment options, we see declining share of checkout, right, which is why it's so important for us to really continue to grow our buy now, pay later business. We did $8 billion in volume in that business last year and ended the year at $13 billion run rate. You've heard me say before, David, I think our value proposition is second to none there, but it shows why it's so important to focus on presentment and checkout. And having that upstream presentment is certainly important. And look, I don't want people to read too much into my comments. Overall, when we look at the entirety of our business, we are doing just quite fine relative to the competition on share of checkout. There are isolated cases where we see that there's other payment options that have that upfront presentment, and we're not immune to them, certainly.

For 2023 to 2025, your recent guidance calls for 20% revenue and 22% EPS growth. What gives you confidence in being able to achieve these growth rates over the medium term? And do you still feel good about your ability to drive operating margin expansion over the medium term?

Sure, sure. Well, as I noted earlier, like the secular tailwinds in our business simply have not changed. We've got these 2 great tailwinds in growing e-commerce and the digitization of cash payments. And as we've demonstrated, from my earlier comment, we've continued to grow faster than overall e-commerce market. And I expect that to continue. Our share of checkout is already strong, but we can keep improving the consumer experience. And I think very, very importantly, David, because of our scale and ubiquity, like even small improvements that we make in experiences can drive meaningful benefits because we're rolling these out to 30 million-plus merchants or 400 million-plus consumer accounts. And consistent with what we said at Investor Day a year ago, we continue to believe in this progression or this ascendancy of the digital wallet. And we believe that PayPal is going to be one of the digital wallets in the future. We're very clear on that. We have a ton of conviction around that. And we continue to demonstrate that we can expand margins over time as well. We've done that consistently. And that's part of the benefit of our business given the scale that it has is that we can grow at very low unit cost rates, and we'll continue to do that. There's going to be some kind of anomalous margin pressure this year, particularly around the lapping of the release of credit reserves. But when you look at the rest of our business, it's still performing very well, particularly if you normalize for that. And investors should clearly expect to see leverage in our non-transaction costs this year as we continue to focus on efficiency and getting rid of complexity in our business.

For this year, what are your top 3 priorities for spending on new growth initiatives? And do your top 3 spending priorities change as we move into 2023 and beyond?

Well, I would say, first of all, they probably don't change. I think for the near term is, and I'm defining near term as kind of the next 18 to 24 months. We're going to be very focused on some of the things that we've consistently talked about. So checkout is one. Digital wallet would be another one. And then expanding some of these newer areas of our business like buy now, pay later, like crypto, including things like savings and investing. But I put that all into this bucket of the digital wallet. And so I would say checkout, digital wallet and then also platform investments that we're making to increase the efficiency and drive increased capacity and speed for us.

As interest rates increase, how does that affect your approach to growing your BNPL products such as pay in 4 and pay in 3 and will you pivot to longer-term interest-bearing installment products as the cost of funding increases?

Sure. So I talked about some of the great progress we've already made with buy now, pay later. I won't repeat myself. But we're in 7 markets today, 8 markets, if we include Japan with Paidy. So very excited about the speed with which we've launched that product, arguably, the best product launch that we've had in the history of our company. And we are moving into longer duration loans. We've actually already done that in Germany today. And that will include monthly payments that are like better suited for larger or higher average AOVs. And so we will move there. But it's more, David, a result of the consumer demand for that and the expansion of our product versus being responsive to the interest rate environment.

Understood. In addition to being CFO, you're also EVP of Customer Operations. So when you put your second leadership hat on, are there other important initiatives that we haven't discussed today which may fall more on to your CFO responsibilities that you tend to focus more on the customer operations side?

Sure. Well, in customer operations, the thing that we're primarily focused on is providing great experiences for our customers, but there are issues sometimes that pop up where customers have to contact us. Our primary focus is reducing those contacts. We don't want customers to have to contact us. And when they do, we want to be able to handle that without them needing to call back, without transferring them and do it in an efficient manner that delights them. And so we are working very closely in customer operations with our technology and product development teams to root out those defects in the business so that someone doesn't have to call us. If they want to change their phone number on Venmo, they shouldn't need to call customer service. We should be able to give them the tools to intuitively do that themselves. And so I would sort of generally describe this as like rooting out defects to make sure that we just get fewer contacts. Our contact rate today, meaning the number of contacts we get from customers relative to the overall transactions, is about 0.5%. We'd love to get that down to half that, right? And if you think about the opportunity that we have for efficiency and for better customer service when you've got a much lower contact rate like that, it's tremendous. And so it's one of those areas that I point to when we talk about being efficient and getting leverage. We've seen that over the last several years in this area of our business. And with the partnership of our product and technology teams, we expect to see in the future.

I know we're coming up on time. So as a closing question, with 2022 being one of a transition for PayPal, what do you see as the most underappreciated growth drivers at PayPal that could become more important as we exit 2022 and enter 2023?

Well, again, the secular tailwinds for our business have not changed, and we expect them to continue to increase in the years ahead. I think we're only moving further and further into e-commerce, into digital payments, digital wallets having more primacy. But look, we got ahead of ourselves last year when we extrapolated some of the benefits from the pandemic forward. And we're disappointed to be in that position. But there is absolutely zero question, David, that as we assess where we are today relative to pre-pandemic, we're a much, much stronger company than we were 2 years ago in terms of scale, engagement trends and even product innovation. And so we're going to continue to focus on those things that delight our customers and give more utility to the wallet and more ways for them to use us and really try to capture these tailwinds to be one of the leading players in digital payments in the future.

Thank you, John, for your time, your insights, for being so responsive to questions. Always great speaking with you, and thanks for your participation in our conference today.

Thank you for the opportunity, David.