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

All right. We'll go ahead and get started here with PayPal this afternoon. Thank you very much to everybody for joining us this year's TMT conference. Before I get started with Dan Schulman, President and CEO of PayPal, I do have some important disclosures to read. Please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative.

So Dan [ walked in ]. You have your boots on. I have my boots on. This is the start of the last rodeo tour. Is that the deal?

Exactly.

At least as far as investor conferences go. So -- all right. So look, I've got my questions here, but maybe we'll start at a high level. Over the past year, you and the rest of the team at PayPal have taken a number of steps to adjust to both a softer e-commerce environment as well as general macro environment. So how do you feel about your positioning today? And what will you be most focused on in the coming year? Like what does the to-do list look like?

Well, first of all, thanks for having me, James, and thanks for wearing your cowboy boots in empathy. So look, it's been an interesting last several years for all of us, and especially if you were in the e-com sector. We went into the pandemic, everything doubled. Our volumes doubled. We put on over 100 million new actives. And then you come out of the pandemic and you need to adjust to a new reality, as online to in-store adjust. And people are trying to figure out what does that look like. And then at the same time that's happening, you have the war breaking out in Europe, ravaging the European economy. You have COVID shutdowns in China, really limiting exports out of China. You have inflation across the world, which is affecting discretionary spend. All of that impacting kind of the e-commerce market. And on top of that, for us, we also had to absorb $1.9 billion of revenue coming out of our revenue streams as eBay moved to their managed payments. All of that happened in the last 3 years. So as I think about kind of where are we right now, eBay is done. We've lapped that. It was 40% of our profits when we spun out of eBay. It's less than 2% of our profits now, less than 2% of our revenues. So we've lapped that, and we're kind of moving forward on that. In terms of kind of the economy and e-commerce, I said a month ago when we reported Q4 that the quarter was off to a strong start. And here we are about a month later, and I would reiterate that again. I think across our business, we're seeing strength that's beyond what we expected. Both branded checkout is accelerating. Unbranded, it's doing quite well. So we're either beginning to see the beginning of a turn of e-commerce. The inflation cooling slightly. Maybe discretionary spend coming back. Maybe our products really taking an impact in the market. The third thing, obviously, is our cost structure now is exactly where we want it to be. We spend a lot of time on that. I'm sure we'll talk about cost structure going forward. But we feel highly confident in our ability to meet or exceed that 18% EPS target that we put out to grow our operating leverage at least 125 basis points. And then clearly, our products are beginning to make a mark now with our merchants especially. We're seeing a lot of uptick in share types of things where we have our latest integrations. And many of our competitors are actually weaker right now. People talk about the competitive environment. But if you look at the Buy Now, Pay Later players, they're having a very tough time. They're pulling back. They're desperately trying to figure out how to make money while we continue to gain share off of that. So I think we -- it's been -- that's been a real focused couple of years for us. We've had to do quite a number of things. But I think we're going into '23 with the potential for it to be, I think, a very strong year and to come out of it with a lot of momentum.

So let's talk about some of the underlying assumptions there and as you look at '23. Importantly, when we go back to a month or so ago when you reported earnings, you did not provide a top line outlook for 2023. But can we talk about how you're thinking about e-commerce through February and what that portends for the rest of the year? It's obviously a hard question. But what's your view right now of the world from the e-commerce perspective?

Yes. Well, it's still obviously intensely complex set of things that you need to think through. You do have inflation coming down slightly, but it's still stubbornly high. Fed and other central banks will definitely need to continue to take up interest rates. That's for sure. By the way, higher interest rates actually help our business model given the amount of balance we have on our balance sheet unlike a lot of our competitors. But we are still seeing the strength that we saw coming out, and so I feel like 1 of 2 things are happening. I think from our perspective, we thought that e-commerce was going to be flat, maybe up low single digits. I think it's going to be higher than that, and I think it's going to be higher than what we expected in the short term and what we expected for a full year. And again, we're seeing that across the business. Like branded checkout is accelerating from fourth quarter. Unbranded continues to go from strength to strength. We're starting to launch new products into the market like our PayPal Complete Payments down market for unbranded and putting all of our best integrations of branded checkout into that. So we look at this quite carefully. Obviously, it's our whole business, and we have quite a bit of the share of the online market comes through our platform. But as we look country by country, it's different. But China, clearly opening up, seeing exports starting to come out of that. European economy, much better than a lot of us feared it would be. And the U.S., if we do go in a recession, I think it will be shallow, shallower than we anticipated. And we are beginning to see people spending more on discretionary items, at least through our platform. So let's wait until the quarter ends until we see what happens, but I think our view is that e-commerce growth will be stronger than at least we expected going into the year.

So there's that, and the macro environment sounds good. And frankly, we heard something similar from Visa, and they talked about their card not present volumes in a press release late last week. So that seems relatively consistent. But what about the branded checkout? You said that, that seemed to be tracking a little bit better than maybe it was in the fourth quarter. How do you expect that branded checkout to grow relative to kind of the underlying volumes of the stores where PayPal is accepted this year? I mean can it continue to take share online, do you think?

Well, I think that's going to be a debate that will go on until there's a accurate single metric that measures that. Look, we are trying to work with a couple of the big measurement firms out there, whether it be Euromonitor or Salesforce or others, to try and get a consistent view of market share. Look, we've tried to be quite transparent about it. We think there are certain markets where we are gaining quite a bit of share. There are markets where we're losing share. And there are markets where we think we're basically holding share. One way or another -- and that debate will go on, and we'll try to prove our hypothesis that I think, overall, we are holding or gaining share. But one way or another, acceleration of branded checkout from Q4 into Q1 is a good thing. It doesn't matter where you are on that debate. As you see branded checkout accelerate, that is a positive thing for us. I think we look at kind of what the dynamics are in the market. We are anywhere between 3 and 5x the market share of checkout of our nearest competitor. So of course, when you're the biggest, growth rates can be different. We also -- this isn't a zero-sum game between digital wallets. We are all feeding off of people manually entering their card. That's still 25% to 30% of the market. We're taking a lot of share from that as our other digital wallets. But the other thing is we're now beginning to take share and quite meaningfully so from other Buy Now, Pay Later players. And where we have our best integrations in place, it doesn't matter who we're competing against we hold or grow share. They obviously have size advantages in terms of our scale. 80% plus top 1,500 merchants in the U.S. and Europe. 35 million active merchant accounts throughout the world. Consumer preference clearly skews towards PayPal when doing an online checkout. So there are a lot of things that are advantages for PayPal. That said, there are also places where we need to get better, and we're quite upfront about that as well. I think when it comes to mobile checkout, where people aren't on our best integrations, they're not on our Braintree integration. They're not on our mobile SDK. Where you're not native in the mobile app, where you have to go into the app and then jump out to the PayPal servers to complete your PayPal transaction and then go back into the merchant, that adds latency. It adds clicks into it. We know that conversion goes up almost 10%. We have our latest native integrations into that. And so -- but that's where we're putting all of our efforts in terms of checkout and our digital wallets and our unbranded efforts to carry our best integration. So we know where we need to focus, where we do have those integrations going into place. We see them doing exactly what we expected, and now it's just a matter of time for us to roll that out to our base. But we've got quarter-by-quarter objectives. We've made good progress. We'll continue to make good progress, and we've got a lot of assets to build off of.

So I want to ask a couple of follow-up questions to a few of your points there. First, back on branded checkout, our own proprietary research shows that, and I'm sure you know this better even than we do, is that brand-wise, Venmo skews to a younger demographic that is really kind of entering the workforce in force now and with strength. And we've had Pay with Venmo roll out at Amazon. But -- and we're also seeing Venmo -- Pay with Venmo expand to other merchants as well so you can start to monetize that. But how should we think about the path forward for Venmo? And what does that look like? And are we at a point yet that, that's contributing to this improvement in branded checkout that we're seeing?

There are places in our business where I give us an A for execution. I think our unbranded right now, some of our checkout experiences, some of our SDKs and APIs have gone from really 0 to being best-in-class over the last year. On Venmo, it would be harder or greater on that. Look, Venmo is a beloved brand. You got some 90 million active accounts just here in the U.S. It's almost 1/3 of the U.S., 60 million or so monthly active accounts on Venmo. It's beloved. It's a verb. People use it. When I go to college campuses, I always ask this question, like how many of you use Venmo? It's 100%. It's not like 85%. It's 100%. So it's exactly that demographic that you're talking about. And so it's got huge potential in terms of its monetization capabilities, but the reality of that versus the potential is not what I would expect at this time. By the way, that's not to say that it's not growing great. It's doing over $100 million of revenue every single month, growing at double digits. It's obviously a meaningful part and a growing part of PayPal. But I think there's so much more that we can do with the franchise. Pay with Venmo is slowly but surely coming along. When you went into Amazon, it's basically getting 1/3 of the market or more of acceptance. We just were accepted at Starbucks. We're in all the leading mobile apps right now. And you're beginning to see that take hold, but that will take some time. I think that tap-to-pay, our partnership with Apple moving into the Venmo business accounts, could be a meaningful mover of that. And we need to and should do a much better job on linking credit and debit into the app. Because where we have, people have done that. You see CLV is 5x of a Venmo customer. So I am -- there's a lot to like about it, but we need to do a lot more to really take full advantage of its potential.

Got it. Got it. And then back on capability and product capability on branded. Let's talk about the -- you mentioned the competition a little bit in passing, but the one that we hear about a lot is Apple Pay. And I think that's probably a key source of concern even with particularly Apple Pay's growth online. What advantages do you see or do you think PayPal has relative to Apple Pay? And where does PayPal still need to do work to be comparable in terms of tech, user experience, adoption, et cetera? Like what's -- like where have you executed well on the to-do-list? And what's still on the to-do list?

Yes. Well, clearly, we have a lot of advantages in general, not just versus Apple Pay but others. Our acceptance at merchants is magnitudes greater than any other wallet. Consumer preference is at least 2 to 3x. Some studies have shown 8x for using PayPal at checkout. We have kind of the highest conversion rates in the market, the lowest loss rates in the market for our merchant partners. We also accept a wide range of payment financial instruments. You can pay with rewards points. You can pay with your balance. You can pay now or you can pay later or Buy Now, Pay Later, which has now accepted over 300,000 merchants upstream on product pages. Over 2 million merchants have had a Buy Now, Pay Later experience with PayPal. Over 30 million consumers have used Buy Now, Pay Later at merchants 200 million times. It's an amazing franchise that grew at 160% last year that is differentiated than in Apple Pay or others. And our app has more services in it. You can go to it beforehand. You can look for coupons, promotions, discounts. We're putting in order tracking post purchase as well. So we have a lot of things that an Apple Pay or others don't have. And where we have some gaps versus Apple Pay, which are in things like authentication, we're closing that gap quite a bit. Our passwordless login now is up to about 60% in the U.S. We're implementing pass keys that enables us to move right into biometrics across both Android and Apple. So we're closing those kind of gaps. Where Apple still has an advantage, and it's one where I think it's an unfair playing field, is we don't have access to the NFC chip. So in store, they have full access to that, and that will inevitably be a regulatory issue at some point in time. So I think we're closing the gaps where we think we have gaps, and we're doing that quite aggressively and quite quickly. And we also have a number of advantages that others right now just don't have.

Right, right. No, that makes sense. So let's talk about profitability, margins, et cetera. You talked about that is the -- that you think that you can grow EPS this year, at least 18% on the back of at least 120 basis points or a little better of margin expansion. Clearly, for investors, and it makes sense, as cost of capital goes up, interest rates go up, near-term profitability becomes more important for investors. And you have a large-scale cost savings plan out there. But can you take us through some of those cost savings, where they're coming from, how they're progressing? And if we were to see a better top line year than you would expect, how do you mix the flow-through versus returning some incremental investment, et cetera?

Yes. Well, we're kind of ahead of the targets that we talked about. Last year, we laid out that we felt we'd do $1.3 billion of savings this year. We added another $600 million on top of that. And I think we are at the beginning of that cost journey. We just had a long multi-day staff meeting, looking at kind of the impact of our machine learning and our AI capabilities inside the company. And literally, every part of the company is going to be impacted by that. Our back office, our front office, our coding, our legal teams, our marketing, all of that, we're going to be able to do at much lower cost structures than we have and much better than we do today. I think this idea of us having operating margin leverage as we expand our revenues going forward is something that we see for multiple years ahead. This is not a 2023 and you're where you need to be. This is '23, '24, '25. There is so much that we're going to be able to do to reduce costs, but not just reduce costs because that's never your way towards greatness. It's important to be as efficient as you can be. But I think reduce our cost and become just much better than what we're doing. I'm already seeing that in our product delivery in terms of our ability to say we're going to do something and then go do it and then for it to do what we thought it was going to do. But I think as we grow our revenues, and I feel good about our momentum on that front, you will see a lot of that drop down to the bottom line. And that's why we're highly confident of our 18% EPS growth, but highly confident of operating margin leverage in the years ahead.

Right. Well, that's good to hear. Let's talk about management. Yesterday, it was announced that Blake is stepping down as CFO. On that news, certainly, my own heart goes out to him and his family for -- all the best for him. But -- so that's a seat to fill. Obviously, your own seat to fill. Can you just talk about how we should expect that to progress? And maybe as you're talking about the progression, maybe more importantly, as we were kind of chatting beforehand, what do you see as the biggest challenges for the next CEO of PayPal? It's a multifaceted business that's got a lot of complexity that I'm not sure everybody always appreciates.

Yes. Well, first of all, on Blake, obviously, it didn't work out as any of us hoped. He came into PayPal. He was here for about 3 weeks or so before he had a medical condition that he had to address. We've been waiting to see how that goes and how he feels. And these jobs, as all of you know, they're 24/7. They are incredibly physically and emotionally demanding jobs, and you've got to be 100%. And Blake and I spoke, we had been speaking all the time, and we both agreed that it's going to be very difficult for that to happen. And Gabrielle has done such a wonderful job for almost a year plus now, and we are very close partners. She is maybe the only person in the company who I know for sure works harder than I do and knows the business inside and out. And we have not missed a beat since John left for Walmart. Gabs came in, and it's just been super. So we'll continue on with that. And as you were saying, I also wish the very best for Blake. He will be a senior adviser for us. He will help Gabs over the course of the next couple of months and hopefully help me as well. But this was the right thing for both PayPal and for Blake. In terms of the next CEO of PayPal, look, it's a very complex global company that's got massive scale on the consumer side. We have like 400 million active accounts across the world, 35 million business accounts. It's a big B2B company. It's a big B2C company. It's a big network company. It is -- operates in an incredibly fast-moving ecosystem. I'd say, are we in financial services? Are we in technology? Are we in other parts of the chain, really kind of the underlying platform piece of it? Yes, we're in all of that. We are partners to the biggest financial institutions in the world, all of the networks. We serve small businesses to the largest enterprises and most sophisticated enterprises in the world. And we are massively regulated. We are 67 regulatory entities throughout the world. We work with finance ministers and government officials on everything that we think about because we are at the leading edge of a lot of where the financial system is moving towards. And we have massive scale. We do 6 billion-plus transactions a quarter. We do -- what did we do last year? $1.3 trillion, $1.4 trillion through our platform. And so we need to be quite thoughtful and quite deliberate as we think about the next CEO. They need to continue to assure that we continue on with the initiatives that we have in place. They have the same discipline around productivity and cost structure, but that they continue to evolve our value proposition going forward. And we need to never stand still around that. That anticipating what customers need, assuring that we can deliver against that, which we are getting better and better at, is incredibly important. I do think that the next CEO, because I do think we will exit this year with a good amount of momentum, I think a lot of things will be in place. And really, the next thing to really think about is what does the ecosystem look like going forward? Clearly, you're seeing a lot of retrenchment in the ecosystem. Look, PayPal is a massively strong company, generate well in excess of $5 billion of free cash flow every single year, incredibly strong balance sheet. We're gaining a lot of momentum. We have a lot of partnerships, but kind of thinking about where the ecosystem is going and what is our part in that will be, I think, a big part of what the next CEO looks like, along with assuring that we have a value proposition that nobody can replicate. We have assets and information and data and AI and machine learning tools that nobody else has right now. We have the largest vault of financial instruments in the world by far and away. We have the largest dataset. We should be able to and we are beginning to work on kind of what does that next generation of checkout look like and how is it that we can build something that actually nobody else will be able to replicate or be very difficult for them to replicate. And so there's a lot for the next leader for PayPal to focus on, to be excited about. And I couldn't be more excited about continuing on the Board and helping them in that next chapter.

Yes. No, for sure. It's like -- it's a very unique position and challenge because PayPal has tremendous strengths. But at the same time, even if just because of cost of capital, et cetera, the world is changing. And so like the way that you have to put together and manage those partnerships, et cetera, are changing as well.

Absolutely, yes.

So a big job to do. Well, Dan, thank you very much for joining us. That's all the time we have. Thank you to everybody for listening in.

Thank you, everyone.

Thank you.