PayPal (PYPL) Report

Since Saul initiated a position, just thought I would share my notes.

PayPal Inc.

The Twitter Intro

PayPal is a technology platform that allows its customers to accept and receive digital and mobile payments anywhere in the world, anytime, on any platform and through any device (e.g., mobile, tablets, personal computers or wearables).

PayPal’s History

PayPal’s history is a short but storied tale that involves some of the most legendary entrepreneurs that have passed through Silicon Valley. Indeed, some even credit PayPal’s incredible success for transforming Silicon Valley into the hotbed for tech startups that it is today.

Early Days. In 1998, Max Levchin and Peter Thiel met at a lecture Thiel gave at Stanford University. After exchanging ideas for startups, the idea they liked the best was developing cryptography for handheld devices, namely Palm Pilots. The company is this early phase was called Fieldlink.

In 1999, after Fieldlink failed to gain traction, the company changed its name to Confinity and shifted focus to a much more specific application: Transferring cash using Palm Pilots. This Wired article from 1999, besides being amazingly quaint, also shows the extraordinary vision Thiel possessed even at these early stages in the company’s growth:

The bill for lunch arrives, but you’ve left your wallet in the car. Your lunchmate doesn’t want to pick up the tab.

So she pulls out her Palm III, beams you a little program called PayPal, and suggests you beam back your share of the bill. Later that day, the cash comes out of your account and drops into hers.

That scenario should be a reality by September, when Confinity, a Palo Alto, California software start-up, launches PayPal, an application that will allow individuals to “beam” sums of money between handheld devices such as mobile phones, Palm Pilots, and pagers.

“All these devices will become one day just like your wallet,” said Confinity CEO Peter Thiel. “Every one of your friends will become like a virtual, miniature ATM.”

Read the entire article at http://www.wired.com/1999/07/paypal-puts-dough-in-your-palm/…

Later that same year the company introduced the concept of transferring money via email, an idea that would eventually launch the company to dizzying heights.

In March 2000, Confinity merged with X.com, a company Elon Musk co-founded that was focused on online banking solutions. Musk believed so strongly in their flagship service that he renamed the company PayPal in 2001. After the company started receiving lots of positive feedback from eBay customers, the company shifted focus again, this time to the growing e-commerce market.

Musk would not remain the CEO for long. He believed the company should move from a Unix to Microsoft platform. He lost the battle and was replaced by Thiel shortly thereafter.

If this seems like a lot of fundamental shifts in focus, it was. Many of the early PayPal employees have since commented on how “nimble” the company was as a startup. In a video at the link, Reid Hoffman, former PayPal executive vice president who would later go on to co-found LinkedIn, explains the many “pivots” PayPal needed to perform just to stay afloat: http://www.fastcompany.com/1837839/reid-hoffman-paypals-pivo…

Besides being incredibly nimble, the company was also defined by the relationships and friendships within. Headhunters were never used to hire talent and, for better or worse, an eye was always kept on how well a potential hire would fit in with the existing employees:

“When we started PayPal, I remember one of the early conversations I had with Max [Levchin] was that I wanted to build a company where everybody would be really great friends and, no matter what happened with the company, the friendships would survive,” former PayPal CEO Peter Thiel said. “In some ways that was very utopian. We didn’t only hire our friends, but we did hire people that we thought we could become really good friends with.”

From http://www.techrepublic.com/article/how-the-paypal-mafia-red…

Looking back, it is remarkable how many characteristics PayPal pioneered for the modern day Silicon Valley startup. According to a Tech Republic article, they were:

1. One of the first viral apps: PayPal users were able to send money to someone without an account, forcing them to open an account to claim their money.

2. One of the first companies to use a platform strategy: Sacks said that PayPal was “essentially an app on top of eBay.”

3. One of the first companies to offer an embeddable widget: Users could put the PayPal payment logo onto an eBay auction. Embeddable content later became key for YouTube and was a big part of how it grew.

4. One of the first companies to rely on an iterative product strategy: Features were released whenever they were finished, not at the mercy of product cycles.

From http://www.techrepublic.com/article/how-the-paypal-mafia-red…

After PayPal turned their attention to e-commerce, eBay was never able to thwart them despite controlling the checkout line, perpetually changing the rules to their advantage, and releasing competing products. In 2002, PayPal went public and a few short months later were acquired by eBay.

The eBay Years. Within a year of being acquired, nearly all of PayPal’s key executives had moved on. The culture shock of trying to integrate with a more traditional corporation was just too much.

(Off topic side note: The original PayPal members, now affectionately known as the “PayPal Mafia”, went on to conquer the tech business world. Among the startups this group went on to found or co-found: LinkedIn, Yelp, Youtube, Tesla, SpaceX, SolarCity, and Yammer. This is from 2011, but this Business Insider article tried tracking them all down to note their various accomplishments since leaving PayPal: http://www.businessinsider.com/the-paypal-mafia-is-even-more…).

After being acquired, PayPal became eBay’s default choice and competed with and ultimately defeated a slew of competitors: eBay subsidiary Billpoint, Citibank’s C2It, Yahoo!’s PayDirect, Google Checkout, and Western Union’s BidPay. All these services were eventually shut down in the subsequent years.

In 2005, eBay acquired for PayPal the payment gateway of Verisign for $370 million.

In 2008, PayPal acquired Fraud Sciences, an Israeli online security startup to bolster their fraud prevention services for $169 million. Later in the year they acquired Bill Me Later, an online payments company offering credit at the checkout of thousands of online retailers.

In 2010, PayPal broke 100 million active user accounts. At the time, they were in 190 markets through 25 different currencies.

In 2013, PayPal acquired Braintree, an online payments platform for merchants, for $800 million. Also a part of the Braintree acquisition was Venmo, a P2P mobile payments app.

In 2015, PayPal acquired Paydiant for $280 million. Paydiant is a cloud-based mobile wallet. Later in the year, PayPal acquired Xoom, a digital international remittance company.

eBay Spinoff. In September 2014, it was announced eBay would spinoff PayPal. In July 2015 the spinoff was completed.

Why Customers Use PayPal

Answering and understanding this question is obviously crucial in evaluating PayPal’s future business prospects, but I think a lot of times people who don’t use PayPal’s services don’t quite understand PayPal’s appeal. Thus I am attempting to explain the attraction of PayPal to its millions of account holders. Of course, there might be many reasons that I miss so if you can think of any, please reply to this thread. Personal examples are welcome!

Let’s look at the primary reasons why people use PayPal’s flagship service:

1) Send or receive payments for online auctions and purchases on eBay, Etsy, and other websites. PayPal is, by far, one of the easiest ways regular people can accept payments online for the occasional sale of goods. For instance, my wife will sell about three or four things on eBay every year. PayPal allows her to do this seamlessly along with her customers. Ditto for the weekend artist or craftsman who sell their goods on Etsy or Pinterest.

2) Buy goods online with smaller retailers. Who has ever shopped for items online only to find the exact item they want at a great discount on a website from which they’ve never made a purchase before. In many such cases, it makes sense for the consumer to use PayPal over using a credit card.

For starters, there are security reasons. There is something to be said for entering your credit card and bank accounts once when you first open your PayPal account and then never having to do it again. By paying with PayPal you keep your information private, meaning you don’t have to worry about a hacker capturing your account data from online merchants you’ve done business with.

Many experts believe PayPal also protects your data better than the banking and credit card industry:

According to PayPal your data is safe. (But who wouldn’t say that?) PayPal states that your information is encrypted with the highest level commercially available. Its servers check your browser to make sure it employs the latest encryption technology and your data is stored on servers that aren’t directly connected to the Internet.

Slava Gomzin, author of “Hacking Point of Sale: Payment Application Secrets, Threats, and Solutions,” supports their contention. “If you have a choice on the Web, always select PayPal,” Gomzin says.

PayPal even pays hackers if they find vulnerabilities in its systems. According to Dean Turner, director of security intelligence at PayPal, “If you care about the product [and] you care about your customers, you care about your customers’ security – this is what you have to do.”

From http://www.investopedia.com/articles/personal-finance/011215…

Second, there’s convenience. I hate fetching my wallet, retrieving my credit card from its confines, and then entering all of the accompanying information (e.g. credit card #, expiration date, CCV, billing address, etc.) every single time I want to buy something on the internet. It is much easier to click the PayPal icon on the retailer’s website and be done with it.

3) Peer to peer payments. It’s very easy to send money to friends or family – no matter the reason – using PayPal. It’s much better than writing and mailing a check or, even worse, using a service like Western Union at a steep fee.

Of course, PayPal offers many other services but I just wanted to try to explain why its flagship service is currently dominating the e-commerce payments market despite efforts from MasterCard, Visa, and American Express to cut into its market share.

Why Businesses Like PayPal

I think there are two primary reasons why any online business in today’s world has to offer PayPal as a checkout option if it wants to compete.

First and foremost, is the sheer amount of PayPal account holders. With nearly 180 million active accounts, no business would ever want to turn away so many potential customers. Second, businesses want to sell merchandise and no other online payment option does a better job of having shoppers finish their shopping experience with an actual purchase:

A new study from comScore shows PayPal has the edge over its rivals on that front. Shoppers using PayPal finished their purchases 87.5% of the time, compared to 51.1% for people paying with second-place Visa (V) Checkout. Other competitors such as Amazon and MasterCard (MA) were lumped into a single group with a 45.6% conversion rate.

A key factor in PayPal’s performance is its One Touch product, which debuted last year and enables payment authentication without requiring the shopper to enter a user name or password each time. Twenty-one million people currently use One Touch.

From http://www.investors.com/research/ibd-stock-analysis/paypals…

Look at those conversion rates again: PayPal crushes the competition when it comes to closing an online sale. Retailers who sell their merchandise and services on the web are not going to allow other payment services start crowding PayPal out.

PayPal’s Brands

Venmo: One cannot begin to talk about PayPal without mentioning Venmo. It has become a payments monster, devouring all other peer-to-peer services in its path.

Payment volume for the popular money-transfer app, now owned by PayPal, grew 154 percent year over year in the first quarter of 2016 to $3.2 billion. That’s up from $1.26 billion in the same quarter last year.

From http://www.recode.net/2016/4/27/11586488/venmo-is-growing-ri…

Practically all this growth is from millennials with whom Venmo is extremely popular. The Venmo app allows mobile users to transfer money person-to-person via their bank account, debit card, your Venmo balance and even credit card. They charge a nominal fee for credit card transfers. In other words, it’s a perfect app that allows young people to split dinner tabs, take a taxi together, or let a friend borrow some money without having to have the exact amount of cash on hand that the situation requires.

Venmo is actually a money loser for PayPal right now. It has to pay a small transaction fee for each of these money transfers but allows their users to make the transfer for free (except when it involves a credit card). But PayPal is slowly exploring ways for Venmo to make money without disrupting its user growth and I think that’s the right approach. Mark Zuckerberg took nearly the same approach with Facebook, famously not wanting to ruin Facebook’s coolness in its quest for profits and that seemed to work out pretty well.

Plus, PayPal is not sitting on its hands with Venmo. It is already exploring a Pay with Venmo option that would allow its users to pay for merchandise at physical retail locations:

PayPal thinks it may have an answer. Earlier this year it launched Pay With Venmo, a service that lets Venmo users easily place purchases in apps using their Venmo account information. PayPal will charge app makers a fee for each transaction that goes through the new payment method.

PayPal CEO Dan Schulman said on Wednesday’s earnings call that 550,000 Venmo users now are eligible to use Pay With Venmo. The service will be available to all Venmo users by the end of the year, he said.

Braintree: Sets up online payment systems for traditional and e-commerce retailers.

Paydiant: A cloud-based white label mobile wallet app. In other words, it allows businesses to create their own mobile wallet app.

Xoom: Xoom is a digital remittance company that allows users to transfer money across borders. From Fortune:

CEO Dan Schulman is trying a little bit of everything in his efforts to keep PayPal competitive. And immigrant workers in the U.S. may turn out to be one of his secret weapons, thanks to a PayPal subsidiary called Xoom.

Xoom is an app-based money-transfer service, designed to capture part of the $600 billion global market for remittances—money sent across borders, typically from a worker in one country to his or her family members in another. For decades, this business has been concentrated in storefront locations where lines are long and security problems can be a hurdle.

Last July, PayPal paid $890 million to buy Xoom, which moves such transactions out of the physical store and on to the mobile screen. Xoom’s app lets users transfer money to 53 countries, designating the recipient and specifying whether the payment should go to a bank account or involve a cash pickup or delivery. Senders must link transactions to a bank or credit card account, but it’s safer and cheaper than using a money-transfer office.

From http://fortune.com/2016/06/14/paypal-immigrants-xoom/

PayPal’s Numbers


Revenues (millions)			Q1		Q2		Q3		Q4	
2014					1874		1983		1971		2193	
2015					2137		2297		2258		2556
2016					2544

EPS (non-GAAP)			        Q1		Q2		Q3		Q4
2014					0.27		0.28		0.24		0.28	
2015					0.29		0.32		0.31		0.36	
2016					0.37

Revenue Growth (billions)
2015 Q1 TTM Revenue = 8.284
2016 Q1 TTM Revenue = 9.665
Year Over Year Revenue Growth = 16.55%, previous Q 15.3%

EPS Growth
2015 Q1 TTM EPS = 1.09
2016 Q1 TTM EPS = 1.36
Year Over Year EPS Growth = 24.8%, previous Q 19.6%

P/E (Check Current Price) = 37.36/1.36 = 27.47

1YPEG = 27.47/24.8 = 1.11

PayPal Metrics

Here is a look at some of PayPal’s other important metrics growth:

of active accounts: 184 million, +11% YOY

Payment transactions: 1.414 billion, + 26% YOY
Payment transactions per active account: 28.4, +12% YOY
Total Payment Volume: $81.056 billion, +29% YOY
Transaction margin: 60.4%

And here’s a look at the historic growth of those numbers:


# of Active Accounts (millions) 		Q1		Q2		Q3		Q4
2014						148		152		157		162
2015						165		169		173		179
2016						184

Payment Transactions (millions)		        Q1		Q2		Q3		Q4
2014						918		930		972		1144
2015						1123		1161		1216		1428
2016						1414

Payment Transactions Per Active Account	        Q1		Q2		Q3		Q4
2014						23		23		24		24.5	
2015						25.2		26.1		26.9		27.5
2016						28.4

Total Payment Volume	(billions)		Q1		Q2		Q3		Q4
2014						53.676		56.736		58.184		66.039
2015						63.021		67.482		69.738		81.523
2016						81.056

Transaction Margin (percentage)		        Q1		Q2		Q3		Q4
2014						65.0		65.7		63.1		63.5	
2015						64.2		63.8		62.3		61.1
2016						60.4

Matt
Long PYPL
MasterCard (MA), PayPal (PYPL), and Verizon (VZ) Ticker Guide
See all my holdings at http://my.fool.com/profile/CMFCochrane/info.aspx

45 Likes

Matt, What an incredible tale! Tell me you didn’t put all that together just since I posted my brief summaries! :wink:

What a history!

thanks

Saul

2 Likes

What a history!

I love reading about the histories of the companies I invest in and PayPal’s was particularly fascinating. I’ve been working on the write-up for quite a while but recently have just been swamped and couldn’t find the time (or motivation) to just finish it. When you initiated a position, I took that as a sign to just get it done :slight_smile:

Matt
MasterCard (MA), PayPal (PYPL), and Verizon (VZ) Ticker Guide
See all my holdings at http://my.fool.com/profile/CMFCochrane/info.aspx

1 Like

I’ve been using PayPal probably since there has been a PayPal. However, I’ve never looked at it as an investment. I like the trend on revenue, but the EPS seems low at first blush given the number of transactions.

The history looks like a silicone valley who’s who. Which immediately makes me wonder how bad is dilution from share based compensation?

Should we be worried about the new wave of cell phone based payment strategies like Apple Pay and Google Pay and many others? I’d never heard of Venmo until I started reading this thread. Looks like Square Cash is another alternative. How big is the moat?

Taking a closer look but not eager to buy another financial after all the BOFI hoopla

3 Likes

Matt,

Interesting writeup on PayPal. I’ve been thinking on this all day. A lot of what you point out here looks great, but at a gut level I’m having some mixed feelings.

Pulling out my Devil’s Advocate cap for a moment …

PayPal has a huge early adopter advantage and thus significant brand name recognition. This has built up a lot of momentum in the company as online payments become more common and people become increasingly concerned with the security implications of handing out credit card details.

However, I don’t see that PayPal has any significant advantage which another company couldn’t match. For example, Verified by Visa is becoming very common for credit card payments and I end up choosing it over PayPal for its simplicity and also to eliminate the PayPal middleman. Other services are also spreading rapidly, MasterCard SecureCode, Apple Pay, and Google Wallet (and Android Pay) being the obvious big names.

This has me concerned that even if PayPal continues to increase revenue and total transactions, margins may fall causing earnings to suffer.

As I write this, I am looking back at the first post in this thread. I see the final section, “Transaction Margin (percentage)” shows a downward trend from 65.0% in Q1 2014 to 60.4% in Q1 2016. For now, Total Payment Volume is increasing faster than Transaction Margin is decreasing, however that if this trend continues earnings may grow slowly.

From this perspective the current price seems perhaps a fair valuation or perhaps a bit high.

Any thoughts on this? Does PayPal have some compelling advantage I am missing?

All that aside (and removing my Devil’s Advocate cap), PYPL looks intriguing enough for a closer look. Matt, thank you for this amazing writeup of a very interesting company!

4 Likes

Hi Othalan,

However, I don’t see that PayPal has any significant advantage which another company couldn’t match. For example, Verified by Visa is becoming very common for credit card payments and I end up choosing it over PayPal for its simplicity and also to eliminate the PayPal middleman. Other services are also spreading rapidly, MasterCard SecureCode, Apple Pay, and Google Wallet (and Android Pay) being the obvious big names.

I agree with Your statement and that is why I own Visa (V), Mastecard (MA), Apple (AAPL), and Google (GOOGL) in addition to PayPal (PYPL). I believe transactions will continue to shift from paper currency based to electronic transfers and there is more than enough business for all of these companies to benefit. Who will be the BIG winner? Only time will tell but I feel I have the trend covered.

Wiseguy

2 Likes

I stopped using PayPal because my account got hacked twice. The hackers were able to get more information than just by logging into my account (e.g. entire bank account number). Luckily their consumer protection is pretty good, but I just don’t trust them.

Since then I turned on two factor authentication, and even that doesn’t work like it should. I have it set up to text me, but then I can’t use it abroad or in certain areas where cell phone reception is poor. Their alternative (using a Symantec app) is confusing and I’ve never been able to get it to work. I wish they would just use Google’s authenticator app which is very simple to set up and use.

They also have a ton of competition. I’d rather use Apple Pay (don’t have to provide credit card numbers to merchants) or Pay with Amazon (I use Amazon so much that it’s worth storing my credit cards there). Occasionally when I sell something on eBay or get payments from various sites it still goes through PayPal, and I’ll sometimes do person to person payments, but overall I don’t think much revenue goes to PayPal for those transactions.

PayPal feels like they should be much more of a success given how early they got started. They just haven’t grown along with the general eCommerce market.

Also, I hate how they push their debit card ads when you log in all the time.

4 Likes

“Transaction Margin (percentage)” shows a downward trend from 65.0% in Q1 2014 to 60.4% in Q1 2016. For now, Total Payment Volume is increasing faster than Transaction Margin is decreasing, however that if this trend continues earnings may grow slowly.

Othalan, Shame on you. :wink: You didn’t read my source material (Bert’s wonderful deep dive that I referenced in the Reviews, and which Matt said he read four or five times already). I won’t put it all in italics as it’s so hard to read, but everything after this comes from Bert’s write-up:

Saul

…the company’s reported decline of 380 bps for transaction margins. The CFO described the decline as based on several factors. Part of the decline is due to their strategy of improving their relationship with large retailers. Obviously, larger retailers won’t pay the percentage fees of PayPal’s smaller customers.

In addition, their new Braintree platform has a significantly higher percentage of card payments, and therefore lower rates, that PYPC is able to collect.

“We continue to see volume accelerate across our platform, driven in part by strong growth of our newer businesses. The mix shift to these newer businesses where we are investing puts pressure on our transaction margin, which good cost control will help offset."

While this seems reasonable enough to me (Bert), the stock performance these last couple of months suggests that investors remain dubious.

Regarding the decrease in payment margins, the CFO discussed the company’s strategy.

It’s a deliberate part of our strategy as we’re trying to increase the ubiquity of PayPal and allow our customers to use PayPal at larger merchants where we’re going to see decreased percentages. Fortunately for us, we have the ability to offset that decrease with the operating leverage in our business. And as a management team, we’re focused on our margins, our generation of free cash flow and growing EPS and not getting so focused on just one aspect of the P&L.”

Being focused on gross margin dollars and not gross margin expense makes sense to me (Bert), particularly for one of the larger companies in the space that can use its size effectively.

The acquisition of Zoom, which took place in July, 2015, also had an impact on net margins. Zoom is still very much in an investment mode, and will have operating losses at least until the end of this year. Excluding the Zoom acquisition, the balance of the transactional revenues reported a small increase in net margins.

3 Likes

Saul, thank you. I had completely missed that article and the discussion on PayPal’s strategy. I’m still a bit dubious as I don’t see any real edge PayPal has over the competition, but I’m continuing my research even so…

Hi again Othalan,

Try reading the whole article. It may answer some of your questions.

Best,

Saul