A few reasons to be bullish on PayPal
If PayPal returns to double-digit growth, the stock will take off. This level of growth might come sooner than the market expects.
Hello!
PayPal stock has been a disappointment. Over the past five years, PayPal's stock price declined 42%, while the S&P 500 and Nasdaq Composite indices advanced 81% and 106% respectively. The widely accepted narrative is that PayPal is losing its business to Apple Pay, and new entrants to the space, such as Shop Pay.
The multiples fairly reflect single-digit growth in revenue and flattish gross profit growth. However, if PayPal turns things around and returns to double-digit growth, I believe the stock will take off. PayPal still has the brand name and healthy cash flow, and is a major force in the payments industry.
In today’s essay, I attempted to break down PayPal’s business into components, highlighting that the company is already doing fine in several areas, including international and enterprise. What’s left is reigniting growth in branded checkout in the U.S. And that’s exactly where the company’s focus is.
Let’s dive into it!
Jevgenijs
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I believe many people would agree that if PayPal returns to double-digit growth (let’s say high teens), the stock would take off. It has the brand name, the scale, the cash flow, and the analysts’ coverage. However, over the past couple of years, the company struggled to hit this mark, consistently reporting 7-8% growth in revenue (and even poorer gross profit growth). I think this is about to change.
Before diving into growth drivers, let’s quickly review how PayPal makes money. There are three key components of PayPal’s business: 1) PayPal checkout (also referred to as “branded checkout”), 2) Braintree (also referred to as “unbranded card processing”, and 3) Venmo. There are also Xoom, Zettle, and several other services, but those have marginal contributions.
Over 90% of PayPal’s revenue in Q1 2024 came from processing payment transactions, so the total payment volume (or “TPV”) and the take rates (gross and net) are the key operating metrics. The non-transaction revenue comes primarily from the interest on customer account balances and interest-bearing consumer and merchant loans.
Branded checkout is only the second largest source of payment volume, but it is, by far, the largest contributor to revenue and gross profit. The gross and net take rates that PayPal enjoys from branded checkout greatly exceed the take rates for unbranded card processing.
Thus, Mizuho Securities estimates that PayPal has a 2.25% net take rate on branded checkout and a 0.30% net take rate on unbranded processing. In Q1 2024, the “blended” gross take rate was 1.91%, and the net take rate was 0.86%.
In terms of the geographic split, the U.S. is the largest market for PayPal and was responsible for over 64% of TPV in Q1 2024. PayPal’s 10-K states that “no single country outside of the United States generated more than 10% of total net revenues”, but the company generated 42% of its net revenues from outside of the U.S.
Now let’s get to what will help PayPal get back to double-digit revenue (and eventually gross profit) growth. I’ll start with the obvious…
Braintree is winning in enterprise
PayPal’s declining take rates get a lot of attention and often form a bearish thesis. The explanation is simple: the company’s e-commerce gateway business, Braintree, is growing much faster than branded checkout. Braintree operates at lower take rates; thus, bringing the overall company’s take rates down.
However, Braintree grows at a much higher rate than the e-commerce market, suggesting that it takes the market share from the incumbents. Moreover, the company’s TPV grows at a similar rate to Stripe and Adyen. For instance, in 2023, Braintree’s TPV grew 31%, compared to 30% for Adyen and 22-29% for Stripe (Stripe’s annual letter stated that the company processed “over $1 trillion”, hence, the range in the growth rate).
Braintree is a payments gateway, and relies on Fiserv for processing payments (both Stripe and Adyen have in-house processing capabilities). It also has a much narrower service offering than its peers (e.g. no capabilities to support issuing). Therefore, I believe that over time, Braintree can improve profitability by broadening its offering, selling value-added services (e.g. fraud prevention), and, perhaps, even bringing processing in-house.
….over the last few years, as we've been building the service, whether it's Braintree or now with PPCP, we've been investing in that and establishing a beachhead for our product across the market. In doing so, though, we also have been building value-added services that, to be totally transparent, we haven't been able to price to value or we haven't been able to ensure that we're engaged with our customers in a real end-to-end strategic conversation. That's changing now.
Alex Chriss, PayPal CEO, Q1 2024 earnings call
Braintree already delivers double-digit revenue growth, and now needs to improve gross margins to translate that into double-digit gross profit growth.
Now let’s discuss PayPal’s growth outside of the United States…
International growth is accelerating
In my previous write-up on PayPal I highlighted that in Q3 2023, international revenue growth surpassed the company’s revenue growth in the U.S. In the following two quarters, the trend continued, with international revenue growth accelerating to 14% YoY (on an FX-neutral basis) in Q1 2024, compared to 8% YoY growth in the U.S.
International revenue represented 42% of the company’s total revenue in Q1 2024, so growth acceleration into double-digits is a big deal for PayPal. During the earnings call, Jamie Miller, the company’s CFO commented that international revenue growth was driven by “strength in Continental Europe and Asia”.
PayPal typically does not disclose revenue by country (only “U.S.” and “International”), but in Q3 2023 they did disclose that the company’s operations in the European Union generated 20% of net revenue, and accounted for 31% of gross loans and interest receivable from customers. Visa and Mastercard also reported strong growth in Europe in their first-quarter earnings releases.
There is no Venmo outside of the U.S., and Braintree business is heavily skewed towards the U.S. market, so international growth means growth of branded checkout….and, as mentioned above, branded checkout means healthy take rates.
Now let’s discuss the “troubled” part, branded checkout…
Branded checkout returns to growth
Throughout 2023, PayPal reported a decline in core products and services revenue despite growth in TPV. Thus, the company’s 10-Qs and the 10-K included notes that the growth in transaction revenue was primarily driven by the growth in unbranded processing, while the revenue from core products declined.
Transaction revenues grew by $1.7 billion, or 7%, in 2023 compared to 2022 driven primarily by growth in TPV and the number of payment transactions from our Braintree products and services, partially offset by a decline in revenues from our core PayPal products and services.
2023 10-K (and you can find similar notes in Q1, Q2 and Q3 2023 10-Qs)
However, in the first quarter of 2024, 10-Q mentions that while growth, again, came primarily from unbranded processing, revenue from core products and services increased. My understanding is that the decline in revenue in 2023 (despite growth in payment volume) was driven by the take rate decline (enterprise merchants representing a bigger share in TPV), and the trend finally reversed.
Transaction revenues grew by $670 million, or 11%, in the three months ended March 31, 2024 compared to the same period of the prior year driven primarily by growth in TPV and the number of payment transactions from our Braintree products and services and, to a lesser extent, growth in our core PayPal products and services.
Q1 2024 10-Q
Jamie Miller, the company’s CFO, attributed growth to branded checkout to “strength in large enterprise and international.” In Q1 2024, branded processing represented 27% of PayPal’s total payment volume, and, as mentioned earlier, was the largest component of the company’s revenue and gross profit (given the take rate profile).
Branded checkout continued to grow profitably and was a nice contributor to our growth this quarter. We did benefit from leap day, but we also benefited from strength in large enterprise and international.
Jamie Miller, PayPal CFO, Q1 2024 earnings call
The most widely accepted thesis behind declining revenue in branded checkout is that PayPal is losing customers to Apple Pay, Shop Pay, and other wallet and “accelerated checkout” solutions (aka “Apple Pay is eating PayPal’s lunch”), but…
Wallet users are not leaving
I don’t see users abandoning PayPal’s services. Since Q4 2023, the company started reporting monthly active users (previously it would only report yearly active users). As you can see from the chart below, the number of PayPal’s monthly active users did not decline in the past three years.
These users are not becoming less active. As the number of branded transactions per account suggests, user activity stopped declining in 2022.
From the merchants’ perspective, PayPal is somewhat similar to American Express. You probably will survive by accepting only Visa and Mastercard, but you don’t want to miss a sale, so you accept paying a higher fee for enabling the PayPal button on your website. As the number of users is not declining, the PayPal button is not disappearing from merchants’ websites.
For reference, at the end of Q1 2024, American Express had 44 million proprietary cards issued to roughly 31 million U.S. consumers (some consumers hold multiple cards) and 21 million proprietary cards issued to roughly 16 million consumers outside of the U.S.
So what could fuel branded checkout growth in the U.S.? (as I argued earlier, internationally, branded checkout is already growing in double-digits). First, PayPal is investing heavily in its PayPal wallet and the checkout experience. The First Look event might not have shocked the world, but it introduced several features that will improve the value proposition of PayPal wallet (rewards, Advanced Offers) and improve the checkout experience (Fastlane, passkeys).
On the consumer front, the PayPal app is at the center of our strategy to leverage the power of our data to create more value for our customers and unlock new sources of revenue and margin expansion opportunities. In the first quarter, we revamped the PayPal app with a new look and feel and introduced enhancements to our rewards program to enable shoppers to get the most out of their money while increasing conversion for merchants.
Alex Chriss, PayPal CEO, Q1 2024 earnings call
Second, PayPal is investing in making its products attractive for small businesses. The integrations with e-commerce platforms, such as BigCommerce to distribute PayPal Complete Payments and business profiles on Venmo (another feature launched during the First Look event), are not groundbreaking innovations, but they are meaningful steps to address competition with Shopify (or rather Shop Pay), and Cash App.
I have a deep passion for helping small businesses succeed. Frankly, this is an area where PayPal took its eye off the ball. Over the years, we've deprecated products and made pricing decisions that negatively affected our market positioning. Despite that, we still have the largest population of SMBs anywhere, who are using our products and eager for us to do more for them. This is an area where we are investing to correct our course. We are here to serve and win the small business market.
Alex Chriss, Q1 2024 earnings call
Couple the above efforts with the high single-digit growth in e-commerce (7.5% YoY growth in Q4 2023), and I think double-digit growth in revenue for branded checkout is within reach. And, again, branded checkout has very healthy margins.
But there is more…
Going beyond payment acceptance
PayPal has limited user monetization outside of online commerce, meaning it mostly makes money from its customers using PayPal wallet to shop online. Thus, Alex Chriss, mentioned on the earnings call that only 4% of PayPal users have the company’s debit card (“have”, not even use).
Debit Card is the key monetization instrument for Cash App. The optimist in me sees this as an opportunity to sell more services to the company’s customers and increase monetization. Cash App is building its own branded checkout (Cash App Pay), I think PayPal can borrow the blueprint from Cash App on how to monetize its users with debit cards and instant deposits.
In addition, Alex Chriss revealed a few numbers about Venmo. Thus, Venmo has 60 million monthly active users, who add $18 billion in new funds per month (or $54 billion per quarter). These are comparable metrics to Cash App. In Q1 2024, Cash App reported 57 million monthly active users and $71 billion of quarterly inflows….and generated $1.26 billion in gross profit.
We have the leading P2P platform with incredible customer base with disposable income 22% higher than the U.S. average, 60 million monthly active users and 90 million 12-months actives. There’s $18 billion of net new funds that flow into the platform of Venmo every single month.
Alex Chriss, PayPal CEO, Q1 2024 earnings call
Thus, monetization of PayPal and Venmo users besides online commerce and peer-to-peer payments, can further support PayPal’s efforts to return to growth. Nothing groundbreaking or very innovative is needed, there’s a lot to learn from the peers.
In summary, I am not saying that PayPal is out of the woods just yet. But I am, for the first time in a few years, optimistic about its potential to return to meaningful growth. Let’s see how this pays out.
Cover image source: PayPal
Disclaimer: Information contained in this newsletter is intended for educational and informational purposes only and should not be considered financial advice. You should do your own research or seek professional advice before making any investment decisions.