Fintech Rivalries: How Fintech Companies Stack Up Against Each Other, Part 1
featuring PayPal, Block, Toast and Shift4 Payments
You hear and read a lot about Fintech companies “disrupting” established players, be it banks, payment processors, or card schemes. Yet, first and foremost, Fintech companies compete with each other. Cash App competes with Venmo, Stripe competes with Adyen, Affirm competes with Klarna, Toast competes with Shift4, SoFi competes with LendingClub, and so on. Consumers don’t look for another bank and merchants don’t look for another payment processor. They look for a solution to their problem (that established players can’t or don’t want to solve) and this creates an opportunity for Fintech companies.
There are several Fintech rivalries that have fascinated me, such as Block and PayPal, Affirm and Klarna, SoFi and LendingClub, and, most recently, Toast and Shift4 Payments. Rivalries between publicly traded companies are especially interesting. You get a lot of information about the past performance of those companies, and on top of that, valuation multiples show how investors evaluate their future growth prospects. After I started writing a newsletter on this topic, I realized that it would be impossible to cover all these rivalries at once. Therefore, expect a mini-series that I will publish over the coming weeks!
Block vs. PayPal
Block is primarily an offline acquirer through its Square business (but has a wide product offering for online retailers ranging from payment processing to full-stack e-commerce platform), while PayPal is primarily an online acquirer through its PayPal Checkout and Braintree products (but has extended its offering for offline merchants by acquiring iZettle and bringing it to the U.S. market). However, Block and PayPal compete with each other head-to-head in consumer wallets (Block owns Cash App, while PayPal offers consumers its PayPal digital wallet and Venmo), and in Buy Now Pay Later lending (Block acquired Afterpay to enter the BNPL space, while PayPal relied on a combination of in-house developments and acquisitions).
As of this writing, PayPal (NASDAQ: PYPL 0.00%↑) had a market capitalization of $99.14 billion and Enterprise Value of $99.66 billion, compared to the market capitalization and Enterprise Value of $52.88 billion and $53.22 billion respectively for Block, Inc (NYSE: SQ 0.00%↑).
Let’s kick off the comparison by looking at the core metric for any payment company: the volume of processed payments. Block calls it “Gross Payment Volume” (or “GPV”), while PayPal calls it “Total Payment Volume”(or “TPV”). In Q3 2022 (their latest reported quarters), Block reported a quarterly Gross Payment Volume of $54.4 billion, while PayPal reported a quarterly Total Payment Volume of $337.0 billion. However, PayPal includes peer-to-peer payment volume (PayPal and Venmo users sending money to each other) in the reported TPV, while Block doesn’t. Excluding peer-to-peer volume, PayPal’s TPV in Q3 2022 was $244.0 billion.
While PayPal dwarfs Block in terms of processed payment volume, the difference in revenue is not so dramatic. Thus, in Q3 2022 PayPal reported total revenue of $6.85 billion, compared to Block’s $4.52 billion. It should be noted that Block’s revenue includes Bitcoin revenue (Cash App users can buy Bitcoin in the application), which is essentially the value of the coins that the company sells to its users. As the company makes a thin gross profit margin on Bitcoin sales (around 2%), it is worth looking at the company’s revenue excluding Bitcoin. Thus, in Q3 2022, Block reported $2.57 billion in revenue, excluding revenue from Bitcoin.
PayPal doesn’t explicitly report gross profit numbers. Instead, it reports “Transaction Margin”, as one of its KPIs. PayPal defines “Transaction Margin” as “total revenue less transaction expense and transaction and credit losses, divided by total revenue”, which essentially is the company’s gross profit margin. Thus, in Q3 2022 PayPal reported $3.49 billion in gross profit, compared to $1.57 billion in gross profit reported by Block. This translates to a gross profit margin of 51.0% for PayPal and a 34.7% gross profit margin for Block. Please mind the impact of Bitcoin revenue on Block’s gross profit margin. Excluding Bitcoin, Block's gross profit margin was 55.6%.
If you compare PayPal and Block on an EV / Sales multiple (adjusting for the “noise” of Block’s Bitcoin revenue), you would notice that Block commands a meaningful valuation premium. The difference in the growth rates might be one of the factors contributing to this premium. As you can see from the chart below, both companies benefited from the pandemic, but while PayPal’s gross profit growth evaporated by the end of 2021, Block continued to grow throughout 2022. In Q3 2022, PayPal reported a 4.2% YoY growth in gross profit, while Block reported a 36.3% YoY growth in gross profit. Block benefited from the reopening of the economy after the pandemic lockdowns and continued growth in its Cash App business.
Finally, both companies use Adjusted EBITDA as a measure of their profitability (PayPal’s management calls it “Non-GAAP net income”, but in practice, it is “Adjusted EBITDA” given the adjustments that they make in calculating it). In Q3 2022, PayPal reported $1.25 billion in “Non-GAAP Net Income”, while Block reported $0.33 billion in “Adjusted EBITDA”. Block did not provide guidance for Q4 2022, while PayPal guided for Non-GAAP EPS of $1.18 - 1.20, which implies approximately $1.36 - 1.38 billion in “Non-GAAP net income.” As you can see, Block commands an even higher valuation premium on Adjusted EBITDA basis.
Want to learn more? Revisit Q3 2022 earnings reviews…
👉🏻 PayPal Q3 2022 Earnings: forget growth, it's a margin story now
👉🏻 Block, Inc. Q3 2022 Earnings: can Cash App become the primary bank account?
Toast vs. Shift4 Payments
Let’s talk about two more merchant acquirers, Toast and Shift4 Payments. Both companies offer their clients end-to-end solutions for accepting payments including POS software, integrated payment terminals and payment processing. However, they differ in terms of the industry focus. Thus, Toast is focusing exclusively on the restaurant industry, while Shift4 has a diversified client base and serves clients from food and beverage, hospitality, sports and entertainment, gaming, and other industries. Toast gets more media and analyst attention (and as I will describe later in the text, commands a premium valuation), so let’s look at the numbers to understand why.
As of this writing, Toast (NYSE: TOST 0.00%↑) had a market capitalization of $12.88 billion, and Enterprise Value of $11.92 billion, compared to a market capitalization and Enterprise value of $5.45 billion and $4.96 billion respectively, for Shift4 Payments (NYSE: FOUR 0.00%↑).
Let’s start with payment volume, which Toast calls “Gross Processing Volume”, and Shift4 calls “End-to-End Payment Volume.” The reason for Shift4 using “End-to-End Payment Volume” comes from the fact in some cases Shift4 doesn’t handle processing “end-to-end” and acts as a gateway routing a transaction to another processor. As the name suggests, the reported volume includes only the volume, which the company processed “end-to-end.” In Q3 2022, Toast reported $25.2 billion in Gross Payment Volume, compared to $20.6 billion reported by Shift4. As the chart below illustrates, Toast has been growing at a faster pace in 2021 and 2022, so the gap in GPV keeps widening.
Both companies generate most of their revenue from payment processing (in Q3 2022, payments-based revenue contributed 83.5% of Toast’s revenue, and 93.0% of Shift4’s revenue). In Q3 2022, Toast reported $752.0 million in revenue (54.6% YoY increase), compared to $547.3 million reported by Shift4 (44.9% YoY increase). Revenue from payment processing is a function of payment volume and take rates (merchant fees expressed as percentage of payment volume), and as take rates for both companies were quite stable over the last two years, revenue trajectory for Toast and Shift4 resembles their GPV trajectory (see the chart below).
However, in terms of the reported gross profit, the picture looks quite different. Thus, while Toast might have been outrunning Shift4 in terms of the payment volume and revenue growth, it is not the case with gross profit (with the exception of the latest reported quarter). In Q3 2022, Toast reported $151.0 million in gross profit, compared to $127.5 million reported by Shift4, but as you can see from the chart below, the gap in gross profit was much narrower in Q1 and Q2 2022. Both companies guided for flat (or slightly lower) revenue in Q4 2022, but it will be interesting to see what they report in terms of gross profit.
Toast clearly commands a meaningful valuation premium, if you compare both companies on an EV / Sales multiple. Toast’s trailing 12-month revenue (Q4 2021 - Q3 2022) was $2.47 billion, compared to $1.86 billion reported by Shift4, which translates to 4.8 and 2.7 EV / Sales multiples respectively. This premium doesn’t make sense given comparable gross profit levels generated by the two companies…unless you believe that Toast can considerably improve its gross profitability, while maintaining the revenue growth pace. In its latest reported quarter, Toast achieved a significant improvement in its gross profit margin, from 16.7% in Q2 2022 to 20.1% in Q3 2022, but we are yet to see if this was a sustainable improvement.
The difference in the valuation multiples of Toast and Shift4 make even less sense if you compare the two on an Adjusted EBITDA basis. Shift4 Payments was profitable on an adjusted basis in each of the quarters during the 2020 - 2022 period. In its latest reported quarters, Q2 and Q3 2022, the company reported profitability even on a non-adjusted GAAP basis ($15.0 and $46.5 million). Toast, in contrast, is yet to achieve this phase. I would expect Toast’s management to set achieving profitability on an adjusted basis as the goal for 2023, but the path to GAAP profitability remains unclear given the company’s gross margins and operating expense levels.
Want to learn more about Toast and Shift4 Payments?
👉🏻 Toast Profile: a Fintech that aims to become the operating system for restaurants
👉🏻 Shift4 Payments Profile: not pretending to be a software company
To be continued…
Cover image: Venmo
Disclosure & Disclaimer: I own shares in several companies that I write about in this newsletter, as I am bullish on the transformation in the financial services industry. However, the information contained in this newsletter is intended for 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.