Where next for PayPal and PayPal shares?

With margins holding steady, PayPal generates most of its growth organically, and the majority of revenue is directly tied to the amount of transactions conducted through its system and the value of those transactions, both of which have risen considerably over the past three years.

PayPal generates 87% of its revenue from charging consumers and merchants for transactions conducted using its system, including its PayPal Credit, Venmo, Braintree and Xoom products. PayPal’s revenue from transactions has risen 41% in the last three years to $11.4 billion in 2017.

In addition to the headway being made in getting more people and merchants to adopt PayPal, the company’s existing customers are using PayPal more and more each year. On average, each PayPal account used the system to conduct 36 transactions over the course of last year, compared to 28 transactions back in 2015.

The smaller pool of revenue comes from all of PayPal’s other activities, like earning interest and fees from its credit businesses, charging subscription or gateway fees, joint ventures and the other services it provides to merchants. Revenue from these activities increased 55% from $1.1 billion in 2015 to $1.7 billion last year.

The US: PayPal’s biggest market drags down profit

The US is PayPal’s biggest market, accounting for more than half of all its net revenues. But the company’s domestic operations are not profitable, and losses have swelled over the past three years and held back the growing profit being delivered by its international arms.  

PayPal’s pre-tax loss in the US ballooned to $593 million last year from $342 million in 2016, which in turn had widened from a $253 million loss in 2015. Meanwhile, profit from all its other international operations grew from $1.74 billion in 2015 to $1.97 billion in 2016, rising to $2.79 billion last year.

The present: PayPal continues to deliver in early 2018

PayPal has maintained the momentum from last year, after releasing another set of progressive results for the first three months of 2018. Revenue rose to $3.69 billion from $2.98 billion the year before as total payment volumes grew to $132.4 billion from $100.6 billion. That resulted in a 25% jump in pre-tax profit to $548 million while net income, also benefiting from lower tax, climbed one-third higher to $511 million. Although revenue came in higher than expected, earnings missed the mark.

Quarterly growth in account numbers has been consistent at 4% over the last three quarters and PayPal ended March with 237 million active accounts, 15% more than a year ago and over eight million more than the end of 2017. Meanwhile, the average amount of transactions carried out by each user has now grown 8% in each of the last three quarters, hitting a new high.

PayPal’s 2018 financial guidance

Although PayPal is confident it can continue substantial growth this year, it is expecting to deliver a slower rate of growth compared to what was seen in 2017, when revenue climbed 21%, earnings per share (EPS) rose 28% to $1.47, and underlying EPS grew 27% to $1.90.

PayPal tweaked its full year guidance when it released its first quarter results, after gaining a better understanding about the impact of the ongoing sale of US consumer credit receivables to Synchrony Financial and its equity compensation plans. It lowered its earnings guidance but raised expectations for underlying earnings.

PayPal is expecting to deliver revenue within the range of $15.20 billion to $15.40 billion. EPS is expected to grow 18% to 20% and fall within a range of $1.73 to $1.76 this year, with underlying EPS rising 22% to 23% to a range of $2.31 to $2.34.

What to look for in PayPal’s 2018 interim results

More immediately, investors can look to PayPal’s second quarter results, when the company will reveal how it is getting on at the halfway point. PayPal has provided guidance for the three months to end of June and expects a slight slowdown in revenue growth and broadly flat earnings compared to the first quarter of the year.

PayPal has guided revenue to be in the range of $3.78 billion to $3.83 billion, with EPS of $0.41 to $0.43 and an underlying EPS of $0.54 to $0.56.

Investors can also pen PayPal’s annual general meeting (AGM) in their diaries on 23 May, followed by an investor day on 24 May.

Can PayPal shares keep up their momentum?

PayPal shares picked up momentum in 2017, soaring 87% over the course of the year to comfortably outperform the wider market, with the S&P 500 rising 19%. PayPal continued to rise in the new year, to reach an all-time high of $85.45 in late January, just before its annual results. From there, shares have lost steam after the loss of eBay overshadowed its full-year results.

The announcement concerning the end of the pair’s relationship initially created excitement around eBay shares and placed pressure on PayPal shares, but that trend has since reversed following both companies releasing their first quarter results.

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eBay shares had railed following a strong performance over the holiday season late last year, but its performance in early 2018 failed to create as much of a buzz, and investors were disappointed with the auction site’s revenue forecast and ability to deliver reliable and steady growth. As the likes of Amazon continue to power ahead, eBay is coming under increasing pressure to come up with a bigger vision for what role the company will play in the future.

The future: where is PayPal’s next phase of growth going to come from?

With new technological developments constantly emerging, PayPal has managed to adapt to the rapid evolution of the market over the last 20 years, but its role remains the same: connect merchants and consumers around the world.

Going further, PayPal’s mission to ‘democratise the management and movement of money’ would be echoed among crypto-fans, who will also be aware that billionaire Thiel (one of PayPal’s original founders who left when eBay took over) is a big believer in bitcoin.

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One of the main benefits for consumers is that they supply their details to PayPal and PayPal only. When you purchase something at a shop using your bank card you share your details with the merchant. PayPal on the other hand, completes the transaction without sharing any personal details with the merchant. PayPal bolsters its offer to consumers by allowing them to link everything together for free, bringing bank accounts, debit and credit cards under one roof while also offering its own PayPal account and credit services. The consumer business is less about making money and more about driving volume to merchants, where 87% of transaction revenue is generated. The only money PayPal directly takes from consumers is either interest of fees related to foreign exchange or credit services.

This highlights the importance of merchants and their adoption of PayPal as a payment service. The main source of revenue is charging fees for processing transactions on their behalf, but it also charges gateway fees for linking online businesses to its processing network. PayPal’s growth has been partly down to the way it entices businesses, allowing them to integrate PayPal for free. Before long, PayPal will to become an ever-more important supplier to these companies by offering business advice and a multitude of add-on services, including the provision of credit to small and midsize enterprises (SMEs) that are struggling to get anything out of a traditional bank or lender.

PayPal’s two-sided platform is the core product at the heart of the operation serving both consumers and merchants. PayPal’s offer to merchants is enhanced by gateway services serving online businesses and Braintree, which specifically targets retailers that primarily offer services through mobile applications. PayPal serves consumers through other brands like Venmo, a person to person (P2P) mobile app in the US, and its international money transfer service Xoom.

PayPal eyes growth through smartphones

Smartphones and mobiles are key to PayPal’s future, particularly amid the rise of digital services like Android Pay, Apple Pay and Samsung Pay. PayPal carried out 2.7 billion mobile payment transactions last year, jumping 35% from 2 billion in 2016 – and the growth in mobile payment volumes accelerated at an even faster pace, having soared 52% from $102 billion to $155 billion.

That rate of growth continued in early 2018, with PayPal processing $49 billion in mobile payments in the first quarter, up 52% from the year before.

PayPal’s Peer-to-Peer services Venmo and Xoom

Investors are very attentive to Venmo, primarily used by the younger generation as a way of sending money to family and friends using a mobile. It processed twice as much money in 2017 than it did the year before and that continues to grow significantly, even if growth slowed in early 2018 compared to last year.

P2P is a bit of a paradox for PayPal, as the service is great for growing volumes but not so great for profit, with the firm making little money from this activity. It only takes a small cut if a credit card is used but monetising P2P presents a major opportunity for PayPal as people who use PayPal, Venmo and Xoom to send and receive money are also more likely to shop using those platforms.

According to PayPal ‘P2P services increases our ubiquity, strengthens our value proposition and helps reduce churn among our consumers’, and while it may be some time, they are key to the company’s long-term growth.

PayPal’s checkout service One Touch

One Touch is PayPal’s new product, offered to both consumers and merchants. Consumers use One Touch to stay logged in when using online merchants that also use the product. This allows for faster purchases while maintaining security. A total of 92 million consumers and 8.6 million merchants had opted-in for the service by the end of March.

Is PayPal moving toward traditional banking?

The company already provides several credit services to businesses. PayPal Working Capital allows companies to borrow a certain percentage of their annual payment volumes and, having recently bolstered its underwriting capacity by buying Swift, PayPal now offers short-term loans judged based on a case-by-case basis.

PayPal provides accounts, loans, money transfers, forex services, and even the PayPal Cash debit card. According to the Wall Street Journal, the company is now rolling out new products and services in the US such as allowing direct deposits into PayPal accounts and a new ATM-friendly debit card for shopping on the high street, and most importantly it is all covered by the same government-guided insurance that the big traditional banks provide.

However, this move is apparently aimed at the millions of people in the US who don’t have a bank account, known as the ‘unbanked’, or those that have an account but are turning to the likes of expensive payday lenders because their access to credit has been closed off. This would follow the existing strategy used when providing credit, providing funds to those companies that the banks have cut-off. US figures stretching back to 2015 estimate nine million Americans – 7% of the population – didn’t have a bank account with another 24.5 million (20%) using services outside the banking system.

That’s important, because PayPal has no intention of becoming a traditional bank. It is going for what turns out to be a huge chunk of the American population – the 27% that have been squeezed out of the banking system. PayPal likes to keep its rivals close and works with the likes of Visa and MasterCard, and the latest move is in partnership with numerous banking partners, according to the WSJ. Much of its existing credit services are carried out in partnership with some licensed third-party.

This is likely to be part of a wider trend that would shift the customer-facing aspects of banking to fintech and payment providers, with banks acting more as a supplier of services and taking on the high costs and strict regulations inherent in the sector. Companies like PayPal look more like a bank as time goes on, but PayPal is not a bank.

What challenges does PayPal face in 2018 and beyond?

PayPal has proven effective in handling any challenges that have come its way and its next, more immediate, challenge will be proving that the loss of eBay is not detrimental to its long-term prospects. But the payments processer does face other potential headwinds going forward.

PayPal and Brexit

Payment processers are international by nature and PayPal, like the rest of the industry, is trying to navigate the uncertainty surrounding the UK’s decision to the leave the EU and how Brexit will impact their business. Bearing in mind that international markets are driving profit growth at present, $11 out of every $100 of revenue PayPal makes comes from the UK, which plays an outsized role in PayPal’s wider EU market.

PayPal’s EU arm that also currently serves the UK is based in Luxembourg, so the company is concerned about its licenses allowing it to operate in the UK and, with forex being one of the most substantial parts of the business, the potential loss of cross-border trade between the UK and EU. Cross-border transactions represented 21% of all the payments made through PayPal’s system last year, dipping down from 22% over the prior two years. 

The more volatile relationship between sterling and the euro has been a challenge for many, but particularly those directly involved in forex. PayPal also shares concerns with other sectors about the availability of staff in the country post-Brexit.

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PayPal: keeping its enemies close

The company’s relationship with firms like Visa, Mastercard, and Apple have played an integral part in PayPal’s growth and its decision to work with others has so far paid-off. But these also pose the biggest threat to PayPal and that means relations are important if they are to stay partners and not rivals. Chief Executive Dan Schulman stressed how partnerships in the US and internationally are ‘flourishing’.

But ultimately, Visa and Mastercard do compete with PayPal. Whereas PayPal is pushing its new One Touch system aimed at streamlining online payments, Visa and Mastercard currently offer their competing services separately to one another. However, the pair have recently announced plans to combine their Visa Checkout and Masterpass online payment buttons into one single button to ramp up the competition. Other firms like American Express and Discover Financial Services are reportedly intending to join Visa and Mastercard. Elsewhere, Alphabet’s Google is looking to bring its payment services under one roof, including Google Pay, Android Pay, and Google Wallet.

PayPal’s game has never been to muscle its way in and push others out, but slip into the market and become an important cog in everyone’s system and being indispensable to everyone it works with – merchants, consumers and partners. PayPal’s main job is to stay relevant.