PayPal

Q2 22’ SUMMARY

PayPal continued building momentum from strength in the business’ global platform, which is capitalizing on strong consumer spending across the globe despite cross currents in various markets.

Overall, PayPal continues to capture share of the massive digital payments industry, which has an expanding TAM as more commerce activity transpires online. The growing TAM and PayPal’s continuous user acquisition efforts are the reasons that the business has yet to mature to the point of stagnation.

Key Takeaways from Q2 22’

Key Takeaway 1- Paypal’s platform continues gaining scale

• Active accounts increased materially in Q2 22’ with strength across consumer and merchant accounts even at record levels of scale.

• Engagement on the platform outpaced account growth as PayPal is acquiring greater numbers of users who are engaging more and more on the platform.

Key Takeaway 2- the business drove growth across portoflio

• PayPal’s core transaction revenues increased materially in Q2 22’ as the business monetizes digital commerce.

• PayPal’s secondary Other Value Added Services revenues was the outperformer in Q2 22’ as the company capitalizes on Buy-Now-Pay-Later trend.

Key Takeaway 3- consumer spending is strong even post-pandemic

• E-commerce spending demonstrated strong momentum in Q2 22’ even after the massive adoption during the pandemic.

• Globally, e-commerce is expected to continue taking share from brick and mortar retail, which is expected to continue growing as well.

GROWTH TRENDS

growth Factor 1- strong domestic business

While PayPal has a large global business, the domestic business is core to the company. In Q2 22’, the domestic business drove all of the company’s growth as the international business continued to face headwinds that emerged in 2H 21’. This divergent performance was not enough to derail the business’ growth as the domestic business is materially larger and generated growth that more than compensated for the temporary international headwinds.

The international business is still a material contributing force to PayPal’s growth in recent periods; however, it was a headwind in Q2 22’ with revenues slightly contracting. While this business was impacted by currency volatility, there were several factors that caused this business to lack growth in Q2 22’. Importantly, there is no evidence that the factors are sustainable, which means the business is poised to resume growth as the conditions abate.

• Reopening activities disproportionately affected the international business due to COVID management being more stringent abroad.

• Geopolitical tensions from the Russian invasion of Ukraine created economic headwinds in the period.

growth Factor 2- platform monetization

PayPal’s platform monetization drove momentum in the core transactions business. PayPal’s business model places the business in a central role in the digital commerce megatrend. The platform enables buyers and sellers to digitally transact with each other in a seamless manner. PayPal has massive scale, which is a product of the company’s first mover advantage. The business is designed to monetize digital commerce by way of charging transaction fees to buyers and sellers that commercially engage with each other using PayPal’s proven technology.

• Venmo, Braintree, and e-commerce were cited as drivers of transaction revenue growth in Q2 22’.

• PayPal experienced negative headwinds from eBay and PayPal’s broken relationship, which has had the effect of reducing headline revenues.

• Excluding fees from eBay, total revenue would have increased 14% instead of the 9% reported for Q2 22’.

• The transactions business is fundamentally driven by active accounts and activity (spend) per active account, which both increased in Q2 22’.

While the Value Added Services business is not nearly as important to the business as transaction services, it is still a meaningful contributor to PayPal’s growth and profitability. The company has integrated services outside of core payments into the business model, which is a wise move given PayPal’s proximity to consumers and businesses. The business continued to rebound from the massive blow dealt by COVID in Q2 20’.

• PayPal’s partnership with Synchrony Bank is cited as driving strong growth for Buy-Now-Pay-Later services.

• PayPal’s BNPL offering has wider reach than any other player due to PayPal’s existing proximity to businesses and consumers who engage in e-commerce.

• PayPal faced growth headwinds due to lapping PPP loan-related revenue in Q2 21’.

growth Factor 3- Platform engagement growth

PayPal’s payment platform generated strong results driven by increased scale and spending. PayPal is truly defying limits by continuing to compound at scale despite the business’ decades long tenure.

• Strength in Q2 22’ was driven by growth in active accounts, which is driven by new users as well as reactivated accounts.

• PayPal continued to expand merchants, which drives more consumers to sign up for PayPal thus further integrating the platform into consumer’s digital life.

• Total Payment Value (TPV) growth was even faster than active account growth driven by P2P (Peer-to-Peer), non-P2P, Venmo, and Braintree activities.

OPERATIONAL EFFICIENCIES

PayPal’s efficiency was a headwind in Q2 22’ driven by temporary factors as well as structural ones. The business faced headwinds from the lost eBay revenues, which came with higher margins. The business also faced headwinds related to lower margins from Braintree transactions, which scaled materially in Q2 22’. Going forward, PayPal will be rolling out a massive cost cutting program aimed at driving leverage by removing redundancies in the PayPal, Braintree, and Venmo systems. Additionally, base effects will start kicking in thus creating a low base in late 22’.

INDUSTRY TRENDS

PayPal’s business model and scale uniquely positions the business to capitalize on the growing e-commerce megatrend. PayPal is deeply entrenched in the digital payments industry based on the platform’s connection with hundreds of millions of economic participants. In other word, e-commerce’s gain is PayPal’s gain.

Specifically, e-commerce spending in the U.S. increased 7% in Q2 22’, which is on top of 14% growth in Q2 21’. In Q2 22’, e-commerce spend represented 15% of retail spending in the US, which is on par with the 15% representation in Q2 21’. This is especially positive as 20’ and 21’ were strong years for e-commerce spending given the COVID impact on brick and mortar spending. Additionally, e-commerce spending as a percentage of total spend was slightly more significant than the 14% representation in Q1 22’.

In 22’, market research firm eMarketer expects e-commerce spending in the US to increase 9% in 22’ after a strong period of growth in 20’ and 21’. Looking out into the medium term, the firm is projecting e-commerce spending to grow at a 5yr CAGR of 12% for the five year period ending 26’. This compounded growth is expected to outpace that of brick and mortar spending, which is expected to drive e-commerce as a percentage of total from 15% in 21’ to 21% in 26’.

In 22’, eMarketer expects global e-commerce spending to increase 10% after a strong period of growth in 20’ and 21’. Looking out into the medium term, the firm is projecting e-commerce spending to grow at a 5yr CAGR of 9% for the five year period ending 26’. This compounded growth is expected to outpace that of brick and mortar spending, which is expected to drive e-commerce as a percentage of total from 19% in 21’ to 24% in 26’.

The Buy-Now-Pay-Later trend is expected to continue growing from a user base and payment value perspective. This financing option has truly taken hold in the economy, which bodes well for business’ that contribute to the infrastructure of this novel and classic form of financing. In 22’, eMarket expects BNPL users to grow 56% to reach 79mm in the US. This is a massive increase from the 102% growth in 21’ as more and more consumers adopt BNPL, which is being facilitated by merchants offering the financing type. These users are expected to spend $76bln using BNPL, which is a staggering 77% increase from the $43bln BNPL spend in 21’.

Looking ahead to the medium term, eMarket is projecting users and payment value to grow at a 5yr CAGR of 16% and 27%, respectively. This implies that BNPL users will represent about 40% of internet users in the US, which is a material expansion from the 20% in 21’. Financially, this implies that BNPL will represent about 11% of all e-commerce spend by 26’, which is more than 2x the 5% representation in 21’.

FORECAST AND VALUATION

PayPal is positioned to continue gaining share in the expanding global digital payments industry. The business is uniquely integrated into the infrastructure of digital payments, which creates a massive flywheel that is self-sustaining. PayPal has strong global recognition, which is critical for consumers and merchants as payment service providers must be a trusted brand given the sensitivity of the underlying information. In Q2 22’, management’s guidance appears conservative given e-commerce trends and sequential momentum. The Pragmatic forecast takes this conservatism into account, which leads to projected growth of 10% in 22’ as PayPal accelerates growth in 2H 22’. This accelerated growth is driven by continued momentum in the business and fully lapping the eBay impacts on the business. While 22’ is a year of expense inefficiency, this is likely to reverse in 23’ as PayPal generates operating leverage from revenue growth combined with cost cutting.

PayPal’s stock is significantly undervalued on a historical basis. This is primarily driven by immense negativity in the stock market in 22’, which did not spare PayPal’s stock. Even with the operating deleverage in 22’, the stock is worth much more using discounted historical multiples. The catalyst for the stock is expected to be a turn in market sentiment, which is effectively suppressing countless stocks in 22’. The stock is poised to increase even more than the Pragmatic projections once PayPal demonstrates material earnings growth in 23’ driven by revenue growth and massive cost cutting.