Paypal (PYPL): Read and React

Hello and welcome to the first ever installment of Read and React from LeftBrain. Today we cover the February 3rd earnings report of PayPal, ticker PYPL. Let's get into it. I'm your host, Brian Dress, Director of Research here at LeftBrain. Since this is our first time in this format, we'd like to define a few key terms for you. Left Brain is an investment research subscription service covering mostly high-growth stocks and high-income securities. These are the types of reports we use to make investment decisions at our affiliated businesses. You can learn more about what we do at www.leftbrainir.com. Read and React is our version of a short-form report we produce usually after an earnings release where we identify the most important points involved, which is intended to enable informed decision-making on a condensed timeframe. For those of you unfamiliar, PayPal is a global payments platform that supports online money transfers. Formerly a subsidiary of eBay, PayPal spun off in an IPO in 2002 and is one of the fastest-growing large-cap companies around. Last but not least, I want to introduce Janice Quek, the senior investment analyst at Left Brain. Janice, thanks for joining us on Read and React.

Hi, Brian.

We want to talk about PayPal and what happened after your earnings. First thing I would note is that PayPal's stock jumped around 8% the day of earnings and has continued higher since. So I'd like you to give us a little bit of a brief summary of the business and financial results that you observed after reading the Q4 earnings report.

Sure, Brian. So PayPal announced another impressive quarter, in fact, its strongest quarter ever, delivering revenues of 6.12 billion And that's up 23% on a year-on-year basis. Its total payments volume, or essentially the value of the goods transacted on its platform, was about $277 billion in the quarter alone. And that's an increase of 39% year-on-year from the same quarter last year. So PayPal also added a record of a net of 16 million new users to its platform. That's very impressive results.

Yeah, that's a great start to our understanding of the report. And, you know, as we look through at securities through the left-brain lens, margin expansion is one of the key factors we look for. And what did your analysis show from the 2020 results for PayPal in this regard?

So with that strong top-line performance I mentioned earlier, PayPal was able to make some gains from volume leverage, and the company's operating margin expanded dip by more than 1% in Q4 to about 24.7%. And at the same time, you see earnings rise and free cash flow increasing. All good news for shareholders.

Excellent. And then, of course, you know, the stock market is a discounting mechanism for future business results, and this is something we take as given, but, you know, that's part of the left-brain process. What did you learn from PayPal management's statements in the wake of Q4 results that informs your outlook for 2021 and beyond for PayPal?

You know, I think being able to deliver results that we've seen really speaks to the leadership's execution there. The macro environment was just favorable, but it takes good leadership to use these tailwinds to accelerate the business, right? And PayPal pushed out many new products and features very quickly, made it easy for merchants to get on board on the platform, and accept digital payments to capture that surge in demand. And that has driven a lot of new growth, and in time to come, these new users will be trying out other products on the platform. So we think that management has executed well to position PayPal for a good outlook.

So it sounds like PayPal's doing really well with existing products, but also has a whole suite of additional products that it seems to be rolling out kind of in the present and also in the future. At Left Brain, we always look in depth at the numbers on the balance sheet, income statement, everywhere in between, but we aren't willing to recommend an investment unless we're dealing with a world-class business. With that in mind, what I'm most interested in is the business case for PayPal. Can you tell the audience what you are seeing in regards to the overall adoption of digital payments and how PayPal fits into that overall trend?

Yeah, we, we see this happening over the past decade with digital payments and financial services gaining traction with consumers. And the drivers of that has been really the rise of e-commerce, the evolution of technology, mobile device use. And within the last 10 years, major emerging markets have seen an average of 10% to 20% drop in using cash for transactions. And in mature markets, that number, that percentage is about 20% to 30%. In China specifically, that percentage is about 50%. And so the value of digital payment transactions are forecasted to grow annually at a rate of 12% over the next 4 to 5 years. So we see a tremendous expansion of the environment there and the opportunity growing. PayPal has that breadth of products, global reach, and a trusted brand to benefit from this trend.

That's a great point. You know, we're becoming a cashless society, and it seems PayPal is right at the tip of the spear on that. And really benefiting from that trend. So now a little bit of trivia about PayPal. Janice, first question is, in July 2017, PayPal in China announced a partnership with— was it A, HP, B, Baidu, or C, WeChat?

B, Baidu. So the arrangement allowed the Chinese firm's 100 million mobile wallet users to then make payments to PayPal's 17 million merchants at that time. Time through the Baidu service.

Yeah, interestingly enough, Baidu stock is trading almost 80% higher than it was in December of '17. Clearly, the pandemic is an accelerator of trends already in existence. I mean, it's changed the way that many of us do business and behave in general as consumers. And I'd like to hear your view on how this phenomenon relates to PayPal.

Yeah, when we look back at, at How it all started, the pandemic created the need for people to social distance as much as possible, and lockdown measures resulted in physical stores closing, so everyone had to purchase online, even if they never had the habit of doing that before COVID And PayPal's business really saw a surge in activity for many of these new users who are using digital payments for the very first time. They tried it, they liked it, and they want to continue with it even as the pandemic restrictions eased and were lifted in many areas. And at the start of the pandemic, PayPal had 305 million accounts, and by the end of the year, by the end of 2020, it had about 377 million accounts, and that new account add was more than twice its usual annual adds. So we see quite a bit of behavioral changes there, and the pandemic really accelerating that growth and demand.

I think the concern for many investors is that many of these trends we observe in the current environment will evaporate once life returns sort of to normal. Can you convince us and the audience that is not the case with PayPal?

Yeah, I think that's a key issue to address. But I think we're seeing some profound and lasting behavioral changes here with digital payments adoption. Some early indicators have been that even as pandemic restrictions were lifted in Q3 and Q4, Users are not leaving the platform en masse. User engagement is sustained and in fact increasing. Transactions per user is rising each quarter, and that speaks of the engagement of the, of users on the platform, and the number of transactions is trending up. So I don't think that many will return to cash-only transactions at the same rate before the pandemic now that people are comfortable with using digital payments platform like PayPal. The initial barriers to adoption have been breached, and the convenience and just the ease of transacting digitally is so compelling that I think a lot of people will stay.

So Janice, I definitely agree. A lot of the behavior changes we see in COVID are going to be sticky. There's no doubt that life has changed and our behavior has changed. Can you tell us more what we can expect in the coming years for PayPal? What's growth going to be like post-COVID?

As it relates to PayPal's financials, the company's guidance at the recent earnings call says it all, you know, for the outlook. It projects 50 million net new active user adds in 2021. And if we compare that number of 50 million to the average of 35 to 38 million annual adds that it was getting pre-COVID, we can see how that demand has grown. And even as the pandemic effects are no longer as pronounced, the guidance for revenue is about $25.5 billion for the new year, and that's a growth of 19%. So PayPal also expects payment volume to increase in the high 20-plus percent range, which when all these metrics, metrics when taken in the context of impressive performance in the pandemic year in 2020, It is very exciting to see such strong expectations from management. And this is a really good start to post-pandemic beginnings, right? It gives me confidence and assurance of PayPal's opportunity and position here in the digital payments landscape.

So basically, you're saying that the growth rates we see now are pretty much sustainable in a going-forward basis?

I think so. I mean, I feel like we've seen that those early indicators of that coming through. Through sustained engagement, the number of transactions are trending up. And so those are encouraging signs. And I think that we can— there's a lot to look forward to for PayPal.

So Janice, we know that growth is strong for PayPal overall and also with some of its lines of business. So I want to drill down on some of those drivers of growth and whether you view that growth as sustainable. First, can you tell us what is Venmo and what is Zoom? And what percentage of the overall business are they? And what is the outlook for those businesses?

So I'll start off with your first question on Venmo and Zoom. Venmo is a mobile payment app that users can use to pay for their purchases and then send and receive funds from another user. Zoom is a cross-border funds transfer and payment service. It's a remittance provider. And together, we estimate they constitute about less than 20% of PayPal's overall business. And services like Zoom and Venmo are not on the core PayPal platform. They have— they keep their own brands. And they have the potential to seize the global payments opportunity not covered by the core PayPal platform. They've been expanding your reach into more markets and deepening user engagement with more monetizable services and features. So the outlook for Venmo and Zoom is very promising.

So I have more interest in China. You know, how do you view PayPal's position in the world's largest market in China?

That is a good question. And from a geographical standpoint, PayPal has very global reach, but it is just making inroads into the world's largest consumer and seller market, China, like you mentioned. And many Chinese are shopping abroad. And while Alipay and WeChat Pay, both from from Alibaba and Tencent Holdings respectively, they're popular digital payment methods over there, but it is not frequently offered as a payment option for merchants outside of China. PayPal, as the only foreign payments company to operate a full domestic payments business in China, is now able to bridge that connection between China's 1.1 billion consumers and PayPal's 29 million merchants. And that also goes the other way of enabling Chinese merchants to sell to PayPal's 377 million consumers outside of China. So that's another growth driver for the future.

I mean, I think, like we see for a lot of businesses, the opportunity in China is extremely exciting, and for PayPal, definitely seems to be a particularly profound opportunity going forward. So we'll keep an eye on that. And then the last thing I wanted to ask you in this segment was kind of something in the news, which is cryptocurrency. How does cryptocurrency fit in for PayPal and its business? And what about the integration of other value-added technologies?

That is another growth opportunity that PayPal recently announced. It will start offering the buying and selling of cryptocurrencies, and PayPal intends to also allow users to purchase from their merchants with cryptocurrency in the near future. Right from their PayPal account. And we've seen how cryptocurrency demand is growing rapidly, and we think that this could potentially be another strong revenue generator for PayPal. And lastly, just to quickly touch on capability acquisition and technology integration, PayPal is very active on the mergers and acquisitions front, and this has contributed to more value-added services from them. And the cross-use of products for its users. And once again, that's another monetizable revenue stream there for PayPal. So, you know, we've touched on quite a few revenue— potential revenue growth generators, and I think that that growth can be sustainable from some of these avenues we've talked about.

So, Janice, at LeftBrain, we have a system of rating which is green light, yellow light, red light. Green light means We like the company. It's basically a buy. Yellow light, more neutral. Red light, basically no chance we're going to keep following the company. And I'd like you to make your case for why the competitive environment is actually in PayPal's favor. Why do you think PayPal has a good positioning in the market?

PayPal is one of the largest digital payments providers globally with a strong brand name and some of the broadest range of financial services and products offered on a platform. It has 377 million users, the largest by number of users outside of China. And most people are really familiar with PayPal as a trusted and secure payment method. It definitely is a leader in the space. And let us not forget that the market opportunity here is approximately $110 trillion. So plenty of room for many players to expand without impacting others, but PayPal remains the leader in this digital payment space.

And how do you think about Square and maybe some of the more traditional finance players positioning in the space? Do you worry about their inroads relative to PayPal, or do you think PayPal is going to maintain that strong position going forward?

I think that up-and-coming companies like Square, they're making good progress. Again, you know, the, the opportunity here is about $110 trillion, so lots of room for many players to run, right, and grow. PayPal has just made so much progress over the years, and they're early market movers, so, you know, we don't see that they're— I mean, while the competitive landscape is going to get more challenging, I don't see PayPal losing its market leadership.

Yeah, that's definitely good to know. As we consider whether to invest in or recommend an investment in PayPal. Okay, now for the second question. When PayPal was originally established, which one of these principals was not part of the team yet? Was it A, Max Levchin, B, Peter Thiel, C, Elon Musk, or D, Luke Nosek?

It was Elon Musk. PayPal was originally established in December of 1998 as Confinity by Max Levchin, Peter Thiel, and Luke Nosek. Elon Musk only joined later.

And like we said before, PayPal's IPO in 20— uh, in 2002 listed under PYPL at $13 a share, and today it trades at over $250 a share. So pretty amazing performance. At Left Brain, we really like founder-led businesses We like strong management with alignment of interests with investors. So can you quickly speak about the quality of management at PayPal and the CEO, Shulman, how you view him and sort of how the way he runs the business?

So PayPal's current CEO, Dan Shulman, has been at the helm since 2014. A little bit about background here, he has extensive experience working for many tech companies over the period of time. He started at AT&T and he He worked for companies like Virgin Mobile too before joining PayPal. And over the last 6 years, Dan has really led PayPal to the top of the industry by sharpening its business lines, its value proposition, and positioning PayPal to thrive and capitalize on favorable external trends. So I think PayPal has been very well managed by Dan.

Yeah, again, for left brain, this is a huge, a huge point for us. So it's good to know that we have an innovative and strong manager at the helm here. As we look at PayPal through the left-brain lens, can you talk a little bit more what you see on the financial side of things in terms of revenue growth trajectory, margins, and anything else that kind of fits in that category?

So I think to summarize our conversation here, Brian, I see a company that has steady top-line growth performance. Balanced spending on innovation and growth opportunities that has led to strong profit margins and stable cash flow generations.

What constitutes a green light through the left-brain lens? We consider a few different factors, which are, you know, accelerating revenue growth, margin expansion, an expanding market, benign competitive environment, an innovative product or service, which we know PayPal has, and strong management, which we also think PayPal has.

And these are all criteria that are really great for investors. And I think that PayPal is just a great company through the left-brain lens. And that's why we rated it a green light.

Absolutely. Yeah, I definitely agree. You wrote a great report on PayPal. I encourage everyone to go out and see it on our website, www.leftbrainir.com. Absolutely agree with your rating. Green light here. We see a lot of positives in terms of competitive environment, a growing market, revenue growth trajectory, expanding margins, and everything else that really fits into the left-brain way of thinking of investments. Thank you so much, Janice, for joining us and giving us your views and analysis of PayPal.

Thank you, Brian. It was fun having this conversation.

We hope this has been useful for those watching at home. For more content like this, along with an entire library of written reports on high-growth stocks and high-income securities, visit us on our website, www.leftbrainir.com, for the informed decisions and independent thought that power our search for prime investment opportunities. I'm Brian Dress for Read and React. I can't wait to see you again next time.