• FY23 revenue/adj. PATMI was in line with expectations at 101%/102% of our forecasts. 4Q23 revenue grew 9% YoY led by a 15% YoY rise in total payments volume. Adj. PATMI grew 13% YoY mainly due to higher operating leverage.
• For FY24e, PayPal expects adj. EPS of US$5.10 or flat compared to FY23. It also expects gross profit to remain flat YoY at US$13.7bn. This implies continued gross margin contraction due to the business-mix shift towards the Braintree unit.
• We maintain a BUY recommendation but lower our DCF target price to US$83.00 (prev. US$101.00), with an unchanged WACC of 7% and terminal growth rate of 4%. We cut our FY24e revenue/adj. PATMI estimates by 1%/13% as payments volume shift towards low-margin unbranded checkout solutions like Braintree. PayPal is well-positioned to benefit from its two-sided global network of 426 mn consumers and merchants, a secular shift to digital commerce, as well as new solutions like Fastlane by PayPal to enhance guest checkout, targeted marketing, digital invoicing, and business lending.

The Positives

+ Revenue beat on higher payments volume and user engagement. In 4Q23, PayPal’s total revenue rose 9% YoY to US$8.0b, which came ~2% ahead of the top end of company guidance. This was mainly driven by a 15% YoY rise in total payments volume (TPV) to US$409.8bn as consumer spending remained resilient on its platforms. PayPal’s branded checkout volumes grew 5% YoY, unbranded processing volumes (Braintree) grew 29% YoY, and Venmo volumes grew 8% YoY to US$68.9bn. Meanwhile, the number of payment transactions were up 13% YoY while the number of payment transactions per active account rose 14% YoY to 59x in 4Q23 from 51x in 4Q22.

+ Cost controls drive operating leverage. In 4Q23, PayPal’s OPEX fell by 20% YoY to US$1.9bn resulting in an operating margin of 22% (vs 17% in 4Q22). The improvement was mainly driven by cost-cutting measures including job cuts and lower sales-related costs. PayPal further plans to cut 2,500 jobs (9% of its workforce) this year to boost profitability.

The Negative

- Shrinking user base, Braintree continues to be a drag on gross margin. Active users fell by 2% YoY to 426mn as minimally engaged users continued to churn out, particularly in Latin America and Asia Pacific regions. In addition, the gross margin fell to 46% in 4Q23 from 50% in 4Q22 due to strength in its low-margin unbranded checkout solutions like Braintree. Management highlighted that unbranded processing volumes increased by 30% YoY in FY23 and now comprises about 35% of the total TPV (vs 30% in FY22).

• 9M23 revenue/adj. PATMI was within expectation at 74%/73% of our FY23e forecasts. In 3Q23, revenue rose 8% YoY to US$4bn driven by 15% YoY surge in total payment volume to US$388bn. Venmo’s payment volume grew 7% YoY to US$68bn.
• For 4Q23e, PayPal expects total revenue to grow by 7.5% YoY to US$7.9bn. Gross margin pressure is expected to continue due to a business-mix shift towards unbranded checkout solutions like Braintree. Adj. EPS is expected to grow by 10% YoY to US$1.36 led by higher operating leverage.
• We maintain a BUY recommendation and nudge our DCF target price to US$101.00 (prev. US$98.00) using a WACC of 7% and terminal growth rate of 4%. Our FY23e revenue estimates remain unchanged, while we increase our EBITDA by 1% to reflect lower expenses. PayPal enjoys long-term tailwinds from two-sided network effects, a secular shift to cashless payments, as well as Venmo monetization initiatives like Tap to Pay and a payment option on Amazon.

The Positives

+ Higher payment volumes. In 3Q23, PayPal’s total payment volume (TPV) surged by 15% YoY to US$388bn, driven by resilient consumer spending on its platforms (Braintree, PayPal branded checkout, and Venmo) amid moderating inflation. In 3Q23, PayPal delivered 32% YoY growth in unbranded processing volumes (Braintree), while branded checkout volumes grew by 6% YoY. Venmo’s TPV grew 7% YoY to US$68bn. We believe that the addition of Venmo as a payment option on Amazon’s check-out page will likely accelerate PayPal’s overall payment volumes.

+ Boost in transactions per active account. The number of transactions per active account rose 13% YoY to 57x in 3Q23 from 50x in 3Q22. This is a sizable increase given PayPal’s strategic decision to focus on driving higher engagement within existing active accounts instead of adding new accounts. PayPal is boosting customer engagements by adding new features like passkeys to allow frictionless payments, Tap to Pay on iPhone, and cryptocurrency buying and selling.

The Negative

- Drop in active accounts; gross margins remain under pressure. PayPal ended 3Q23 with 428mn active accounts, down 1% YoY. Management highlighted that this was mainly due to efforts to churn out lower-quality customers, particularly in Latin America and Southeast Asia. In addition, the gross margin fell to 45% in 3Q23 from 51% in 3Q22 due to strength in its lower-margin unbranded checkout solutions like Braintree.

• 1H23 revenue/PATMI was within expectation at 49%/48% of our FY23e forecasts. In 2Q23, revenue grew 7% YoY to US$3bn led by 11% YoY increase in total payment volume benefiting from resilient consumer spending.
• In 2Q23, gross margin fell to 46% from 49% in 2Q22 due to volume mix shift towards the lower-margin Braintree unit and 65% YoY spike in credit loan provisions to US$112mn.
• For FY23e, PayPal reiterated its adj. EPS guidance to grow 20% YoY to US4.95 and 100 basis points YoY improvement in adj. operating margin to 22% driven by higher operating leverage. GAAP EPS guidance raised to US$3.49 from US$3.42.
• We maintain a BUY recommendation with a lower DCF target price of US$98.00 (prev. US$103.00) using a WACC of 7% and terminal growth rate of 4%. Our FY23e revenue estimates remain unchanged, while we nudge lower our EBITDA by 2% due to higher transaction-related expenses and credit loan provisions. PayPal enjoys long-term tailwinds from two-sided network effects, secular shift to electronic payments, as well as Venmo monetization initiatives like Tap to Pay and payment option on Amazon.

The Positives

+ Transactions per active account continued to climb. PayPal’s customer engagement as measured by the number of transactions per active user increased to 55x in2Q23 from 49x in 2Q22. The management has shifted its strategy to driving more engagement within existing users away from trying to grow active users. PayPal is boosting user engagements through new features, including Tap to Pay on iPhone, cryptocurrency buying and selling, and QR code payments. Moreover, PayPal’s Venmo (popular peer-to-peer payment platform) has been added as a payment option on Amazon’s checkout page.

+ Double-digit growth in total payment volume. In 2Q23, PayPal’s total payment volume (TPV) surged by 11% YoY to US$377bn driven by resilient consumer spending. Management highlighted that e-commerce spending is expected to grow by mid-single digits YoY in FY23e compared with its prior expectation of flat growth as there appears to be shift from travel and services to goods spending.

The Negative

- Active account growth slows, continuation of gross margin compression. In 2Q23, active accounts grew by 0.5% YoY to 431mn but decreased by 2mn sequentially due to higher churn from lower usage accounts. In addition, the gross margin fell to 46% in 2Q23 from 49% in 2Q22. The drop was mainly due to both the volume mix shift towards the lower-margin Braintree unit and higher loan provisions. In 2Q23, credit losses spiked by 65% YoY to US$112mn. Management highlighted that the company has tightened its underwriting standards for business loans offered to merchants.

• 1Q23 revenue/PATMI was within expectation at 24%/21% of our FY23e forecasts. Revenue growth of 9% YoY to US$7bn was led by 12% YoY increase in total payment volume. PATMI rose 56% YoY (28% normalized) driven by continued cost savings.
• For FY23e, PayPal now expects adj. operating margin to expand by 100 basis points from the previous 125 basis points due to strength in its lower-margin unbranded checkouts (Braintree). But GAAP EPS guidance raised to US$3.42 from US$3.27.
• We maintain a BUY recommendation with a DCF target price of US$103 (WACC 7%, g 4%). Our FY23e revenue estimates remain unchanged, while we nudge lower our EBITDA by 1% due to higher transaction expenses related to Braintree partially offset by lower operating expenses. PayPal enjoys long-term tailwinds from two-sided network effects, secular shift to electronic payments, as well as addition of Venmo as payment method on Amazon.

The Positives

+ Improvement in customer engagement. In 1Q23, the number of payment transactions per active account grew by 13% YoY to 53.1x on an annualized basis (up from 47x in 1Q22). PayPal is increasing customer engagement through product innovations and partnerships, including the roll-out of Venmo payment option for person-to-business (P2B) transactions on Amazon. PayPal has also partnered with Apple to allow merchants to use their iPhone as a mobile point of sale (POS) terminal without the need for any additional hardware.

+ Focused on improving profitability. In 1Q23, PayPal’s non-transaction expenses (general and administrative, and technology) fell by 10% YoY due to cost controls resulting in adj. operating margin of 23% (vs. 21% in 1Q22). For FY23e, PayPal has outlined a total of US$1.9bn in cost cuts, mostly through job cuts and real estate consolidation. In 1Q23, PayPal laid off 2,000 employees (7% of its workforce) citing challenging macro-economic environment.

The Negative

- Active accounts decline sequentially. In 1Q23, active accounts grew by 1% YoY to 433mn but decreased by 2mn compared with 4Q22. The drop was mainly driven by higher churn from lower usage accounts and the management’s decision to focus on driving more engagement with existing customers. Notably, PayPal indicated that it expects no net new additions in FY23e during 4Q22 earnings call.

• 4Q22 results were in line with expectations. FY22 revenue/PATMI was at 100% of our forecasts. In 4Q22, revenue grew 7% YoY driven by total payment volume of US$357.4bn (up 9% YoY in constant currency). PATMI rose 15% YoY (7% normalized) on accelerated cost reductions
• Payment transactions per active account set a new high at 51.4x on an annualized basis. 2.9mn net new active accounts were added in 4Q22, taking the total to 435mn.
• We maintain a BUY recommendation with a lower DCF target price of US$103 (WACC 7%, g 4%), down from US$110. Our FY23e revenue is lowered 2% as consumers are cutting back on discretionary spending; while we have increased our PATMI by 4% due to lower operating expenses. PayPal enjoys long-term tailwinds from two-sided network effects, secular shift to electronic payments, as well as rolling out Venmo payment option on Amazon.

The Positives

+ Customer engagement continues to climb. In 4Q22, customer engagement improved, with the number of payment transactions per active account up by 13% YoY to 51.4x on an annualized basis. This is a sizable increase given PayPal’s intent to shift away from adding new accounts and toward more engagement with existing users. The rolling out of Venmo payment option for person-to-business (P2B) transactions on Amazon could accelerate this engagement.

+ Focused on improving operating margin. In 4Q22, PayPal’s operating expenses fell by 5% YoY due to cost controls (job cuts and real estate consolidation) resulting in adj. operating margin of 22.9% (vs. 21.8% in 4Q21). Management noted that the company has exceeded its US$900mn cost-savings target for FY22. In addition, the company has identified US$600mn of additional cost synergies for FY23e, on top of the previously announced US$1.3bn. This includes recently-announced layoffs of 2,000 employees (7% of its workforce).

The Negative

- Slowdown in TPV growth. In 4Q22, PayPal’s total payment volume (TPV) grew 5% YoY (9% YoY in constant currency) to US$357.4bn. The growth rate decelerated significantly from 23% in 4Q21 mainly due to weak trends in global e-commerce and cuts to consumer discretionary spending amid inflationary pressures.

• 3Q22 results were in line with expectations. 9M22 revenue/PATMI was at 71%/67% of our FY22e forecasts. In 3Q22, revenue grew 11% YoY driven by higher transaction revenues. PATMI rose 22% YoY (5% YoY fall normalized) due to cost controls.
• Transactions per active account set a new high at 50.1x on an annualized basis. 2.9mn net new active accounts were added in 3Q22, taking the total to 432mn. Total payment volume grew 9% YoY to US$337bn but expected to decelerate to 8.5% YoY in 4Q22.
• We maintain a BUY recommendation with a lower DCF target price of US$110 (WACC 7%, g 4%), down from US$116. Our FY22e revenue is lowered 3% due to macro headwinds like weaker spending on discretionary items; while we have increased our PATMI by 8% due to lower expenses. PayPal enjoys tailwinds from a structural shift to digital payments, a strong two-sided network effect, as well as new strategic partnerships with Amazon and Apple to fuel growth.

The Positives

+ Rising customer engagement. In 3Q22, PayPal gained traction in its effort to boost user engagement as average transactions per active account grew 13% YoY to 50.1x on an annualized basis. This is a sizable increase as the company is now focusing more on driving user engagement rather than adding more customers. PayPal added 2.9mn net new active accounts in 3Q22, taking its total to 432mn.

+ Cost saving initiatives boost profitability. In 3Q22, total expenses grew just 11.5% YoY, and were 5.2% lower sequentially. PayPal is on track to cut costs by US$900mn in FY22e and US$1.3bn in FY23e, across transaction and operating expenses. The company plans to reduce expenses through job cuts and real estate consolidation.  The cost-cutting measures began in 3Q22 and are expected to ramp up in 4Q22e. Cost savings are expected to boost adj. operating margin to 22.5% in 4Q22e from 21.8% in 4Q21.

+ New strategic initiatives to support growth. PayPal is working with Apple on several new strategic initiatives that could benefit PayPal and Venmo merchants and consumers. PayPal will leverage Apple’s Tap to Pay on iPhone functionality for the U.S. merchants to accept contactless debit or credit card payments using an iPhone and the PayPal or Venmo iOS application. Apple Pay will also be added as a payment option in PayPal's checkout flows. Additionally, online retailer Amazon has agreed to accept Venmo payments on its platform. The payment option is likely to be available for all U.S. Amazon customers in time for the peak holiday season.

The Negative

- Decelerating growth in TPV. In 3Q22, PayPal’s total payment volume (TPV) grew 9% YoY (14% YoY in constant currency) to US$337bn. The growth rate decelerated significantly from 26% in 3Q21. PayPal expects that slowdown to continue in 4Q22 with just 8.5% TPV growth. The soft guidance reflects continued weakening trends in e-commerce, and an uncertain macroeconomic environment.

Outlook

For 4Q22e, PayPal expects total revenue to grow 7% YoY (9% YoY in constant currency) to US$7.4bn (Figure 1). The management attributes the soft revenue guidance to the slowing e-commerce market and early indications that low/middle-income level consumers are cutting back on their discretionary spending. Additionally, PayPal isn’t witnessing signs of an early start to the holiday season as occurred last year. PayPal expects to add 2.3mn to 4.3mn net new active accounts (implied).

For FY23e, PayPal expects e-commerce growth to remain under pressure but highlighted its confidence to deliver 100bps of adj. operating margin improvement and to grow adj. EPS by at least 15% YoY. This is mainly because non-transactional operating expenses are expected to remain flat or fall slightly YoY.

• Total payments volume spiked >3x in last 5 years, with the company adding over 200mn active accounts. Powerful two-sided network effect, increasing digital payments and growth of online shopping to drive revenue growth of 13% over the next 2 years.
• PayPal is a compelling business partner as it boosts conversion rates/sales for merchants. Customers are more likely to complete a purchase when core PayPal checkout is available than those using credit cards due to stored credentials.
• PayPal benefits from newer consumer-to-consumer payment trends through its peer-to-peer (P2P) Venmo payment service. Venmo’s total payments volume surged 45% YoY to US$230.1bn in FY21. Venmo will also be available on Amazon later this year.
• We initiate coverage with a BUY recommendation and DCF-based target price (WACC 7.0%, g 4.0%) of US$116.

Company Background

Spun off from eBay in July 2015, PayPal Holdings Inc (PYPL) is a global provider of digital and mobile payment solutions. The company’s two-sided platform serves nearly 426mn active accounts in over 200 markets. Its payment solutions include PayPal, Venmo, Xoom and Honey. PayPal generates nearly 90% of its total revenues from transaction revenues.

Investment Merits

1. PayPal’s two-sided network is a key competitive advantage. PayPal’s active accounts grew by 13% YoY to 426mn in FY21, while it added 197mn net new accounts over the last four years. This is mainly due to its two-sided platform that serves both consumers and businesses. This allows PayPal to leverage consumer information to boost sales for merchants by providing shopping deals for its digital wallet users. PayPal's total payments volume (TPV) has also spiked to US$1.2tn in FY21 from US$578bn in FY18 due to a larger user base and an increased number of payment transactions. We expect PayPal to continue double-digit revenue growth of 13% over the next 2 years due to network effects and secular trends in the payment industry, including increasing digital payments adoption and the rise of online shopping.
2. PayPal helps to boost checkout conversion rates/sales for merchants. Online merchants witness a higher conversion rate as consumers who choose PayPal Checkout as a payment method are less likely to abandon their cart due to a better buying experience through stored credentials. The company boasts conversion rates of 80%-90% compared to an industry average of ~50%. That value proposition help PayPal to partner with nearly 75% of the top 1,500 retailers in North America and Europe, including Walmart, Shopify, and Booking.com. PayPal also offers working capital loans to its merchants which contributes to increased merchant sales and thereby surge in volume of payments processed. We believe that new products and services such as QR Code payments and Buy Now Pay Later should also help improve checkout conversion for merchants and increase customer engagement with PayPal digital wallet.
3. Venmo monetization to support growth. Initially allowing peer-to-peer (P2P) money transfers with friends and family, Venmo now keeps on adding features to its app. Users can now create business profiles to accept payments, pay for purchases at over 2mn PayPal merchants across the U.S, and buy/sell cryptocurrencies. Venmo’s total payments volume surged 45% YoY to US$230.1bn in FY21. We believe that another significant milestone for Venmo's growth will be its partnership with Amazon, under which Amazon will accept Venmo payments on its platform.

We initiate coverage with a BUY rating. Our target price is US$116 based on a DCF valuation with a WACC of 7.0% and terminal growth of 4.0%.

REVENUE

PayPal has two revenue segments: Transaction revenues (92% of FY21 revenues) and revenues from other value-added services (8%). Transaction revenues are generated from fees charged to consumers and merchants based on the total payments volume (TPV). Other value-added services include revenue from subscription fees, partnerships, referral fees, and interest earned on loan receivables or certain customer balances.

Total revenue expanded at 18% CAGR in the past four years (Figure 1) to US$25.4bn in FY21.

Over FY18-21, PayPal’s TPV rose at a CAGR of 29% to US$1.3tn in FY21 (Figure 2). The growth was mainly driven by the number of active users, merchant acceptance, and the secular shift towards digital payments and e-commerce. PayPal generates revenues from operations in several regions, primarily the US (54% of FY21 revenues) and the UK (9%) (Figure 3).