PayPal Q1 2023 Earnings Review

Digesting the Results of this Payments Giant.

Brad Freeman

May 8, 2023

1. Demand

Revenue beat estimates by 0.7% and beat PayPal’s guide by 1%.

**TPV = Total Payment Volume; TPA = Transactions per Account**

Demand Context:

The 3-year revenue CAGR is 20% when excluding the impact from eBays’s migration.
Revenue rose 10.4% YoY on an FX neutral (FXN) basis as currency headwinds continue to ease. This was vs. internal guidance calling for about 9% growth.
Both branded and non-branded volume growth accelerated meaningfully from Q4.
Venmo revenue rose double digits YoY despite some of its toughest comps ever. Volume growth for Venmo accelerated over 500 bps vs. last quarter.
U.S. revenue rose 13% YoY and international rose 3% YoY (7% FX neutral).
- U.S. revenue is 59% of total vs. 57% of total YoY.
Transaction revenue fell 5% QoQ and rose 6% YoY.
Other value add services fell 1% QoQ and rose 39% YoY.

2. Margins

EBIT beat estimates by 4.6% and beat PayPal’s guidance by 4.6% as well.
EPS of $1.10 beat estimates by $0.07 and its guide by $0.08.
GAAP EPS beat estimates by $0.03 and its guide by $0.07.
Free cash flow missed expectations due to a unique item discussed below.

Margin Context:

Transaction margin is being pressured by non-branded Braintree revenue growth far exceeding the company’s expectations. This is also pressuring transaction take rate (1.80% vs. 1.85% YoY) and the company’s other margin lines. The negative trend is being temporarily amplified by it sunsetting PayPal white-label service to move those clients to PayPal Commerce Platform (PPCP). Pressure is expected to continue for a few quarters with transaction margin bottoming thereafter. PayPal is actively working on the margin profile here via the following objectives:

PPCP debuting for smaller merchants with lower volumes and so higher margins.
PPCP being integrated into PayPal’s largest selling channel partners to facilitate efficient growth.
Expanding globally. Cross-border transactions carry a higher margin profile due to added complexity and FX services.
Adding more value add services on top of the platform like risk as a service, open orchestration and Hyperwallet payouts. Hyperwallet is especially attractive to giant marketplaces needing to pay sellers in as flexible and expedient of a way as possible. That’s why Braintree has won Airbnb and Uber as clients recently (among many others).

Importantly, PayPal’s non-transaction operating expenses are being cut (fell 12% YoY) to counteract this pressure. That’s why EBIT and net income expanded meaningfully and why EBIT growth was faster than it has been in 2 years. Recovering cross-border volumes also helped here with YoY growth turning positive this quarter for the first time in a while.

Other headwinds that dampened the level of margin expansion in the period include:

The continued normalization of credit usage following the stimulus-era debit shock.
Lapping the start of the company’s most meaningful cost control objectives.

Somewhat notably, AI was a key theme of the call. CEO Dan Schulman sees generative AI as feeding more cost savings efforts over the next several quarters.

3. Balance Sheet

$1.4 billion in buybacks for the quarter.
$15.3 billion in cash and equivalents.
$10.5 billion in debt.
Credit Metrics:
- Transaction expense rate rose from 0.87% to 0.93% due to Braintree proliferation.
- Transaction and Credit Loss rate rose from 0.11% to 0.12% despite a normalizing credit backdrop as industry loss rates rise. Its risk mitigation investments are paying off.
  - Transaction loss rate was 0.08% of volume vs. 0.10% of volume YoY due to these investments.
- Built $32 million in credit reserves vs. releasing $9 million in the YoY period. This slightly weighed on net income growth.
- PayPal Business Loans (PPBL) widened its credit box early in 2022 and is working through modestly higher delinquencies as a result. The rise has been very manageable compared to competitors. It expects this delinquency rate to peak this quarter.
- Buy now, pay later (BNPL) delinquencies remain in very, very good shape.

4. 2023 Guidance

Raised its EPS guide from $4.79 to $4.87 which also beat estimates by $0.06. This represents 20% YoY earnings growth vs. its original guide calling for 15% YoY growth.
Raised its $3.27 GAAP EPS guide by $0.15 which also beat estimates by $0.03.
Reiterated its $5 billion in FCF guidance. $4 billion of that will be returned to shareholders via buybacks vs. $4.2 billion in 2022.
Lowered its EBIT margin expansion guidance from 125 bps to 100 bps due to Braintree growing much faster than it expected.

Revenue growth will be “stronger than previously expected” with second half growth similar to the first half. This was better than consensus estimates called for by about 100 bps. This raise comes from a combination of successful product enhancements and expectations for low single digit e-commerce industry growth vs. its original assumption of 0% growth.

More EBIT Color for the full year guide -- Q2 EBIT margin will again expand QoQ. Q3 EBIT margin will be pressured by lapping the largest benefit from added interest income via rate hikes as well as cost saving efforts. Q4 EBIT margin will resume QoQ expansion.

Finally Q2 2023 guidance was roughly in line on revenue and EPS.

5. Call & Presentation

Free Cash Flow:

Free cash flow generation fell 3% YoY. This was due to $430 million in added cash taxes via transfers of intellectual property. FCF margin ex-this charge was 20.3% and would have expanded QoQ and YoY.

Checkout Volume:

Branded volume rose 6.5% FXN as it maintained share in all core markets. Just like last quarter, leadership told us that when merchants have its latest, Braintree powered checkout stack implemented, PayPal is maintaining or growing branded share in all instances. That’s how it has reduced average checkout latency by 40% YoY. Work to get the rest of its merchants on this flow are ongoing.

PayPal branded checkout continues to lead in merchant share adoption and continues to boast authorization rates 6% better than the average while its mere presence continues to deliver a 44% merchant conversion lift. PayPal users make 60% more transactions on a merchants site and deliver a 20% boost to repeat buyers as well. These are massive perks which should drive continued adoption. It expects further growth acceleration here (which is needed) as investments work and comps ease. Importantly, it also reiterated that all Braintree merchants deliver higher branded PayPal checkout share vs. non-Braintree merchants. Branded and white-label truly work well together.

Still, Braintree continues to be the standout here. Non-branded volume rose 30% YoY FXN to take share in all core markets. Again, this will likely continue hitting transaction margin this year before the aforementioned initiatives reverse that trend in 2024.

Braintree, per leadership, is now as large as Stripe and Adyen on a volume basis and is growing faster. It has reached this scale while boasting the lowest loss rates and highest authorization rates in the industry.

Accounts:

The QoQ decline in accounts looks alarming on the surface, but needs more context. A few quarters ago, PayPal decided to end low engagement retention programs yielding a negative investment return. It stopped trying to keep low value customers just for the sake of propping up its user metrics. It shifted to prioritizing highly engaged users and monthly active users (MAUs). MAUs rose QoQ. Transactions per account growth was faster than it has been in several quarters and accelerated throughout the entire period. Its newest customer cohort is transacting 24% more frequently with 40% higher revenue per account vs. the YoY cohort. This is all evidence to the team that its shift is beginning (key work beginning) to bear fruit.

Buy Now, Pay later (BNPL):

32 million customers are using this vs. 30 million QoQ & zero 24 months ago.
Volume grew 70% YoY as it is now “among the largest in the world” here.
PayPal BNPL customers continue to spend 30% more vs. non-users
PayPal continues to boast “industry leading” authorization and loss rates for merchants. It pays to know the customer better than your competition.
It continues to expect to sell its BNPL receivables this year to shed balance sheet risk and become more asset light.

“PayPal BNPL is clearly taking share.” -- CEO Dan Schulman

Venmo:

Will debut Venmo to PayPal peer to peer (P2P) transfers this year… finally.
Just added Venmo (and PayPal) Checkout with McDonald’s and Microsoft’s Xbox and Teams.
Amazon and Starbucks checkout volume is “growing nicely.” Wanted a lot more detail here.
Teen accounts are in beta testing.

Digital Wallet:

55% of PayPal accounts are now app users vs. 49% YoY. These accounts generate 35% more volume with 25% lower churn on average
6 million users are now engaging with its new rewards feature and delivering 45% more volume vs. non-users.
Post purchase tracking (for PayPal and non-PayPal purchases) is now live with a 20% transaction per account boost for users.

6. Take

Branded share is stable which is great to hear. Braintree continues to be the standout which is hurting margins -- but that pressure should only last for a few more quarters thanks to the aforementioned initiatives. We got another profit raise and more assurances that profit AND revenue growth will be persistent for the next several years. This is not a 1 year feature.

The issue here was Schulman deciding to tell investors to expect a beat during in-period investor conferences. This raised the bar for the quarter while PayPal delivered very small outperformance. Any outperformance in this environment should have been enough to appease investors if Schulman kept his optimism to himself. He overpromised.

We also heard less on Venmo and Amazon than we wanted to, but loved the McDonald’s and Microsoft news. It’s inning one for Venmo commerce and momentum needs to pick up going forward. It should.

Finally, the level of transaction margin compression was disappointing. HOWEVER… the reasoning is as ideal as a margin headwind can get (Braintree domination). With all that said, the results were rock solid across the board. Not perfect, but mainly positive despite a chaotic, daunting backdrop. It’s likely just time for a new CEO who will be named this year. I have no plans to trim following this report. If the share price reacts negatively enough, I’ll add.