PayPal's Second Quarter Is Mixed as eBay 'Band-Aid' Gets Torn Off 

PayPal (PYPL) on Wednesday, after the closing bell, reported a mixed headline result with its second-quarter earnings. Revenue of $6.24 billion (+17% YoY ex-FX) was a tad short vs. the $6.27 billion consensus, however, adjusted earnings per share of $1.15 (+8% YoY), edged out expectations of $1.12 per share.

Excluding eBay (EBAY) Marketplaces, where revenues declined 51% on a spot basis, revenue would have been up 32% YoY at spot rates - representing a 2-year compounded annual growth rate (CAGR) of 20%. which provides a bit more clarity given the dynamics of the pandemic.

"On the heels of a record year, we continued to drive strong results in the second quarter, reflecting some of the best performance in our history. Our platform now supports 403 million active accounts, with an annualized TPV run rate of approximately $1.25 trillion. Clearly PayPal has evolved into an essential service in the emerging digital economy," commented CEO Dan Schulman on the release.

Taking a look at the operating highlights, (annual growth rates stated on a FX-Neutral basis), total payment volume (TPV) of $311 billion (+36% YoY or 43% ex-eBay Marketplaces) was much stronger than FactSet expectations of $295.172 billion - on a 2-year basis, this represents a 34% CAGR. Making up this key metric, Merchant Services TPV grew 43% YoY, while the eBay Marketplaces TPV declined 41% YoY. Notably, with this quarter's results, the company has reached TPV of over $1.1 trillion over the past 12 months.

Importantly the growth rate of Merchant Services TPV far outpaces that of eBay Marketplaces TPV, with the former having grown 33% YoY in 2020 (and seeing a 29% 3-year CAGR from 2016 to 2019); and the latter growing a mere 13% in 2020 (and seeing a paltry 1.5% 3-year CAGR from 2016 to 2019).

Sticking with eBay Marketplaces' TPV for a moment, we note that this line item represents a mere 4% of TPV and on the call, Schulman said that the team now expects "that eBay will be essentially 100% complete with their migration to managed payments by the end of the third quarter," with eBay Marketplaces TPV to be less than 3% of total TPV and revenue exiting 2021. Despite that this accelerated ramp will result in an additional 100 basis points of revenue pressure in 2021, the company maintained its full year revenue guidance; this is important because as we will see below, the fiscal 2021 revenue guidance was just shy vs. expectations, however, it appears the miss may simply be due to this accelerated dynamic.

"The good news," said Schulman about the guidance, "is that this pressure begins to ease in Q4 and obviously positions us for accelerated revenue growth in 2022."

Back to the overall metrics, driving that solid TPV growth, the company added an impressive 11.4 million net new active accounts (NNAs) in the quarter for an increase of 16% YoY bringing the total number of active accounts to 403 million, largely in line with expectations. Within that number, the company added 1.5 million merchant accounts, bringing the total number of active merchant accounts to 32 million (+16% YoY). Just to further demonstrate the speed with which the company is growing its user base, management noted on release that that 11.4 million quarterly number amounts to 1.5 NNAs every second of the second quarter.

Customer engagement also improved, as PayPal is now averaging 43.5 (11% YoY) transactions per active account on a trailing 12-month basis. The company also saw a ~6% YoY increase in the number of daily active accounts using PayPal core experiences, a solid increase given we already saw a 37% increase on this front in the year-ago period. 

Merchant Services volumes increased 43% YoY and represented 96% of TPV in the quarter, with CFO John Rainy attributing the strong growth to "a resurgence in travel in advance as well as core payment volumes." Additionally, Person-to-Person (P2P) volume (including core PayPal, Venmo and Xoom) increased 41% in the quarter to $90 billion, representing roughly 29% of TPV. In Venmo alone, volume increased 58% to $58 billion, though this was short versus the $59.168 billion consensus.

As for the company's total take rate (total revenue divided by TPV), a key profitability metric for payment processors, was 2.01% (-36bps YoY), slightly below the 2.1% consensus, while the transaction take rate (transaction revenue divided by TPV) came in at 1.86% (-37bps YoY) with the annual decline attributable to "lower eBay volumes, higher Braintree share (including increased bill pay volumes) and y/y reduction in hedge revenue."

Looking at FY21 guidance, management reaffirmed expectations for revenue growth of ~20% at current spot rates, and ~18.5% on an FX-neutral basis, to ~$25.75 billion. This sales guidance is a bit light compared to the current $25.867 billion consensus. Additionally, despite lowering non-GAAP operating margin guidance to a "flat to modest expansion" (from "~100bps of non-GAAP operating margin expansion" guided for in the first quarter), management reaffirmed expectations non-GAAP earnings per share to be ~4.70, also a bit short vs. the $4.73 per share consensus. That said, TPV guidance was a bright spot as the increased their FY21 outlook "on strong volume trends," now expecting ~33% - 35% YoY growth, up from ~30% YoY previously forecast.

As we noted above, while that revenue target may be short vs. expectations, the consensus was likely not factoring in the accelerated eBay dynamic, with management now expecting a ~7pts headwind from eBay's managed payments transition, up from ~6% guides for in the prior quarter. 

We always knew that these eBay-related revenues were going away and as an analyst from JPMorgan put it during the call, we are simply 'ripping off the Band-Aid.'

Thinking through this (admittedly with some "back of the envelope" math), if we assume that without the eBay headwind that revenue would have grown ~21% at spot rates from 2020 levels of $21.454 billion (simply adding back that ~100bps of revenue pressure called out by Schulman on the call), we would have gotten a revenue guide of ~$25.959 billion. For example, we may very well have been looking at a beat on FY21 guidance if not for the accelerated eBay headwind. As a result, we think this is more about timing than anything fundamental about which to be concerned. We always knew that these eBay-related revenues were going away and as an analyst from JPMorgan put it during the call, we are simply "ripping off the Band-Aid" -- which may hurt for a moment but is definitely the best way to do it.

"Frankly, the sooner eBay transitions the better it is for our future revenue growth," said Schulman. "I'd also say just one other thing, we are making a lot of progress with a lot of other marketplaces coming out of the eBay restrictions. And we continue to see Alibaba (BABA) continue to ramp. We're really pleased to watch the growth rates there. And we're making a lot of progress with a lot of other marketplaces that we'll talk about as we get along further in the year. So this eBay transition is behind us at the end of this quarter. The headwinds dissipate and we're glad to start to move forward. And as John said, we'll really be able to see the strength of the franchise start to shine as a result of that."

Looking ahead to the third quarter of 2021, where the company will be up against its toughest revenue comp vs. 2020, management expects revenue to grow ~13% to ~14% at current spot rates to a range of ~$6.15 billion to ~$6.25 billion, which is light compared to the $6.439 billion consensus. On the bottom line, management expects to deliver adjusted earnings per share of ~$1.07, which missed the $1.14 per share consensus.

Regarding the upcoming launch of the "Super App" Schulman noted that the platform is now "code complete" and that the team is now beginning to slowly ramp it with plans to be fully ramped in the U.S. in the next several months "with a host of products and services across payments, basic consumer financial services, and commerce and shopping tools launching every quarter. New features will include high-yield savings, early access to direct deposit funds, new and improved bill pay functionality, messaging capabilities outside of p2p to enable family and friend Communications, as well as additional crypto capabilities and customized deals and offers."

Lastly, we remind members that PayPal's new pricing changes, the first headline pricing change in 20 years, is set to take effect on Aug. 2, 2021 with prices going from 2.9% plus $0.30 per transaction for both the branded wallet and unbranded processing to 3.49% plus $0.49 per transaction for branded online payments using PayPal and 2.59% plus $0.49 per transaction unbranded processing of debit and credit cards online. Explaining the strategic rational, management said on the release that consumers are nearly three times more likely to complete their purchase when PayPal is available at checkout, and that "Buy Now, Pay Later solutions" have resulted in a 15% lift in payment volume for businesses. Given the clear benefit of accepting branded PayPal at checkout and the commoditized nature of unbranded processing, we believe the updated price dynamic to make perfect sense, especially with a Super App that sounds like it will further increase PayPal user engagement on the way.

All in, we believe the quarter was stronger than the headline results would indicate and that the underlying business fundamentals remain as strong as ever. Moreover, we continue to believe that habits formed during the pandemic are here to stay and work to PayPal's advantage, with Schulman saying during the Q&A session that "elevated spend around online is continuing even as we see economies reopen."

"If you even look at things like our daily active users, our daily active users vs. pre-pandemic levels are up 43%. They were up substantially last year and they continue to grow as we go into this year. And so, I think we have a lot of strength in the core. Some of that is being masked by eBay. But eBay is all about timing."

With the new pricing model imminent, a Super App that will bring even more services and engagement (and therefore monetization opportunities) set to be released in the U.S. in coming months, an accelerated adoption of digital payment mediums resulting from the pandemic, and the eBay headwind nearly behind us, we believe the path ahead to be as bright as ever. While we wouldn't be surprised to see the after-hours selloff continue into tomorrow's session, we believe that once the weak hands shakeout, this selloff will ultimately prove to be a buying opportunity that we look forward to taking advantage of.