PayPal : Q3-22 Earnings Analyst Call Transcript

Third Quarter 2022 Analyst Call | November 3, 2022

C O R P O R A T E P A R T I C I P A N T S

Dan Schulman, Chief Executive Officer and President

Gabrielle Rabinovitch, Acting Chief Financial Officer and Senior Vice President, Investor Relations and Treasurer

C O N F E R E N C E C A L L P A R T I C I P A N T S

Sanjay Sakhrani, KBW

Dan Perlin, RBC

Ashwin Shirvaikar, Citi

Tim Chiodo, Credit Suisse

Ken Suchoski, Autonomous Research

Josh Beck, KeyBanc

Dominick Gabriele, Oppenheiner

Trevor Williams, Jefferies

Harshita Rawat, Bernstein

P R E S E N T A T I O N

Operator

Good day and welcome to PayPal's Q3 2022 Analyst Call. I'd now like to welcome Gabrielle Rabinovitch to begin the conference. Gabrielle over to you.

Gabrielle Rabinovitch

Super. Thanks, April. Hey, thanks everyone for joining us this afternoon. I'm here with Dan and the rest of the IR team. I know we've got a lot to cover. So, I think we can go right into questions. Can we start with the first question.

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Third Quarter 2022 Analyst Call | November 3, 2022

Operator

First question comes from the line of Sanjay Sakhrani from KBW. Sanjay, please go ahead.

Sanjay Sakhrani

Thank you. You guys have a pretty healthy deposit base. I'm just curious how we should think about the asset sensitivity going forward with [interest] rates going up so much. And then just a quick follow up, Dan mentioned the low-end consumer pulling back spending, is there any way to quantify what that exposure is as a percentage of TPV (Total Payment Volume)? Thanks.

Gabrielle Rabinovitch

I'll start with interest income on customer stored balance. OVAS (Other Value Added Services) revenue grew 6% in the quarter. That was based on both interest income and customer stored balance. We were [also] lapping some higher-than-normal [loan] servicing fees on our credit business from Q3 of last year. Our overall outlook for OVAS revenue growth [for FY'22] is now a little higher than it was just a quarter ago. When we started the year, we had more conservative estimates, in part because we were thinking that our overall credit business might grow at a slower rate than it did. Of course, we were only baking in what we currently knew in terms of the rate environment. I think [that] this year, other value added services revenue [will] probably growing mid-teens. Now we don't have one-for-one sensitivity with fed[eral] funds movements because of the way the customer balances are actually invested. We have customer balances that sit globally [across different] jurisdictions, and they're predominantly in our core markets and those funds get invested. There's some duration on those investments. They're not all overnight [duration]. That said, when [interest] rates increase, we do see a benefit from that. The low and negative rate environment in certain jurisdictions was a headwind for us the past few years. We do expect [interest rates] to continue to contribute to OVAS growth next year. But we haven't quantified what the benefit would be.

On the low-income consumer side, we have not disclosed the percentage of TPV that we would attribute specifically to low income. I think the way low income gets defined might be different in different markets. Our platform itself is very much tethered to discretionary retail. To the extent that we see crowding out [of discretionary spending] across the board and negative real wage growth across most people, that is having an impact on overall discretionary spend. And so, we're taking that into consideration.

Dan Schulman

We have 430 million plus active accounts. It pretty much mirrors the general population. As we look into 2023, it's so early. There are a wide range of outcomes that could happen. We talked about our 15% [non-GAAP] EPS growth and at least 100 basis points of [non-GAAP] operating margin expansion [based on our preliminary FY'23 framework]. We've taken what I would call a pessimistic look at what an economic cycle could be as we go into 2023. If it's better, and it could be because there's a lot of different scenarios around it, then we could see better performance from that. But I do think, despite being prudent, and I think appropriately conservative as we think about what the scenarios could be next year, that 15% EPS return as best I can tell puts us in the top quartile of S&P 500 companies in terms of expected EPS growth rate for next year. So even in a difficult economic environment, what we're doing from a cost perspective and the places where we're investing, as a starting point [would] get us to about $4.70 [in non-GAAP EPS based on our preliminary FY'23 framework]. We think it's a really strong position to be in. I know that doesn't exactly answer what you were asking Sanjay, but it's but how we're thinking about things in general.

Sanjay Sakhrani

No, I appreciate it. It's pretty fluid situation here. Thank you.

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Third Quarter 2022 Analyst Call | November 3, 2022

Dan Schulman

Yeah, it really is. Yep.

Operator

Our next question comes from the line of Dan Perlin from RBC. Dan, please go ahead.

Dan Perlin

Thanks. Good evening. You're speaking of some of those assumptions for '23, I just wanted to make sure we were clear on a few of the key points. One is, are there buybacks assumed in the 15%. Two, is the externalization of credit embedded in the at least 100 basis point margin assumption that you've put out there. And then three, any thoughts around the assumptions that you're using around what's embedded in the cyclicality of the business, i.e., what you're expecting from e-commerce in '23 versus maybe this noncyclical overlay that you're clearly benefiting from which would include things like share gains, client [go lives], Braintree, Apple, Amazon, and those kinds of things. Trying to think about that from a proportional standpoint. Thank you.

Gabrielle Rabinovitch

Yes, I'll start, and Dan can add in how to think about our volume opportunities in the cyclicality versus non-cyclicality. A baseline level of buyback has been incorporated into that [preliminary FY'23] view. But with 1.1 billion shares outstanding, what we're talking about from an earnings growth standpoint, baseline [non-GAAP] EPS growth rate of 15%, that's really coming from the productivity gains that we're making. The predominant driver is both our efficiency initiatives as well as our cost savings, with most coming from the non-transactional operating expense side but some benefit coming from the mitigation on the volume-based side.

From a [credit] externalization standpoint, I would not expect any meaningful impact on our operating margin profile. So, [our preliminary FY'23 framework of] at least 100 basis points of [non-GAAP] operating margin expansion is truly operational and from core business activities. As currently contemplated, the way we're thinking about [credit] externalization would be essentially on forward book business. While we would be looking to deconsolidate, so we would not have loan loss associated with that portion of our portfolio on a go forward basis, it really is not what will be driving the operating margin improvement.

From the standpoint of how we're thinking about volume growth and e-commerce growth to get to this initial framework, we've done a fair amount of sensitivity work around potential volume growth implications. Again, with $1.4 trillion of [payment] volume on our platform [anticipated] this year, of course our initiatives count. The things that we're doing around growing our business, on increasing the merchant penetration across Braintree help, but the macro itself is going to be a big driver of what that addressable e-commerce growth is for next year.

Dan Schulman

I do think this is an environment as difficult as it is, where market leaders should be able to come out of it much stronger than when they went into it. Many of our competitors are really struggling to make money. And some of them will make it, some probably won't make it as well. We have the wherewithal to invest significantly in areas that we have high conviction around and that are really showing results. The reason we keep saying that we [expect] to grow at or above the rate of e-commerce is because of some of the unique advantages and assets that we have and the improvements that we're continuing to make in our value proposition. A rising interest rate environment benefits us, and it is difficult for some others who we compete with who need a low cost of capital to actually make their models work. We're making sure our

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cost structure is in a place that we can deliver robust EPS growth for our investors and also invest. We are very focused on enhancing our value proposition and growing through this. So, it's hard to tell what is going to be incremental from initiatives just like any downward pressure from the macro environment. But we know our initiatives are making a big difference in the market.

Dan Perlin

Yep. Excellent. Transaction expense as a percentage of TPV was 0.89% [in Q3'22]. I'm just wondering, is that a good jumping off point? Understanding that Braintree is growing fast, but I suspect you guys are working very hard on trying to increase engagement with Venmo and PayPal inside of Braintree. So, thank you very much for that.

Gabrielle Rabinovitch

You're right, we're working very hard. At the same time, there is some seasonality overall in the way we see transaction expense [as a] rate [of TPV]. Typically, we see it inflate a touch in Q4. So, I'd expect that [seasonality] to occur this year given the mix of our volume. [I'd expect] Q4 to be slightly higher than where we actualized at in Q3.

Dan Perlin

Thank you.

Gabrielle Rabinovitch

Yes, you bet.

Operator

Next question comes from the line of Ashwin Shirvaikar from Citi. Ashwin, please go ahead.

Ashwin Shirvaikar

Hey, thank you guys for doing this call. I want to go back to, a lot of confidence that was exhibited about the 15% [non-GAAP] EPS growth. What combination of factors might lead you to not do that? Do you have infinite flexibility on the cost side to take cost and investment out? It just seems to be a very strong line in the sand given the level of macro uncertainty. And then I have one other question about Net New Actives (NNAs), which seem to be turning a corner. Is that sort of your read as well? And what should we expect for next year?

Gabrielle Rabinovitch

Yes, I'll start on the on the EPS growth and then Dan can cover the active account piece. We've done a good amount of sensitivity work around that 15% baseline level of non-GAAP EPS growth. We think relative to what we've already called out in terms of the cost savings we've identified, as well as additional opportunities that we're in the process of working through, that we have room to get there. And that would be with a range of TPV and revenue growth scenarios that we think are sufficiently conservative and provide a sufficiently wide range of outcomes.

We have a tremendous amount of opportunity here, in part because of how much we invested in the business through the pandemic period. If you look at what our trends were pre-pandemic in terms of the growth in our non-transaction operating expense relative to our top line growth, on average, we were growing our non-transaction operating expense at about 50% of the rate of growth of revenue. And that very meaningfully changed through the pandemic. We are now at a point where there are opportunities to take some costs out and be more productive. The other piece of this too, is we're becoming more

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disciplined and more focused on certain key priorities. We are not spending on all of the same things. We're being very, very focused and disciplined around the things that we're prioritizing and [certain other lower priority initiatives] we are just either slowing down or stopping. That's allowing us to be a lot more prudent around those cost savings. We're very committed to the 15% [preliminary FY'23 non-GAAP EPS growth framework]. We'll continue to update you on where the savings are coming from and what those productivity initiatives are doing for us.

Dan Schulman

Just an addition to that. The initiatives that we're driving right now, and they're starting to take a hold, are also leading to cost reductions. For instance as we put out more and more passwordless experiences, not only do you have incremental conversion, but you have way less costs coming into customer service as well. This is one small example of all of these things linked together. The more beautiful your experience is, the less costs that come into the business. And that's really what the what the team is focused on.

I can talk to your Net New Active [NNA] question. The real place that we are focused on driving net new actives is the bottom of the funnel. When you have 430 million plus active accounts, churn and how many people you lose out of the bottom of the funnel is the predominant driver of whether or not you grow your accounts going forward. The places that we're investing, especially around checkout around our digital wallet, if we can continue to scale those that will begin to impact our churn rate. If our churn rate goes down, engagement goes up. NNAs will go up as well, because the top of our funnel is relatively robust and has been consistently. But as we also said, we're not going to be spending marketing dollars on chasing NNAs or lower calorie NNAs. Everything we do right now, we look at an NNA that comes in and we look at what's its engagement level, what it's ARPA [Average Revenue Per Account], and we make sure that we calibrate our marketing dollars to that. We can be much more efficient there both in top of funnel, but really just in driving bottom of funnel improvements. I'm hopeful that we'll begin to see that play out over time as well.

Ashwin Shirvaikar

Makes sense. Thank you.

Dan Schulman

Yep.

Operator

Our next question comes from the line of Tim Chiodo from Credit Suisse. Tim, your line is open.

Tim Chiodo

Great. Thanks, mine are just three very quick numbers that I'm hoping we could run through. The first one, you said Braintree growth was about 38% year-over-year, was wondering if you could give the three- year CAGR or the 2019-based CAGR for that number.

Gabrielle Rabinovitch

Still 50%.

Tim Chiodo

Okay, great. So, 50-50-50 for the first three quarters. That's great.

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