PayPal : Q3-22 Earnings Buyside Call Transcript

Third Quarter 2022 Buyside Call | November 4, 2022

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

Dan Schulman, President and Chief Executive Officer

Gabrielle Rabinovitch, Acting CFO and Senior Vice President, Investor Relations and Treasurer

C O N F E R E N C E C A L L H O S T

Mike Ng, Goldman Sachs

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

Mike Ng

Great, thank you. My name is Mike Ng and I cover PayPal at Goldman Sachs. I have the privilege of hosting Dan Schulman, President and CEO of PayPal and Gabrielle Rabinovitch, Acting CFO and SVP, Investor Relations and Treasurer. First, I want to thank Dan and Gabrielle for making themselves available today. It is deeply appreciated and we value your time. We have a long list of questions so I will just get into it.

It was very encouraging to see the cost program coming in better than expected and the framework for 2023. PayPal has done an excellent job demonstrating cost discipline and that shows in the upgraded [non-GAAP] EPS guidance for the year and the commitment to at least 15% [non-GAAP] EPS growth in 2023. First, Dan, can you talk a little bit about the changing macro-economic environment and how that has affected PayPal's strategic priorities.

Dan Schulman

Mike, thank you for hosting the call and thanks everybody for joining us. I think the environment that we are in, as difficult as it is, is an opportunity for us in many ways. I'd rather the economy be booming along but if you are going into difficult time, this is the time where market leaders have the opportunity to improve their position coming out of a difficult economic cycle. You've got a rising interest rate

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Third Quarter 2022 Buyside Call | November 4, 2022

environment. That's clearly a tailwind for us [given that with higher interest rates we earn higher interest on customer balances held on our platform]. It's a headwind for many of our competitors. Others in the market are struggling to make money right now. They are cutting back, they're revamping their business models. We are clearly seeing that in the market and surely some of them won't make it as we go through this economic cycle. We think there is an opportunity to emerge stronger from this than from we went into it. That said, as you pointed out, and as Gabz will talk about in a second, we are looking to control the things we can control. We cannot control the macroeconomic environment. However, we can control where we invest in our high conviction growth areas and we can control to a large extent our cost structure as well. You started to see that come into play. 15% [non-GAAP EPS growth contemplated in our preliminary FY'23 framework] is a line in the sand for us. That is at least 15% EPS because we feel that we are thinking about the future in a prudent manner. We have a lot of levers to pull on the operating expense side. We feel like the initiatives and efforts we have taken over the last several quarters have put us in a good position as we look into what we think may be a difficult economic cycle going forward.

Gabrielle Rabinovitch

In terms of our base case assumptions as we think about the [preliminary] framework for next year. As a starting point, this year our expectation is that non-transaction related operating expense will grow in the low single digits [percentage] and our base case is that next year it will grow at least a few [percentage] points lower [year over year]. There are certainly scenarios where we could be flat to low single digits, but we also have significant levers to pull and we can take that [non-transaction operating expense y/y growth] negative in a tougher economic environment. Some of this is based on the demand environment and what we see. Generally speaking we are focused on simplification, greater productivity, increased market share. You have seen us identify meaningful [cost] savings this year, but we think we can do more. We are taking a prudent approach to the environment generally and we are committed to having a cost structure in place that is going to drive long term profitable growth and really allow us to continue to invest in our high conviction areas. In terms of specific line items where we see opportunity, we see continued opportunity on marketing spend. It's a discretionary area. We are holding ourselves to be more accountable in terms of the return on spend, where it's going, how we think about it supporting our business and our long-term objectives. That's an area where you will continue to see prudence. You've seen that [higher accountability] come in this year and I think we'd expect to see further productivity initiatives next year. In addition, [we are] looking at headcount, workforce planning, where we really need to be investing versus where we have opportunities to operate more efficiently, location strategy and other support areas. I feel like we have a good amount of room to go. We feel like we can operate a lot more productively and we feel like we can support the business longer term in terms of achieving our growth objectives.

Mike Ng

Great. Thank you both. Just rounding out the discussion on 2023, perhaps you could talk about some of the biggest swing factors that could affect revenue performance. What's the macro or eCommerce environment that you're assuming, any color there would be helpful.

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Gabrielle Rabinovitch

I think the biggest macro factor is the growth in eCommerce overall and that will help define how we think about the year ahead. Q4 is a very important one and we are going to be watching it very closely. Discretionary eCommerce is under pressure for a lot of the reasons we all appreciate and so the growth of our core business overall will be dependent on the growth of the market. That said, we would expect to grow at or better [than the overall rate of eCommerce] from a core branded checkout standpoint and that's how we think about our business. On the Braintree side, we do have certain merchant relationships, some of them are larger in nature, some of them chunky. So when we see those integrations come in that does have a beneficial impact in quarter and then for the next 3 quarters post that. Dan mentioned yesterday there were some "live to sites" that were a little delayed and when those come online that will provide some tailwinds from that standpoint of TPV [Total Payment Volume] growth and revenue growth.

Mike Ng

Great. While we are on the topic of industry eCommerce growth, can you talk about what you see as the best methodology for measuring that? A couple of investors have pointed out that there are a slew of options right? In terms of BofA [Bank of America] and card not present data, Visa, Mastercard or the [U.S] Census [Bureau]. What's your preferred way of measuring of what industry eCommerce growth is compared to the branded checkout performance?

Dan Schulman

There isn't a great proxy and that's clear. The proxies that come out are usually wrong when you do look back. If I look back on the various proxies for Q4 of last year and their predictions on US eCommerce growth, for the most part they were off by 30% and 80% from the actual number. Unfortunately, you don't know for sure until there is a backward glance. In real time it's quite difficult to get an assessment on it. We have a pretty good view, but between Amazon and PayPal and maybe a couple of others we are the eCommerce market. So, we have a really good view of what's happening in the marketplace. We see which segments are pulling back. We see what countries are under pressure. We did do 5.6 billion transactions last quarter [Q3'22] alone across 400 million plus active accounts. We have a pretty good view of that. In larger merchants where they've integrated through Braintree, and that would include all wallets, cards, etc., we have a pretty perfect view of what's going on with market share. It's a really difficult thing to assess in real time coming out of a quarter. We do our best to triangulate with the data that we have, with that data we are seeing from external sources. But I would agree with a lot of the investors out there. There's no perfect source and those data sets do move over time as well.

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Mike Ng

Great, thank you. I guess while we're talking about market share can you just talk to how the branded PayPal product is gaining or losing checkout share in certain geographies or verticals. For instance, apparel vs. marketplace vs. general merchandise, whether that's in the quarter or in recent trends.

Dan Schulman

Again, the proxies are not great. But the best proxies are in the US and there are a number of them. We can usually triangulate best in the US versus other markets at least real time. In the US, our branded checkout [TPV] was up about 4% year over year in the quarter. We think that was ahead of where US eCommerce growth was, especially if you exclude things like travel [and events]. I think we at least held share if not gained some share. A lot of the share gain that we see on branded checkout comes from the tremendous success that we are seeing in Buy Now Pay Later. We are moving upstream in more and more merchants and important merchants. We have the opportunity I think to displace other Buy Now Pay Later players in some major merchants over the course of the next 6-12 months as a real sense of rationality is sweeping through the market in terms of the ability to pay for placement. Our value proposition there is excellent and our competitive advantage in that space is meaningful. We know 90%+ of the customers that come into Buy Now Pay Later. That means just from an underwriting perspective, we have much better views than our competitors. It is why our loss rates are we think the lowest in the industry by a good amount and we are not really seeing any deterioration in loss rates through the quarter. That is a competitive advantage for us. Things like password-less, we are making reasonable progress in terms of more and more password-less experiences on the checkout side and it has gone up by about 10% in our base. We are seeing appropriate conversion improvements as a result of that. The digital wallet is having an impact for those who have adopted the digital wallet in terms of their number of checkouts. These are our best experiences, but just our classic experience is quite superior to entering cards. We have on average 600 basis points better conversion rate, [we are] 8x the size, [and] better brand preference. We have a lot of opportunity going forward. It will take time for that to play out over a 35 million active merchant base of a legacy integration, but year-over-year-over year you are going to see continued improvement in that. That is why I am optimistic that in this more difficult economic cycle, that we can actually increase the rate of our share gain as opposed to just maintain it.

Mike Ng

That is great, that is very helpful. I want to go back to something that was mentioned earlier which was the rising rate environment being a tailwind for PayPal. In the quarter, revenue came in as expected but other value-added services [OVAS] obviously outperformed. Could you talk a little bit about the key drivers of OVAS outperformance in the quarter, how you're thinking about that line item for the rest of the year and how important is OVAS growth as a contributor as you think about the revenue growth for 2023.

Gabrielle Rabinovitch

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We don't guide revenue by transaction revenue growth and other value added services growth [OVAS]. That said, OVAS has performed better this year overall. When we started the year, we had some conservative assumptions around how our credit business might perform in 2022. We thought potentially the credit environment might be a little tighter, we could have seen originations get impacted in the overall performance. As it turned out, our credit business has performed very well. The Synchrony gain share and our own on-balance sheet credit activities have performed quite well, so that has performed stronger than what we expected. In addition, we have had a nice tailwind from the [interest] rate environment. As we moved through the year, that has supported stronger OVAS growth. In the quarter [Q3'22], we grew [OVAS revenue] 6% and we were lapping the benefit from some higher than normal servicing revenue that we recognized in [Q3'21]. We'd expect OVAS [revenue] to grow in the mid-teens, that is our expectation for full year 2022. In terms of next year, it could grow around the same rate or maybe a little bit faster than that. Again, it will depend in part on the performance of the credit book which could offset some of the benefit we do get from the [rising interest] rate environment. While interest rates are a tailwind, it is a rolling benefit on our book and that is based upon how customers stored balance gets invested. There is a note in our [Q3'22 Form] 10-Q, note 8, that gives you a sense for the duration. While we do have things that are maturing in the next 12 months and we can reinvest at higher yields, part of the book as well is going to be maturing over a longer period of time. As a practice, we don't realize losses to move into higher-yielding securities. We let the book roll naturally and that has been the way we have run it over time.

Dan Schulman

Some of the newer cards we have put out, our [PayPal Cashback Mastercard], our new debit card, they are beginning to get some real traction in the market. In the first 6 months of putting out our [PayPal Cashback Mastercard], we got as many people signing up for that as we had in the last 22 months for our 2% cash-back offer. Our quarter-over-quarter debit card approvals rose by about 40% with the new debit card coming in. We are looking at in store in a card strategy perspective. We know we have a lot of room to grow there and we are going to be very responsible around looking at our credit book. We have a lot of experience in it, and we know these customers quite well. We are ready in a difficult environment to tighten appropriately. We look at this quite carefully, week-by-week,month-by-month on all of these different metrics. Right now, we are pretty pleased with what we are seeing in that part of the business.

Mike Ng

Great, thank you, I just want to close out some of the discussion around the branded PayPal button. It was helpful to get the TPV breakout and I think you guys said the PayPal branded checkout CAGR was about 26% [FXN from 2018-2021]. I was wondering if you could help us think about the breakout of that between US versus international and if you have any commentary around the US and international performance might look going forward from here on out just given the challenges in places like Europe and the UK?

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