PayPal Holdings Inc.'s Venmo is Growing and Plans to Monetize

PayPal headquarters. Image source: PayPal.

The mobile-payments industry is gaining speed and popularity with each passing week.

In this clip from the Motley Fool's Industry Focus: Tech podcast, Dylan Lewis and intern Eryn Ratcliffe talk about why Venmo is such an interesting company to invest in, what it's doing right that its peers aren't, how much it's grown in the past few years, where the company wants to go from here, and how it fits into the payments industry today. Also, the hosts explain a few problems with the company's business model today, and how it affects the company's investment potential.

A full transcript follows the video.

This podcast was recorded on June 24, 2016.

Dylan Lewis: So Eryn, you named a couple different spaces that you had your eye on, some things that maybe came up with you in everyday life, things that maybe you see your friends using. You said Venmo was one of them. Why don't we talk about Venmo and digital payments first? Some of our listeners might not be familiar with it. You want to give a quick couple sentences on what Venmo is?

Eryn Ratcliffe: Sure. Venmo is a mobile app which you can do person-to-person payments, with friends, or anyone who has the app, and I use it every week for sure -- almost every day -- to pay friends back for bills, or if they bought me something, or even just to split utilities with roommates.

Lewis: You have your Venmo account linked to your bank account, right?

Ratcliffe: Yes, it's linked to my bank account, so if I don't have enough money in my Venmo balance, it draws from my bank account.

Lewis: Interesting. Actually, I use Venmo a little bit differently than you do. I don't have it linked to my bank account, but I basically just paid a big tab one time, had friends pay me back in Venmo, and have been using that balance to settle debts and things like that. But one of the major appeals for Venmo is, I know as a Bank of America user, if I'm transferring money to someone that's outside of Bank of America, I have to pay a 350 ... $3.50 fee on each transfer. Whew, that almost got expensive (laughs).

These free transfers are really great, particularly for young folks. Can you give me some rough numbers here on the space that Venmo plays in? What does digital payments look like, and are they one of the leaders in the space? They seem like one of the most-recognizable names.

Ratcliffe: They definitely are one of the most-recognizable names, but they are a small part of the P-to-P, market in general. The market in 2015 was around $70 to $90 billion, and Venmo was a small part of that. In 2016, in January, they transferred $1 billion just that month.

Lewis: Wow. Seems like a market that's growing, and they are very-well positioned in it, and of course, PayPal (PYPL 0.64%) owns Venmo. They acquired Braintree recently, and Venmo was owned by Braintree at the time. So Peter Lynch likes where we're going so far, but we've got to do our due diligence. We've got to do our homework. We've got to see if PayPal itself is worth investing in, and how Venmo plays into them as a business, to better understand it. So, as a portion of PayPal's total payment volume, which is a really important metric for these payment facilitators, it's basically how much in total payments did they facilitate; so if you give me $3.00 that goes toward that total payment volume. Venmo makes up about 3% for PayPal, so it's contributing, but not nearly as much as PayPal's bread-and-butter payment business -- I think, last year, was $7.5 billion. I think this most-recent quarter was $3.2 billion. To give you an idea, there's a big pie there that PayPal makes up.

One of the problems right now with Venmo is, they're not really contributing much to PayPal's financials. As we talked about, they're not collecting money on the transfers that you and I make. They're only making money as people use credit cards on the service, and with those, I think their take rate -- which is the cut that they take of a transaction -- is roughly 3%; but that winds up being a very-small proportion of the overall transactions on the platform. So given the size right now, relative to PayPal's overall business, and the lack of clear monetization, when you're looking at investing in Venmo via PayPal, you really have to say: "Does PayPal make sense as an investment itself?" I have to say, I think it's very compelling. The numbers have been really impressive for PayPal recently. They're looking at, like, 23% year-over-year revenue growth in the most-recent quarter, on the back of 31% growth in total-payment volume, and 39% growth in merchant-services volume. There's a lot to really love there.

But I think, if you're bullish on Venmo, as you seem to be, you're saying, "What does this turn into? What does this look like?" Basically, management has talked about the idea of Venmo now being kind of what PayPal was in the early 2000s. So we are very early on in the infancy here. In a matter of two-to-three years, they've cited, it can be pretty material as a part of their business. It'll be something that'll be really contributing to the top and bottom lines. So how exactly will that happen is one of the interesting things, and I think some of the things that management has outlined really address some of the pain points that we currently experience as consumers. They've talked about growing out the merchant side of mobile payments -- and we were joking before the show, though you are an intern, you are of drinking age, right?

Ratcliffe: Mm-hmm (affirmative).

Lewis: And so I'm sure you've had your moments where you are out at a bar, maybe grabbing dinner and some drinks, and you are then left with the large bar tab.

Ratcliffe: Yes, well, I try not to be left with it, but I know what you mean.

Lewis: So you go out with a table of six, everyone has a round or two, everyone grabs dinner. Some bars are nice enough to split the checks individually as credit cards. Some are not. So you look at what PayPal wants to do with Venmo, and pay with Venmo for in-app purchases -- I think that these are opportunities to address pain points for consumers, making it easy for people to split checks, and in that respect, I think it's super compelling, and it's something that will monetize what is currently not such a great business for them. It's something that is growing its network, and will be profitable, will be a top-line contributor down the road. But anyone interested in Venmo, that's kind of how you have to look at this business right now. It's a two-to-three-year play, and you're investing in PayPal and its core business at the moment.