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Record Customer Additions Pace PayPal's Exceptional Quarter

By Asit Sharma - Oct 20, 2017 at 1:15PM

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The global payments leader delivers on multiple fronts and once again lifts guidance for the current year.

If you're rooting around for vulnerabilities in PayPal Holdings Inc.'s ( PYPL -1.72% ) business model, you'll have to peer closely. So far this year, the company's focus on a few distinct themes, including higher mobile-transaction volume, additional payment partnerships, and ease of customer use, has fortified existing competitive advantages. PayPal reported impressive results across both its financial statements and key internal metrics in its third-quarter 2017 earnings filing, released Thursday after the closing bell.

PayPal: The raw numbers

Metric Q3 2017 Q3 2016 Year-Over-Year Change
Revenue $3.24 billion $2.67 billion 21.3%
Net income from continuing operations $380 million $323 million 17.7%
Diluted earnings per share $0.31 $0.27 14.8%

Data source: PayPal Holdings Inc. 

What happened with PayPal this quarter?

Blue darts hitting bull's-eyes on three blue dartboards.

Image source: Getty Images.

  • The company recorded $114 billion in total payment volume (TPV), a measure of the total dollar volume of transactions facilitated on the PayPal platform. TPV increased 30% over the prior-year quarter. This marked the highest rate of TPV growth in several quarters. 

  • Net new active customer accounts rose by 8.2 million to 218 million, a leap of 88% over the same period last year. As I pointed out after PayPal's first-quarter earnings report earlier this year, as the company matures, one would expect customer additions to slow. Yet the following excerpt from PayPal's third-quarter 2017 investor update presentation shows that, instead, the "customer adds" trend is accelerating:

    Excerpt from PayPal's third-quarter 2017 investor presentation.

    Image source: PayPal Holdings Q3 2017 investor update presentation. Green and yellow annotations by author.

  • Some of these new customers are reaching the PayPal platform via the company's extremely successful social-transactions app, Venmo, which booked $9.4 billion in TPV, a 93% increase over the prior-year quarter. The app's viral growth is due to its popularity as a peer-to-peer (P2P) payment system -- PayPal doesn't charge a fee when friends and family transfer funds between them. This week, the company announced that the app will be rolled out to over 2 million retail merchants who already accept PayPal. This means that, in the near future, Venmo may begin to meaningfully contribute to PayPal's bottom line.

  • Along with new customer additions, PayPal can boast of increased usage. The company saw 32.8 transactions per active account during the quarter, a year-over-year increase of 9%. 

  • The organization has expended considerable resources to become a mobile-friendly platform, and this is paying off as online commerce continues to shift to mobile devices. During the quarter, mobile transactions rose 54% against the prior year, to $40 billion, accounting for 35% of total company TPV.

  • PayPal's "take rate," i.e., the average revenue the company nets off each transaction, continued a slight multi-quarter decline, landing at 2.84% for the quarter. For reference, PayPal's take rate in the third quarter of 2016 was about 20 basis points higher, at 3.05%. The company attributed the lower rate to higher P2P payments and the addition of lower-fee transactions from its recently acquired bill payment subsidiary TIO Networks.

  • Despite a decreased take rate and higher total operating expenses, PayPal's rapid revenue growth provided enough operating leverage that operating margin, an important gauge of profitability, remained even with the third quarter of 2016, at roughly 13%.

  • PayPal generated $841 million in free cash flow during the quarter, and expects free cash flow for the year to exceed $3 billion.

  • What would a quarter at PayPal be without mention of its fervid drive to sign up platform partners? Here's a timeline image from the company's third-quarter investor update, showing the latest partnerships PayPal has inked:

Timeline of partnership deals using logos of well-known banking, retail, and technology companies.

Image source: PayPal Holdings Q3 2017 investor update.

  • I've included the updated graphic above for the last three quarters, but PayPal has landed so many tie-ups that it's becoming hard to read the shrinking logos. Of the most recent deals, U.S. investors may not be very familiar with Shinhan Financial Group, South Korea's largest credit card issuer, or Banorte, one of Mexico's primary banks, which wields an asset base of $70 billion. But the deals demonstrate that the company is targeting a broad reach globally with dominant financial institutions, much as it's already done in the U.S.

What management had to say

A subtle reason behind PayPal's current success is its continual effort to make it easier for merchants to sell and for customers to purchase. This manifests itself in features like Choice, which lets customers choose from a range of funding options on the platform, from checking accounts to the credit cards of partner companies. Another feature juicing TPV growth is One Touch, which allows users to skip the PayPal login to purchase items online. CEO Dan Schulman illustrated the reach and importance of this feature during the company's post-earnings conference call. It's a great example of how the company is outpacing competitors by liberating customers:

PayPal's One Touch experience continues to set the standard in mobile checkout conversion with almost 2x the conversion rate of the industry average. We now have 70 million consumers who benefit from the speed and convenience of a single-touch checkout and over 6 million merchants around the world who now offer this transformative checkout experience.

Moving forward

As in the second quarter, PayPal's vigorous performance prompted a revision of earnings guidance by management. Versus the previous full-year revenue growth target of 18% to 19%, the company now expects its top-line to expand 19%-20%, to between $12.92 billion and $12.98 billion. Management also tweaked the range for full-year diluted earnings per share, raising the bottom of the band by $0.02, to a final estimate of $1.34-$1.36.

For the fourth quarter, PayPal projects robust revenue growth of between 20% and 22%. Some shareholders are undoubtedly already looking forward to the final quarter of 2017, not to see if the company can hit its targets -- at this point that seems a given -- but to obtain and digest the revenue and earnings growth prospects for the year ahead.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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