PayPal Holdings Inc.'s (NASDAQ:PYPL) fourth-quarter 2017 earnings report, released on Wednesday, held close to a pattern of outsized revenue gains accompanied by vibrant performance in key metrics. But the laudable quarter was clouded by concerns over the company's impending termination as eBay Inc.'s (NASDAQ:EBAY) primary payments processor in 2020.
PayPal: The raw numbers
|Metric||Q4 2017||Q4 2016||Year-Over-Year Change|
|Revenue||$3.74 billion||$2.98 billion||25.5%|
|Net income from continuing operations||$620 million||$390 million||58.9%|
|Diluted earnings per share||$0.50||$0.32||56.3%|
What happened with PayPal this quarter?
Total payment volume, or TPV, which measures the dollar volume of transactions facilitated on PayPal's platform, surged 32% over the fourth quarter of 2016, to $131 billion. Transactions conducted over mobile devices were particularly strong, as the company recorded a 53% leap in mobile TPV, to $48 billion.
TPV growth was paced by healthy expansion in underlying metrics. The company added 8.7 million new accounts during the quarter, with net new active accounts growing 61% over the prior year. Customer frequency also improved, as transactions per active account over a 12 month trailing period rose by 8% during the quarter.
As PayPal has only recently begun to monetize its popular person-to-person (P2P) social payments app Venmo, management didn't quantify the app's impact on the profit and loss statement. However, as in recent quarters, PayPal did provide volume information on the platform, and these numbers continue to impress. Venmo processed $10.4 billion in TPV during the quarter, besting its comparable prior year quarter by 86%. PayPal's overall P2P volume, which includes transactions on its PayPal branded platform, rose 50% to $27 billion.
PayPal's relentless growth narrative was tempered, however, by the news that former parent eBay has decided to replace PayPal as its primary processing partner upon the end of the current operating agreement in July 2020. eBay will take over the role of merchant of record (MOR) from PayPal, and the marketplace purveyor announced Wednesday that it will transfer payments processing to privately held Dutch payment company Adyen after 2020. PayPal will remain a branded checkout option on eBay's site until at least 2023.
While PayPal's management pointed out that the transition won't affect near-term or medium-term guidance, shareholders' unease was nonetheless reflected in a share price drop in the following trading session on Thursday.
Currently, eBay accounts for 13% of PayPal's TPV. During the company's post-earnings conference call, CEO Dan Schulman pointed out that in the 2.5 years since PayPal separated from eBay in a corporate spin-off, the company has already reduced eBay's share of TPV by roughly 9 percentage points. Schulman also noted that while eBay-derived revenue has grown roughly 4% each year, the rest of PayPal's business is sustaining an annual growth rate of 23%.
Thus, by the end of the current operating agreement in mid-2020, Schulman extrapolated that eBay would account for just 4% of TPV, and less than 10% of net revenue. And he emphasized the value of PayPal remaining as a prominent checkout option on eBay's platform through 2023.
While the mutual separation creates a measure of uncertainty in PayPal's revenue model, it also opens up new growth avenues, as the current operating agreement prohibits PayPal from acting as a merchant of record for any other major corporation.
This means that after mid-2020, PayPal is free to explore taking on the additional role of MOR with any number of companies it transacts with. According to management, the top-10 global marketplaces offer tens of billions of dollars worth of TPV. The potential for PayPal to become the primary merchant for even a few of these marketplaces is an unquantified but tangible opportunity, which would appear more valuable than the loss of slow-growing eBay volume.
As PayPal contemplates the end of its primary role in eBay's payment stream, investors may well see a more aggressive acquisition posture. As I recently explained, PayPal's sale of its credit receivables portfolio to credit card partner Synchrony Financial will free up roughly $6 billion of cash this year, as well as boosting cash flow by $1 billion annually. This represents enormous dry powder that the company can use to fuel strategic acquisitions during the five-year transition period, and replace and expand lost revenue.
In the meantime, PayPal continues to display stellar potential. Management's guidance for 2018 is highlighted by revenue growth of 15% to 17%, and earnings per share (EPS) growth of roughly 25%, at the midpoint of a projected EPS range of $1.79 to $1.86. Both the near-term and the longer horizon still appear quite positive for this aggressive payments platform.