Investors are starting to come back around to PayPal Holdings (PYPL 0.48%) after a disappointing second-quarter earnings report sent the shares tumbling around the middle of last year. PayPal saw its adjusted revenue growth accelerate to 19% year over year in the third quarter, so there is good reason to be upbeat about the company's near-term prospects.
Also, investors have been concerned about the pending expiration of the operating agreement with eBay and its impact on PayPal's revenue this year. However, management disclosed during the third quarter report that the absence of eBay will only ding revenue growth by one point in 2020, which seems to be way less than investors had feared.
The stock has been climbing higher since the third-quarter earnings news. With investor concerns over the eBay headwind fading away, the stock could continue marching higher in the new year if the company continues to report momentum with user engagement across its payment platform. Here's how PayPal can keep that momentum going.
PayPal enters cruise control
PayPal reports several numbers in its earnings releases, but the one that is very important to its future success is transactions per active account, which is a measure of user engagement. When asked by an analyst on the third quarter conference call about what drove the acceleration in revenue last quarter, here is how CEO Dan Schulman responded:
Our net new active [customer accounts] and our engagement are really beginning to kick in and starting to drive incremental growth in our revenues. We had records in net new actives for the third quarter, almost 10 million. You've got [transactions per active account] going up again by another 9% to 40 times a year. Just those couple of things are really starting to put more and more acceleration in.
It certainly appears that PayPal has started to reach a tipping point. It expects to end 2019 with about 304 million customer accounts when it reports fourth quarter earnings on Jan. 29. That wide reach has gotten the attention of merchants who want to tap into that base of users. There are now more than 23 million merchants offering PayPal at checkout, which is a mid-teens percentage increase over the year-ago quarter.
The impact of PayPal's increasing brand ubiquity is seen in how merchants are starting to position its checkout button online. Schulman said, "Given the scale we have now, merchants are putting us into more and more prime positions of presentment."
In other words, merchants don't see PayPal as simply a checkout product, but a powerful brand that can pull in more customers. When customers see that PayPal button, they know they can check out with ease and security. The tightening relationship with merchants and customers should continue to be a growth driver this year.
The Honey acquisition makes PayPal more powerful than ever
PayPal just completed a $4 billion acquisition of Honey Science that adds another key catalyst for increasing user engagement in the short term. Honey is a popular online shopping tool that allows its 17 million monthly active users to discover deals when shopping online. It currently works with 30,000 online retailers, including big ones like Amazon.com and Nike.
Obviously, the integration of a powerful shopping tool like this across PayPal's 300 million base of users could be game-changing for PayPal's growth. But there are also advantages on the merchant side of things.
Honey should strengthen PayPal's ability to win over more merchants that are looking for ways to increase conversion at checkout. There's no better way to increase conversion than to tell customers that not only is checking out with PayPal easy, but it also saves you money.
The Honey deal puts PayPal in such a powerful position in e-commerce that even Amazon tried to convince Honey users during the holiday season that the tool, which works as a browser extension, was a security threat and should be uninstalled "immediately." The Honey extension has worked on Amazon's site for a long time, so it's interesting that Amazon decided to let its customers know about this supposed security risk after the deal with PayPal was announced.
The marriage of a ubiquitous online payment platform like PayPal and a discount-discovery tool like Honey could have a significant effect on user engagement. It's easy to see why Schulman called the deal "among the most transformative acquisitions in PayPal's history."
What to watch
PayPal will announce its fourth quarter earnings results on Wednesday, Jan. 29 after the market close. If PayPal delivers a better-than-expected quarter, it will likely be credited to positive trends in transactions per account. Investors will also be very interested to know about the plans to integrate Honey, and what specific impact management expects the acquisition to have on its near-term operating performance.
Management's preliminary 2020 outlook, which was issued before the acquisition of Honey, called for revenue to be up about 17% year over year, which includes the one-point decline from the eBay transition. Adjusted earnings per share are expected to increase between 17% and 18% over 2019.
The stock is richly valued, but more above-average growth this year should justify the premium.