PayPal's Growth Story

In this podcast, Motley Fool host Ricky Mulvey and analyst Nick Sciple discuss:

• PayPal selling off more than $40 billion of buy now, pay later loans.
• The payment processor's capital allocation strategy.
• The DraftKings bid to buy a rival operator.
• Why sports betting companies have a customer stickiness problem.

Motley Fool host Alison Southwick and personal finance expert Robert Brokamp answer listener questions about 401(k)s, investing, and cash management.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on June 20, 2023.

Ricky Mulvey: PayPal sheds assets while DraftKings doubles down. You're listening to Motley Fool Money. I'm Ricky Mulvey, joining us now is Nick Sciple. Nick, good to see you.

Nick Sciple: Great to be back here with you, Ricky.

Ricky Mulvey: Private equity firm KKR is purchasing up to 40 billion Euros of PayPal's Buy Now, Pay Later loans in Europe. PayPal is doing this spin off to a private equity giant. Why are they getting rid of this growth story for them?

Nick Sciple: Long story short, the buy now pay later segment just grew too big too fast for the company. PayPal has said in recent years that it's going to remain an asset light company and that it'll sell its credit portfolio if and when the balance sheet became credit heavy because of the growth to some of these assets. You look back to 2016, sold it's consumer credit portfolio to Synchrony for about seven billion dollars, think about credit cards things like that. This year it's selling off buy now pay later business, really seen and credible growth process more than $20 billion in buy now pay later volume globally last year up 160 percent from 2021. For context, that's bigger than a firm who actually, that's all they do is buy now pay later so just incredible growth for PayPal and became a weight on the balance sheet they wanted to take off.

Ricky Mulvey: There's probably a macro indicator story in there as well, Nick. Gabrielle Rabinovitch is the acting Chief Financial Officer of PayPal and says that this deal will, "Accelerate our PayPal Pay Later originations alongside market demand in Europe while preserving free cashflow for other strategic initiatives, this transaction is yet another example of our disciplined approach to capital allocation." Nick, do you agree with that? PayPal is using a lot of these proceeds to buy back shares?

Nick Sciple: Sure. Then maybe underlying that for your previous guidance had called for $4 billion in share buybacks, now bumping that up to $5 billion. I do agree with her, I think PayPal is great at being a consumer portal, really linking their dedicated users to all the payments solutions they may not need. Not necessarily great at being a bank. We saw that why they sold off their assets to Synchrony before by using its capital to really spin up this business it's created value. But again, this is not the core offering of the business. Actually, you could argue by linking up with KKR and their ability to underwrite some of these, you could grow even faster, originate more on the Buy Now, Pay Later side, not having to take on the capital requirement there yourself now without the need to use cash to fund this part of the business. They have got more cash available. If you'll look at the stock today none GAAP EPA guidance calls for 20 percent growth this year the stock trades at about a 14x forward multiple price to earnings this is not a super expensive stock today it's also not a capital intensive business we shouldn't want it to be so I'm excited to see them take some if this cash put it toward share buy backs instead of being a much bigger banking business.

Ricky Mulvey: You referenced earning growth but revenue growth for PayPal seems to be a little bit harder to find its expectation for this year were about seven, seven-and-a-half percent a lot of Wall Street investors boed those projections so should shareholders be rooting for PayPal to become this stock buyback machine?

Nick Sciple: Sure I think that would be today's prices its an attractive place to be buying PayPal stock $5 billion and share repurchases gets you about six-and-a-half percentage of share is outstanding, if you would like to take into account stock base gap probably close to four-and-a-half percent of shares getting retired. If you just want to talk about low-to-mid single-digit share buybacks on an annual basis and just low double-digit earnings growth. You could look at a company that doubles over the next five years without multiple expansion. I'm a dedicated PayPal user. I think there's lots of other folks on the platform while there is some concern about slowing accounts growth on the platform, I think there's lots of ability to attach additional services to those users and continue to grow earnings year over year. I think an example of that is what we've seen with Buy Now, Pay Later the past few years.

Ricky Mulvey: I want to stay on private equity for a sec because they seem to have their own debt problems. Many private equity firms have financed buyouts over the low interest rate era with this floating rate debt and they didn't really hedge it. Firms like KKR. And now there's $3 trillion of that floating rate debt out there. What are the consequences of this?

Nick Sciple: It means finance costs are going up is really the short answer. Floating rate simply means that the rate you're paying on your loan increases as rates go up over time been well-documented over the past year or so, the Federal Reserve's activities increasing interest rates. So you've got folks they might have been paying three or four percent interests two years ago paying seven or eight percent today with your underlying payment just to support debt service up more than double some real concerns for the business, you need to find some way to make up that cash difference or eat it in your margin.

Ricky Mulvey: Let's move on to a gambling battle that's heating up. The sports betting company DraftKings submitted an all-cash offer of about $200 million to buy Points Bet's, US Assets, Points Bet is the seventh largest sports betting operator in the US set the table. Nick, why does DraftKings want this operation?

Nick Sciple: Draftkings arguably would like to own every sports betting operation in the US if it could. But I think the real strategic goal is to make customer acquisition costs as high as possible for our competitors and hopefully limit the pool of folks participating in the industry. If you think about online gambling the business model, it's really a lifetime value to customer acquisition cost business. How much does it cost to bring in a new customer versus how much are they going to spend over time in the case of these gambling business, how much are they going to lose back to you over time if you get bigger scale? In the case of DraftKings buying Points Bet. You can run, higher-scale adds larger, arguably national ads. Also on the other side of things, if there are more competitors in the market for folks to switch to, arguably you're going to have a lower lifetime value out there because all those folks are trying to acquire your customers as well. So in DraftKings case, if Fanatics wins this deal, you now have a well-funded new entrant coming into the market, likely going to force their marketing spending up and maybe bring down lifetime values. You think about this as an industry that looked like it had stabilized over the past few years in the hands of just a handful of companies, your DraftKings, your FanDuel's, your MGM's, if another competitor comes into the market, maybe reignites this competitive spending spray that we've seen in the past few years. In DraftKings case, maybe they think it's better to spend $200 million now in one chunk than to have a new entrant come in and get milk for that $200 million and increase marketing spend over the next several years. Even if they don't win the deal by increasing Fanatics costs, that just takes that much more cash out of their war chest to go spend on marketing.

Ricky Mulvey: Yes, so Fanatics is the other bidder for these Point's Bet operation. What's their beef with DraftKings over the offer, it seems like a consequence of just regular old capitalism that you have multiple bidders on an asset?

Nick Sciple: Well, DraftKings has done similar things in the past that it was a couple years ago, maybe last year, they put out a bid to acquire Entain for $22 billion Entain is the partner with MGM on their BetMGM app DraftKings ended up pulling that offer back not actually following through on the deal so maybe suggests that argument of pushing prices up, but also just on the side of Fanatics, A they don't want to pay up higher price with B they've been wanting to enter this market for quite a while and there aren't really a ton of other attractive assets out there. You mentioned this is the number 7 player on the market. I don't think one through six are that excited to sell today either they've been hinting and entering sports gambling for quite a while.

You can argue it's synergistic with their existing business on background on fanatics, really the biggest sports license out there partnerships with all the major sports leagues, NBA, NHL, etc. Michael Rubin, the founder, sold hits his stake in the 76ers back in October. Big a lot of the commentary around that suggested this was heading up to a move into sports betting. It's a conflict of interests, owning a team and also being involved in sports gambling. Then so you've seen Michael Rubin sell a really important asset to him to get into the space. Key to the strategy also, looks like they went to IPO soon they held an Investor Day earlier this month. If this is key to your strategy, a story you've been telling for a number of years and you'd like to go public, and it wouldn't be great to have that derailed at this point.

Ricky Mulvey: That's it. On the DraftKings side, this is a company though that while it has a lot of market share, it's still solidly unprofitable. It's running about a $1.5 billion operating loss at about 2.2 billion in income over the past 12 months. It's also spending a lot more on servicing debt. DraftKings is spending all cash to acquire this company. Can it even afford Points Bet?

Nick Sciple: Well, that depends on your answers to those customer acquisition costs versus lifetime value questions we marked earlier on really depends on customer behavior. If you believe that the competitive intensity we've seen all this spending trying to do a land grab in sports betting is going to level off here in the next couple of years. This is the last big deal out there. You could tell a story where, this is all just about getting to scale, and we're going to come out of the tunnel here, in the next couple of years. But it really all depends on customer behavior. A lot of money being spent upfront acquiring customers on an uncertain lifetime value over a long period of time. But I will say this, whoever owns the online sports betting market. The online sports betting market is not going to go away and I think it's probably going to be bigger five and 10 years from now than it is today. But there is questions on whether the company who's owned the market today are going to have the profits to get to a bright future.

Ricky Mulvey: I see the growth story. The narrative I've been telling myself though, is that this is an industry where there are no switching costs and in fact there are switching incentives. It's really tough to build those sticky relationships with customers. Is that enough of a reason for regular investors to just stay away from the industry?

Nick Sciple: I think so. If you think about your game theory, the prisoners dilemma, where if everybody gets along, it's better for everybody else. But the gains of being that person who goes and acquires customers and everybody else isn't spending really leads to a lot of irrational behavior from the overall market. The question is, when does that behavior go away? You really need to see the market stabilized right now, it looks like we're still likely to see some more entrants from Fanatics. For me, I'm not exactly excited about owning the sports gambling profit pool today, I am very excited about owning the sports gambling marketing line items. Think about WWE is a company that has a relationship with DraftKings, lots of media companies out there and that's pure profit for some of these out there on the market. So worth following for that. But I think today profits still something relatively far in the future if these companies.

Ricky Mulvey: I think this potential deal also has to be drawing some regulatory scrutiny. This is a newly legal industry for states basically besides Nevada and DraftKings is already one of the top sports betting operators in the industry.

Nick Sciple: DraftKings still you'd probably be looking at maybe a third of the market after this deal. Points Bet owns a low single-digit percentage of the market. However, in their response to the DraftKings offer, one of the things they mentioned about why they might prefer the fanatics offer is concerns about having to get through the regulatory hurdles, concerns the antitrust folks might want to block the deal and actually they went some real assurances from DraftKings that they will go the legal term as hell or high water, that they want to hell-or-high-water provisions saying, no matter what happens, you are going to follow through on this deal. We talked about earlier whether DraftKings might be serious about making this transaction follow-through. If they're willing to add that hell-or-high-water provision, maybe they are. If not, then maybe this is trying to push the price up, time will tell.

Ricky Mulvey: Nick Sciple, thanks for your time and your insight.

Nick Sciple: Thank you.

Ricky Mulvey: You've got questions, they've got answers. Alison Southwick and Robert Brokamp, tackle your questions about 401(k) insurance and leveraged investing.

Alison Southwick: Our first question comes from Eric. I'm a 28-year-old, currently making around 140,000 in New York City. My current employer does not offer a 401(k) match. After seeing the change in my ex build this past year, I deeply regret not making contributions toward a retirement account. My question is, am I better off contributing to my existing 401(k) account for my previous employers with no company match or is it more beneficial to open up an IRA and make contributions there?

Robert Brokamp: Well, Eric, I'm not completely clear on your situation, so I'm going to go on a couple of scenarios here. First of all, you talked about contributing to your foreign case with your previous employers, and that is not possible. Once you leave a company, you can no longer contribute to the 401(k). You can leave it there generally speaking, although they might force you out, but you can no longer contribute to it. If you have a 401(k) with no match and you want a tax break, and I can understand why, because you're in the 24 percent federal bracket and then you add another 10 percent for New York State and City. So you'd probably still go with your 401(k) at work. That way you can contribute to the traditional 401(k) and get the tax deduction. If you don't have a 401(k) at work, then your option is the IRA because you're not covered by retirement plan contributions to the traditional IRA are deductible. If you are covered by a plan at work and you wanted to contribute to a traditional IRA, you couldn't deduct it. The only reason why you can deduct contribution to a traditional IRA is if you don't have a plan at work or if you do, you make under a certain amount of limit and you make too much. Just to recap, if you are looking for the tax deduction and you have a 401(k) at work, that's the one to go with. If you don't go with the IRA, unfortunately, the IRA has a much lower contribution limit, but that's your best option.

Alison Southwick: Next question comes from Rob. I'm a huge fan of your show. Oh thanks Rob. You have taught me so much about investing and have really set me on a path to success. What are your thoughts on long-term investments in leveraged funds, such as the ProShares ultra pro QQQ ticker, T QQQ. My logic is that on average, these funds go up into the right. Obviously, there are down-markets and a leveraged fund would go down significantly in these time periods. But why wouldn't I want to invest in a leverage fund if I have a long-term horizon? Appreciate your thoughts and insight you guys are the best. Oh, Bro, you're the best.

Robert Brokamp: No, you're the best Alison.

Alison Southwick: You're right.

Robert Brokamp: And Rob is the best because he sent us a question. Thank you, Rob.

Alison Southwick: Thank you, Rob.

Robert Brokamp: And so these leveraged Funds aim to provide, depending on the one to 2-3 times the performance of an index and the case this is ETF, it's called the TQQ because it wants to provide triple the return of the QQQ. QQQ being of course the Nasdaq 100 ETF, which I think is like the fifth biggest in the world. But here's the deal about these. You have to understand how the return is calculated. And here's a quote straight from the ProShares website, ProShares UltiPro QQQ seeks daily investment returns before fees and expenses that correspond to three times the daily performance of the Nasdaq 100 Index. It's trying to triple the performance of the daily performance. When you look at how that works over longer-term time periods, the returns aren't going to be exactly what you might expect. Consider that the last 10 years have been a great time to be investing in the Nasdaq and tech stocks in particular, yes, the QQQ is down 33 percent last year. But over the past decade, this ETF has posted an annual return of 19 percent a year, according to Morning Star. That's pretty amazing. You'd think the triple QQQ would be returning about 57 percent because you do three times that. But actually no, it's just, and I do emphasize just, it was just 40 percent a year.That is a fantastic return, but it's not going to get quite the return you thought.

As Rob points out, the downside is also amplified. While the QQQ was down 33 percent last year, this triple Q was down 79 percent. Or even in 2018 when the QQQ is only down 0.1 percent, this triple QQQ is down almost 20 percent. Here you have to understand how the mathematics of loss works. If you're down 80 percent, it's not like if you get another 80 percent upwards, you're back to breakeven, you need to earn 400 percent just to get back to where you were. If you had this QQQ [laughs] I'm going to check out Qs. There did not exist during the.com crash of 2000-2002. But if it did, it would have been wiped out because you had three straight years of the Nasdaq going down 20 percent to 40 percent. The bottom line for these types of ETFs as this one are the ones that follow the S&P 500 or their indexes, is that during a long bull market or just a regular bull market that has only minor hiccups. The returns will be very attractive, but all it takes is a string of two to three bad years to almost completely wipe them out.

Alison Southwick: Next question comes from Mario. It's so nice to say so long to a bear market. I bought up some ETFs and tech stocks while they got slammed. I'm in retirement and feel comfortable with the amount of cash I have saved up about two-ish years. Do you have any general advice on rotating out of investments during bull markets so you can buy during the next bear market?

Robert Brokamp: This is Mario points out that we are technically back to a bull market, which is very nice. If you had put some cash to work in the summer or fall of 2022, you're looking pretty good right now. To answer is question. I'd say you start with deciding how much you want to keep out of the market as cash to use opportunistically. Here at the Fool, we often talk about having maybe 5-10 percent in cash as what we call like dry powder. Let's say you choose 10 percent. If your stocks do well, so that they grow to be a bigger part of your portfolio. Thus your cash portion will actually shrink as a percentage of your portfolio. That's a hint to maybe sell some stock. Maybe if you choose 10 percent, your cash is shrunk to maybe five percent because your stocks have done so well. That might be a time to sell some of your stocks. Another thing you could do is just not reinvest your dividends and let those accumulate as cash that you then use opportunistically.

Of course, many of your stocks, especially since Mario pointed out that he bought tech stocks. They don't pay dividends. Maybe once a year, you just sell little pieces of them to create your own dividend. Since Mario is retired, I assume he's doing that anyhow, every year. He's selling the stocks a little bit to pay his bills. Maybe he sells a little bit more to build up his dry powder. Now for those who are still working, what you could do is gradually build up your cash with each additional contribution to your 401(k) and your IRA. Besides using this money to buy stocks when they're down, this is also a great way to gradually de-risk your portfolio once you are within maybe 5-10 years of retirement.

Alison Southwick: Next question comes from Skippy, Alison and Bro, exclamation point. Huge fan of years. You two are my favorite part of the Motley Fool experience. That's so nice.

Robert Brokamp: We won't tell everyone else.

Alison Southwick: There's some nice praise in here. Yeah, thank you both for your advice over the years. When switching employers, one has the option to transfer the Roth 401(k) into the new company's 401(k) plan or into a Roth IRA. I contacted Schwab about this and they confirm trustee to trustee and that the transfer rollover would not count against yearly contributions. I have two questions. One, why would someone not want to rollover Roth 401(k) to a Roth IRA as the IRA gives much more flexibility in investing. Two, are there other opportunities to transfer money from a 401(k) to an IRA? If so, should more people explore that option?

Robert Brokamp: Well, Skippy is right, that when you change jobs, you generally can roll your old 401(k) into the new 401(k), but only if you're new 401(k) excepts rollover. Most do, but not all of them do. You can't rollover Roth assets if the new 401(k) doesn't offer Roth accounts most do nowadays, but not all. For example, according to a recent report from Vanguard, about 20 percent of the plans that they administer still don't offer Roth contributions. Yes, when you transfer money from one retirement account to another, it has no effect whatsoever on your contributions limits, that's not considered a contribution. Skippy is also right that an IRA generally has more investment options and lower cost. My wife is a professor and her college is actually switching their retirement plans this summer as reading through the material over the weekend and they found that the planned charges 0.2 percent every year, and that's actually lower than the current expense. Not a big deal, but why pay that if you can just transfer money to an IRA and avoid that cost? Yes, generally speaking, I recommend that people when you can you move money from your employer account to an IRA. The main reason to stay with the plan is if it has investments that are not available outside of the plan, or maybe at price is not available to individual investors.

Just an example, I'm on a member of the Fools 401(k) committee, and we recently added a money market fund to our menu of options that is usually only available to people if you can invest at least $1 million. Now Fool employees can just throw a few hundred dollars in there if they want. Because the people who offer the money market fund allowed it to come into our plan because we have so many assets and that's pretty common actually among 401(k) plans. Then just to answer Skippy's second question about other ways to move money from a 401(k) to an IRA. You usually have to leave the company. But some plans do allow what's called an in-service distribution, which allows you to transfer money while you're still working there. Not all plans do this. In most cases, the plans that do you have to be aged 59 and-a-half, but that's not set in stone. That's really just sort of a default in the industry. Check with your plan provider to see if it's allowed in your 401(k).

Alison Southwick: Our last question comes from Alan. Like a lot of folks, I've got some tech stocks that are down 60 plus percent in my portfolio. I know that if I sell and repurchase a stock within 30 days, it's simply a wash sale and has no tax benefit. I also know that it's risky to sell a stock and wait 30 days because the stock could rebound and I would miss out on those gains, which could outweigh any tax benefit of selling at a loss. However, my losses are quite large. So even if the stock does rebound to some extent, I think I may still have a net benefit. I don't expect these stocks to recover all their losses in the next 30 days. Any wisdom you can share, I still want to own these stocks long term, but I believe if I do this correctly, I could not have to pay capital gains taxes for many years to come. Alan, I'm sorry, buddy. [laughs]

Robert Brokamp: And by the way, we're all in the same boat. Everyone who works here at the Motley Fool has some tech stocks that are down considerably. Let's start for with clarifying the whys and rules around wash-sales. The reason to do it is that the loss offsets any gains on your tax return, which means those gains are tax-free and the losses in excess of the gains can offset up to $300 of ordinary income, and then even losses beyond that can be carried forward to future years indefinitely. But as Alan pointed out, you can't buy the stock back within 30 days or the loss is disallowed. However, even in this situation, not all as lost because the disallowed loss is added to the cost basis of the replacement shares. You still get a tax benefit, just probably not when you wanted it. It's also important to know that you can't buy the stock 30 days before the sale. You can't, let's say there's a stock you want sell and you buy it in one account and you can't, like maybe it's yours or your spouse's, then you sell the stock and the other account at a loss of few days layer. If you do that, the loss will be disallowed. The whole wash sale period is 61 days, really. It's the day you sell the stock 30 days before and the 30 days after.

Again, you can't try to game this by buying it in your wife's or your husband's account. The whole household is what you have to consider. Alan is concerned about selling this stock and being out of it for 30 days. I'll start by pointing out that since the 1920s, when you look at the stock market's performance on a monthly basis, it's profitable about 60 percent of the time. Of course, that means it's unprofitable 40 percent of the time. There's actually a good chance that being out of the stock for 30 days might work out well for you. But if you're really worried about missing out on some upward bounce, then you can sell the stock and investor cash in something that is similar but not substantially identical to what you sold. Then at phrase, substantially identical is often debated by tax professionals. But here's one example. Let's say you sell a stock. You could buy an ETF that tracks that stocks sector or industry for the 30 days and you're fine. 30 days, go by. You sell that ETF, you use the proceeds to buy that stock back. Now of course, you've sold that ETF. If you have a gain or loss, that's a short-term means if it's a short-term gain it's counted in taxed as ordinary income, which is the higher rate of long-term capital gains rates. In the end, is it worth it or not. I'm not going to tell you, but the times that I've done tax-loss harvesting, I've generally just waited to 30 days and it's generally worked out fine.

Alison Southwick: Well, before we go, I wanted to let our listeners know that I'm taking advantage of a benefit of working at The Motley Fool and I'm going to go on sabbatical for the summer. I'm going to spend some time with my family, put up drywall and probably blow out my knee playing pickleball. Before I go though, I am hosting a virtual event for the Motley Fool Foundation as part of their Spark lab conversation series. I'll be interviewing Lister Bradley and Trish Costello. They're two remarkable leaders in venture capital. We'll be talking about the challenges in solutions to improving diversity and inclusion in venture capital and entrepreneurship. You're all invited. Just head over to foolfoundation.org to RSV. 

Ricky Mulvey: As always, people on the program may own stocks mentioned in the Motley Fool may have formal recommendations for or against, so don't buy or sell anything based solely on what you hear. I'm Ricky Mulvey. thanks for listening. We'll be back tomorrow.