PayPal Rating Buy Valuation & Risks TMT Payments Processors, & IT Services Price at 9 Oct 2017 (USD) 66.23 Price target 77.00 52-week range 66.23 - 38.34 Company Update North America United States Company PayPal Reuters Bloomberg Exchange Ticker PYPL.OQ PYPL US NMS PYPL Date 9 October 2017 Deutsche Bank Markets Research Momentum Likely to Continue Tailwinds from partnerships and potential asset monetization On Oct 19 th after the close, we estimate PYPL to report 3Q17 net revenues of $3,186m (+19.5% Y/Y, flat FX) and pro forma EPS of $0.43. PYPL continues striking partnerships with telcos, networks (announced global MA expansion on Oct 5), issuers, and tech platforms and, coupled with the customer choice roll out, it’s seeing incremental net new actives and improving engagement along with better-than-expected mix shift. In addition, we await further details on PYPL’s move to an asset-light strategy with a full or partial sale of the credit portfolio, where we believe the dilution can be partially offset by share repurchases. Furthermore, Venmo is starting to be monetized through Pay with Venmo and a new debit card which, along with pricing levers and new funding options, should help stabilize take rate. With momentum in the business, strong leverage on other operating expenses, and ~50bps better FX since last qtr, we believe guidance could ultimately prove conservative for both FY17 and the medium term. Reiterate Buy. Venmo monetization on the horizon In September, we hosted CFO John Rainey at our DB Tech Conference. Mr. Rainey called Venmo the "crown jewel" of the company and sounded bullish on the prospect of monetizing the asset. We reviewed the Venmo asset in our Oct 3 report, Quantifying the Venmo Opportunity, diving deeper into two potential monetization vehicles, namely Pay with Venmo and the Venmo debit card, which we believe the company can take advantage of given its unique position as a social payments platform. Pay with Venmo was rolled out to all users and is being rolled out to all US merchants (should be done by year-end) making it available for purchases in-app and in-browser. The Venmo debit card opens the in-store opportunity while allowing it to be used with merchants not on the PYPL or Braintree platforms (PYPL captures interchange in the txn). We est. Venmo could deliver incremental revenue growth of 1.4%/3.5%/5.1% and adj EPS of $0.07/$0.25/$0.48 in FY18/FY19/FY20, respectively, and push mid-term guidance higher. Expanding product suite with asset light deal on the horizon We est. 3Q17 txn revs of $2,768m (+19.6% Y/Y) and other value-added services (OVAS) revs of $418m (+18.5% Y/Y). We expect txn revs to be driven by +26% cc growth in TPV due to net new active accounts (DBe +6mn in 3Q17) and higher engagement (32.3 txns per account in 2Q17) thanks to partnerships (22 announced since 2016), acquisitions (TIO Networks closed 3Q17), and P2P growth. Further, we are monitoring the in-store opportunity as network, issuer, Bryan Keane Research Analyst +1-415-617-4246 Ashish Sabadra Research Analyst +1-415-617-3329 Korey Marcello Research Associate +1-904-527-6235 Mahesh Dass Research Associate +1-415-617-2842 Deutsche Bank Securities Inc. Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 083/04/2017. Distributed on: 09/10/2017 23:36:07 GMT 0bed7b6cf11c
Transcript
9 October 2017
Payments, Processors, & IT Services
PayPal
Rating
Buy
Valuation & Risks
TMTPayments Processors, &IT Services
Price at 9 Oct 2017 (USD) 66.23
Price target 77.00
52-week range 66.23 - 38.34
Company UpdateNorth AmericaUnited States
Company
PayPal
Reuters Bloomberg Exchange Ticker
PYPL.OQ PYPL US NMS PYPL
Date9 October 2017
Deutsche BankMarkets Research
Momentum Likely to Continue
Tailwinds from partnerships and potential asset monetizationOn Oct 19th after the close, we estimate PYPL to report 3Q17 net revenues of$3,186m (+19.5% Y/Y, flat FX) and pro forma EPS of $0.43. PYPL continuesstriking partnerships with telcos, networks (announced global MA expansion onOct 5), issuers, and tech platforms and, coupled with the customer choice roll out,it’s seeing incremental net new actives and improving engagement along withbetter-than-expected mix shift. In addition, we await further details on PYPL’smove to an asset-light strategy with a full or partial sale of the credit portfolio,where we believe the dilution can be partially offset by share repurchases.Furthermore, Venmo is starting to be monetized through Pay with Venmo and anew debit card which, along with pricing levers and new funding options, shouldhelp stabilize take rate. With momentum in the business, strong leverage on otheroperating expenses, and ~50bps better FX since last qtr, we believe guidancecould ultimately prove conservative for both FY17 and the medium term. ReiterateBuy.
Venmo monetization on the horizonIn September, we hosted CFO John Rainey at our DB Tech Conference. Mr.Rainey called Venmo the "crown jewel" of the company and sounded bullish onthe prospect of monetizing the asset. We reviewed the Venmo asset in our Oct3 report, Quantifying the Venmo Opportunity, diving deeper into two potentialmonetization vehicles, namely Pay with Venmo and the Venmo debit card, whichwe believe the company can take advantage of given its unique position as asocial payments platform. Pay with Venmo was rolled out to all users and isbeing rolled out to all US merchants (should be done by year-end) making itavailable for purchases in-app and in-browser. The Venmo debit card opens thein-store opportunity while allowing it to be used with merchants not on the PYPLor Braintree platforms (PYPL captures interchange in the txn). We est. Venmocould deliver incremental revenue growth of 1.4%/3.5%/5.1% and adj EPS of$0.07/$0.25/$0.48 in FY18/FY19/FY20, respectively, and push mid-term guidancehigher.
Expanding product suite with asset light deal on the horizonWe est. 3Q17 txn revs of $2,768m (+19.6% Y/Y) and other value-added services(OVAS) revs of $418m (+18.5% Y/Y). We expect txn revs to be driven by +26%cc growth in TPV due to net new active accounts (DBe +6mn in 3Q17) andhigher engagement (32.3 txns per account in 2Q17) thanks to partnerships(22 announced since 2016), acquisitions (TIO Networks closed 3Q17), and P2Pgrowth. Further, we are monitoring the in-store opportunity as network, issuer,
Bryan Keane
Research Analyst
+1-415-617-4246
Ashish Sabadra
Research Analyst
+1-415-617-3329
Korey Marcello
Research Associate
+1-904-527-6235
Mahesh Dass
Research Associate
+1-415-617-2842
Deutsche Bank Securities Inc.
Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should beaware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should considerthis report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONSARE LOCATED IN APPENDIX 1. MCI (P) 083/04/2017.
and wallet partnerships (e.g. Chase) expand physical acceptance. While weexpect txn take rate to decline modestly to 2.52% (-13bps Y/Y) due primarilyto the impact of choice on core PayPal and strong P2P volume growth, pricingrationalization and new funding options such as Rewards Points could helpstabilize txn margins as well as Venmo monetization. We expect OVAS growthto continue being driven by credit (closed Swift Financial acquisition on Sept 19)while a sale of the portfolio ($6.1bn in loans; $380mn in total reserves as if 2Q17)could help alleviate concerns of the balance sheet risk (net charge off 6.9% in2Q17).
Strong operating leverage driving margin expansionWe est. 3Q17 adj. op margins to expand +112bps Y/Y to 19.5% as lower grossmargins from choice are offset by mid-single-digit growth in other operatingexpenses as the scalability of the platform shines (every $1 of revs now resultsin $0.10 of other operating expense). Any impact from the merchant of recordclause in the eBay agreement should be manageable in our view (accounted for4% of TPV growth vs 28% for remainder of biz in 2Q17) given exposure is reducingand positive relationship with the eBay historically. In addition, robust FCFgeneration (PYPL guided to +$2.9bn in FCF) bodes well for continued investmentsin the platform (CapEx was 6% of revs in 2Q17), tuck-in acquisitions to bolstersocial, technology or platform capabilities, and returns to shareholders ($600m ofrepurchases in 1H17). The company also had $6.4bn in cash & equivalents as of2Q17-end with $5.4bn int'l and $1bn in the US while a credit portfolio sale couldinject more cash into the business.
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Quarter PreviewPoised for sustainable transaction revenue growthTransaction revenue grew +18.3% Y/Y (~20% cc) in 2Q17 as robust TPV growthfrom core PayPal and Braintree was offset by a modest -11bps decline in take raterelated driven primarily by growth in P2P volumes, which accounted for ~75% ofthe decline. TPV was $106bn in 2Q17 (+26% cc) with merchant service volumegrowing +30% cc to $91bn and representing 86% of total volume compared to14% for eBay. In addition, mobile accounts for 34% of TPV and grew a robust+50% Y/Y in 2Q17 while P2P represents 21% of TPV. Choice is helping thecompany accelerate customer acquisition (+6.5mn net new actives, +80% Y/Yin 2Q17) and deepen engagement (32.3 txns per active account, +10% Y/Y) ascustomers are educated on the availability of credit/debit as a funding option. Thetransaction take rate was 2.58% and we conservatively expect modest declinesas choice is rolled out across North America, Europe and Asia (already rolledout in the US) and robust growth in P2P volumes continue. However, take ratecould stabilize more than we anticipate as the company continues with pricingrationalization, monetizes zero to low-margin products like Venmo (~8% of TPV in2Q17), and/or as customers adopt new, higher-margin funding mechanisms (e.g.rewards points). Accordingly, we expect transaction revenue growth to acceleratein 3Q17 to +19.6% Y/Y and believe there are multi-year opportunities to drivesustainable transaction volume and revenue growth in-line or ahead of its mid-term outlook.
Monetizing the "crown jewel"Venmo was originally acquired by Braintree in 2012, which was then acquiredby PYPL in 2013. Venmo volumes have grown over 100% since PYPL beganreporting Venmo volumes and most recently grew 103% Y/Y (~18% Q/Q) in 2Q17to $8bn in TPV ($32bn annual run rate). At our annual DB Tech Conference,CFO John Rainey described Venmo as the "crown jewel" of PYPL and that itcould follow a similar path of being a P2P platform that opens up to merchantshopping as core PayPal did. The company has piloted Pay with Venmo with allconsumers but only a few merchants to refine the user experience and plans toroll it out fully to merchants by end of year. It is also seeing strong merchantdemand for Venmo as a pyament option (particularly amongst large merchants)given the favorable demographics for the app (top app for ages 25-34 and in thetop 10 downloaded below 25) boding well for continued merchant acquisition(17mn merchants as of 2Q17-end). With Pay with Venmo rolling out, we expecttake rate moderation to slow and potentially even stabilize and estimate Venmocan contribute 1.4%/3.5%/5.1% to revenue growth and $0.07/$0.25/$0.48 of EPSto FY18/FY19/FY20. However, this is not currently included in our model andpotentially provides upside to our current estimates. Please see our October 3,2017 report Quantifying the Venmo Opportunity for additional details and ourdetailed estimates on the potential for Venmo monetization and our September13, 2017 report CFO Sees Venmo as Crown Jewel for details from our meetingwith John Rainey at our technology conference.
Reviewing the credit portfolio exposure and options for a saleOther value added services revenue grew 19% cc in 2Q17 driven primarily bythe credit portfolio, where the receivables portfolio grew 26% Y/Y. Keeping thecredit on the balance sheet portfolio ($5.5bn outstanding balance, as of 2Q17-end)potentially suppresses the valuation multiple during periods of deteriorating creditquality. Positively, loan losses are growing in-line with the receivables growththough the charge off rate has modestly worsened to 6.9% of principal as of
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June 30, 2017 from 6.3% as of June 30, 2016. Regardless of the impending sale,capital will remain a key part of the offering with it currently representing ~10% ofrevenues and slightly higher contribution to earnings. While a sale in isolation maybe dilutive near-term, we believe the company can offset dilution with immediateshare repurchases from the cash inflow and extending more off balance sheetloans. Even with a sale, the company plans to expand its working capital offering(recently acquired Swift Financial), namely focusing on the SMB space, with ithaving extended $3bn since 2013 to over 115k merchants while Swift Financialhas provided loans to over 20k businesses. PYPL has so far sold $1bn of thereceivables to partnering investors (e.g. Synchrony) and has discussed sellingeither the entire or part of the portfolio by end of 2017, though CFO John Raineysuggested a final decision could extend into 2018.
Partnerships driving customer acquisition and higher engagementPYPL has announced 22 partnership agreements since early 2016 across telcos(America Movil, Vodafone, Telcel, Claro), networks (V, MA, Discover), issuers/bank processors (e.g. JPM, Citi, WFC, FIS), and technology players (e.g. GOOG,FB, BABA, Samsung). The network partnerships announced mid-2016 gave thecompany the ability to use the networks' token services and opened the doorfor the company to expand partnerships with issuers and technology players.PYPL views telco partnerships as a customer acquisition vehicle given wideglobal customer base while networks partnerships gave PYPL access to tokens,provided fee certainty, introduced volume-based incentives, and even reducedor eliminated (in the case of MA) digital wallet fees. With the introduction ofchoice, issuer partners are more willing to promote PYPL as its one of the largestsource of digital distribution for some of these partners. The company also strucka significant deal with JPM to use the ChaseNet rails. In addition, it recentlyrolled out a 2% cash back credit card, which can be used online or in-store, inpartnership with MA and Synchrony that has no cash back limit and no annualfee. Please see our July 24 report New Partnerships Reveal Deeper Strategy formore details on the company's partnership based approach to expanding reachand engagement.
eBay partnershipPYPL was spun-off from eBay into a public company in July 2015. It maintaineda five-year agreement with a one-year wind-down. eBay pays a take rate to PYPLfor transactions as well as a user acquisition fee based on a fixed rate per newuser. PYPL manages risk, customer support, customer onboarding, and buyer/seller protection for eBay in return. eBay accounted for 17% of 2016 volumes but22% of revenues as take rate for EBAY was 3.99% vs. total company take rate of3.06%. Volumes are now 14% of the total as of 2Q17 versus 17% of the total in theprior year period and PYPL has said the company expects the volume, revenue,and profit to commensurately come down overtime as Merchant Services growthaccelerates. During the years ended December 31, 2016, 2015 and 2014 , PYPLearned approximately 22% , 26% , and 29% of revenue from customers on eBay’sMarketplaces platform. PYPL remains committed to partnering with eBay andstates it has maintained good relations with eBay's management team with hopesthat a longer-term agreement can potentially be reached.
FY17 margin expansion driven by other operating expensesPYPL adj. operating margins grew 110bps Y/Y to 21% in 2Q17 and updatedexpectations for FY17 margins to expand relative to FY16 (previously expectedmargins to be flat to up for the year). At its 2015 investor day, PYPL providedmid-term margin guidance, expecting stable to slightly expanding marginswith operating leverage offsetting declining transaction margins. Recently, the
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company has seen significant leverage in the other operating expense line (35%of revenues in 2Q17 vs. 40% in 2Q16), which grew 4.5% Y/Y in 2Q17 as G&Aand product development costs were flat Y/Y while sales & marketing expensesgrew 10% to support brand awareness and choice initiatives. In addition, for thesecond quarter in a row other operating expenses increased just $0.10 for everyincremental dollar of revenue added. PYPL expects to see a similar growth profilein other operating expenses moving forward as it continues improving call centeroperations, realigning the internal organization, and gaining leverage on its two-sided platfrom.
Capital allocation prioritiesPYPL has excellent FCF generation ($0.24 of FCF for every dollar in revenue in2Q17) and is dedicated to returning capital to shareholders via repurchases usingcash on hand and FCF generation. The company ended 2Q17 with $6.4bn in cash,cash equivalents, and short-term investments and generated $747mn in FCF. Saleof the credit portfolio could further increase the cash balance and potentiallyresult in an accelerated repurchase plan. The company has ~$5.4bn in sharerepurchase authorization remaining after announcing a $5bn authorization duringthe 1Q17 earnings call and has returned $600m to shareholders through 1H17.In addition, CFO John Rainey stated recently that the company is looking foracquisitions but has nothing imminent in the pipeline.
Third Quarter 2017 previewPYPL has guided to 3Q17 revenue growth of 18-20% cc (18-20% Y/Y) and EPS inthe range of $0.42-$0.44. We estimate PYPL to report 3Q17 adj. net revenues of$3,186m (19.5% Y/Y, ~19.5% cc) compared to consensus estimate of $3,174m(19% Y/Y). We estimate Transaction revenues of $2,768m (19.6% Y/Y) comparedto consensus estimate of $2,763m (19.4% Y/Y) and Other Value Added Servicesrevenues of $418m (18.5% Y/Y) compared to consensus estimate of $408m(15.7% Y/Y).
We estimate 3Q17 TPV of $109,953 (26% Y/Y, ~26% cc) compared to consensusestimate of $109,033m (24.7% Y/Y). We expect transaction take rate to come inat 2.52% and total take rate at 2.53%. We are modeling operating margins of19.5%, below consensus estimate of 20%, and we estimate 3Q17 EPS of $0.43compared to consensus estimate of $0.43 and company guidance of $0.42-$0.44.
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Figure 1: Quarter preview
Source: Company data, FactSet, Deutsche Bank estimates
Monitoring the FX impact
The primary foreign currency exposures for PayPal are the GBP, EUR, AUD andthe CAD. During the 2Q17 earnings call, PYPL updated its FX guidance from~200bps of FX revenue headwind in FY17 net of its hedging position to ~100bpsof FX revenue headwind in FY17. It also guided to no net FX impact for 3Q17.PYPL uses FX forward contracts to protect its forecasted USD equivalent earningsfrom adverse changes in FX rates. It uses a FX exposure management programto designate certain forward contracts, typically with maturities of 18 months orless, to reduce volatility of cash flows primarily related to forecasted revenuesand expenses denominated in foreign currencies. The company had $119m ofhedge gains in FY16 and $59m of gains in 1H17, partially offsetting $112m of FXrevenue headwinds. PYPL expects hedge gains in FY17 to be similar to levels inFY16, though headwinds seem to be turning to tailwinds. The following FX tableshows how the major currencies have shifted over the course of the quarter.
Figure 2: FX exposure
Source: FactSet
Guidance
3Q17 guidance
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PYPL guided to 3Q17 revenue growth of 18-20% cc (18-20% Y/Y) and EPS of$0.42-$0.44.
FY17 guidanceFollowing 2Q17, PYPL raised revenue guidance from $12.52bn-$12.72bn(+15-17% Y/Y, +17-19% cc) to $12.775bn-$12.875bn (+18-19% Y/Y, +19-20% cc)with FX headwinds of ~100bps compared to ~200bps prior. In addition, it expectsthe effective tax rate to be 17.5-18.5%, down from prior guidance of 18-19% whileEPS is expected to be between $1.80-$1.84 compared to prior guidance of $1.74-$1.79. Further, it expects FCF to be over $2.9bn, up from prior guidance of +$2.7bn. The EPS and FCF guidance increases are due strong 1H17 performanceand continued momentum in the business while revenue guidance additionallybenefits from the TIO Networks acquisition (~$25m in revs).
Figure 3: FY17 guidance, consensus estimate, Deutsche Bank estimate
Source: Company data, FactSet, Deutsche Bank estimates
Three year outlookPYPL’s three year outlook calls for mid-20% TPV growth and 16-17% cc revenuegrowth. PYPL expects stable to growing non-GAAP operating margins and freecash flow to grow in-line with revenues.
■ Mid-20% TPV growth
■ 16-17% cc revenue growth
■ Stable to growing non-GAAP operating margins
■ FCF growing in-line with revenues
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Quantifying the VenmoOpportunityRevisiting potential for monetizationAt our recent Technology Conference in September, PYPL CFO John Rainey raisedquite a stir calling Venmo the “crown jewel” of the company. As a result, wehave taken a closer look on the Venmo monetization opportunity and see excitingpotential avenues to accelerate revenue growth, relieve take rate pressure anddrive higher operating margins. As a leading social payment platform, Venmohas the potential to drive revenue in several forms including C2B paymentsand offering a new physical debit card. Modeling these two revenue sourcescenarios (assumptions in note), we estimate Venmo could deliver incrementalrevenue growth of 1.4%/3.5%/5.1% and adj EPS of $0.07/$0.25/$0.48 in FY18/FY19/FY20, respectively. As a result, we do believe Venmo montezation couldhelp push PYPL’s mid-term guidance of 16-17% rev growth and stable to slightlyexpanding op margins higher. However, given some moving pieces surroundingthe variables and timing, we have not adjusted our current PYPL estimates forVenmo monetization yet.
Social payment platform drives usageWe expect Venmo to continue to develop its social platform (organically andpotentially through acquisitions) since it’s a key component of driving adoptionand transactions. As a leading social payment platform (network effect drivesadoption), Venmo grew TPV in the US to $8bn in 2Q17 growing 103% Y/Y, drivenprimarily by the much-vaunted millennial demographic. Fueling the monetizationopportunity, we believe the social platform can drive further engagement(currently at 2-3 txns per week), volumes, and user growth through paymentservices (e.g. Pay with Venmo, debit card) along with the introduction of valueadded services further down the line (e.g. merchant advertising, targeted offers).A comparable business model is WeChat Pay, which has developed a successfulsocial payment platform in China, originally utilizing its strong social network tothen enable P2P payments which has since been accepted in-store and onlineas a payment option. Venmo is going the other direction, utilizing its strong P2Ppayments and social feed base to open C2B payments, while potentially furtherdeveloping its social networking features like adding messaging or merchantreviews.
Pay with Venmo merchant adoptionPYPL has 17mn merchants (although includes int'l) on its platform and plansto rollout Pay with Venmo to its US merchant base by end of year (~6mn haveaccess through Braintree-enabled merchants, while the others will be able toaccess Venmo through the PYPL button). Additionally, Venmo is attracting newmerchants who were not signed up with PYPL, given Venmo's exposure tomillennials and their affinity to publicize transactions (+90% of txns on Venmohave social feed enabled creating free merchant advertising). PYPL plans tocharge the typical take rate (2.9% + $0.30), while the funding mix for Venmowill be more profitable than PYPL's funding mix, given higher use of balancesand the ability to draw from ACH accounts. As adoption for Pay with Venmoratchets up, we believe transaction usage will increase (estimating 10.4 txns peruser per year by 2020). Accordingly, we estimate Pay with Venmo can contribute
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1.2%/2.8%/3.8% revenue growth and $0.06/$0.20/$0.34 of EPS in FY18/FY19/FY20, respectively.
Debit card opening in-store opportunityVenmo's COO recently confirmed beta testing of a Venmo physical debit card, inpartnership with V and Metropolitan Commercial Bank, allowing adopters to payin-store or online. The card defaults to Balance as the primary funding mechanismwith a secondary option likely linked to the bank account using ACH. The carddirectly links a transaction to Venmo for social media posting or allowing users tosplit the purchase in-app (driving further engagement). Importantly, we estimatePYPL will be able to capture ~120bps of interchange on average in these debitcard transactions making them highly profitable. We estimate adoption of thedebit card ramping to 18% of its user base by 2020. Accordingly, we estimate theDebit card can contribute an incremental 0.2%/0.6%/1.3% revenue growth and$0.01/$0.05/$0.13 of EPS in FY18/FY19/FY20, respectively.
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CFO Sees Venmo asCrown JewelSignificant future tailwindsWe hosted the CFO of PYPL, John Rainey at our Las Vegas Tech conference whowas positive on the company’s future as customer choice and partnerships drivebusiness scale, Venmo (“crown jewel of PYPL”) is monetized, pricing optimizationis implemented (expects benefits each year), and rewiring of the company’soperations delivers ongoing sustainable expense control (half of expenses notvolume related). John is pleased with the tenure and pace of discussionsaround selling either part or the entire credit portfolio (some prospective partnersinterested in either/or) which could potentially still occur this year (although notin a rush) and dilution would be partially offset by share repurchases with thefreed up capital. In addition, we believe the eBay renewal is manageable despiteconcerns over the merchant of record clause particularly given the ongoingdecline in contribution. Secular tailwinds and execution are driving performanceabove mid-term targets which could prove conservative.
Choice and partnerships driving business scaleContrary to original investor fears over the impact to margins from customerchoice, benefits in net new actives (6.5m in 2Q17) as well as engagementand churn have outweighed the impact to transaction expenses where PYPLcontinues to see a better-than-expected mix of Balance/ACH. Positively, customerchoice was rolled out to account sign-up by 2016-end and across the entire UScheckout flow as of 2Q17 with plans to extend the initiative internationally near-term (showcasing confidence in results). Partnerships provide multiple benefitsbeyond scale with the Network deals opening tokens for in-store, providing feecertainty and elimination of the MA wallet fee as well as Issuer support of thePYPL brand while Telcos represent a significant customer acquisition tool andtech players help expand ubiquity in-store for contactless payments and online/in-app. John also highlighted favorable economics as part of the Chase partnershipin addition to faster authorization and less declined transactions helping increasecustomer satisfaction.
Venmo monetization more than just hypeJohn believes Venmo monetization is more than just hype and PYPL could realizesignificant incremental revenues enhancing top-line growth and stabilizing thepace of take rate moderation. Venmo’s funding mix is highly geared towardACH/Balance and there’s no need to update merchant agreements given it hasthe same take rate as core PYPL. In addition, bundling Pay with Venmo andcore PYPL across new merchants eager to accept Venmo for accessing themillennial driven socially shared payments bodes well. Pricing optimization is anongoing strategic priority with PYPL pricing for value across each piece of thebusiness. In addition, John highlighted scale opportunities, with every dollar ofrevenue incrementally adding only ~$0.10 in other operating expenses for 2Q17.Despite growing volumes and more services, customer support calls are decliningand Network partnerships have eliminated one of the biggest customer painpoints, namely funding instrument issues. eBay uses multiple processors todayand renewal risks should be manageable as volume contribution is declining by~300-400bps annually to 14% as of 2Q17.
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New Partnerships RevealDeeper StrategyMulti-faceted partnerships potential to propel it to next phase of growthTaking a deeper look at PYPL’s recent series of partnerships with AndroidPay, Apple, Samsung Pay and now Chase, we believe PYPL is expandingits reach to in-store payments and pushing forward its agenda for furtherconsumer engagement and higher transaction volumes which in turn will improveprofitability. PYPL will be able to drive funding costs down by offering consumersfurther choice in payment options (most recently with rewards points), reapinghigher margins as consumers use balances/ ACH (using Discover rails), andscaling costs lower through the use of ChaseNet. In addition to its move tomonetize Venmo, PYPL is clearly positioning itself to be a winner in mobilepayments.
Potential for new favorable economicsThe newly announced Chase/ PYPL partnership will enable the use of ChaseNet,which charges a fixed rate fee of approximately $0.10 for debit and $0.30-$0.40 for credit by our estimate and varies by volume, for processing Chasecard transactions using PayPal. This deal should replace Chase's interchange andis not tied to the size of the transaction. In addition to volume discounts thatPayPal received from the networks, namely V and MA, it’s unclear if PYPL alsoreceived an incremental interchange discount from issuers beyond Chase givenit’s one of the top merchants of record. Further, Chase (along with Citi and DFS) isoffering the use of its rewards points at places that accept PYPL online or in app,expanding funding choices for customers, which we believe enables customeracquisition as well as providing significantly higher transaction margins. Overall,we believe the favorable economics will help lower transaction expenses andpotentially offset the headwinds from the choice initiative.
In-store opportunity opening upThe Chase deal, which comes on the heels of its agreement with other issuersand the payment networks along with the upcoming NFC mobile experience,will help expand PayPal's in-store acceptance. Card funded transactions at thephysical POS are pass-through transactions where merchants are charged cardpresent interchange rates. In-store transactions should help increase customerengagement but, more importantly, are an incremental revenue opportunity atvery high margins when PayPal Balance (the default payment option where abalance is available) and ACH are used as a funding mechanism. In addition, webelieve PayPal when used within 3rd party wallets such as Android Pay/ SamsungPay leverages the Discover network and PayPal potentially acts similar to a stagedwallet benefitting from transaction economics. PYPL also has the opportunityto monetize the transaction data and generate revenues from data-driven value-added services such as coupons/ targeted offers.
Expanding customer acquisition through issuer partnershipsIssuers are promoting the inclusion of their cards to the PYPL wallet. WFC, forexample, offered $25 cash back to its retail customers if they added their WFCcards to their PYPL account. The Chase partnership enables customers to addtheir Chase cards from its properties and Chase Pay to existing or new PayPal
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accounts. Overall, issuer partnerships and joint marketing can help drive customeracquisition and engagement, delivering on the flywheel effect.
PayPal PYPL.OQ 66.23 (USD) 9 Oct 2017 7, 8, 14, 15*Prices are current as of the end of the previous trading session unless otherwise indicated and are sourced from local exchanges via Reuters, Bloomberg, and other vendors. Otherinformation is sourced from Deutsche Bank, subject companies, and other sources. For disclosures pertaining to recommendations or estimates made on securities other than theprimary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr. Aside from within this report, important conflict disclosures can also be found at https://gm/db.com/equities under the "Disclosures Lookup" and "Legal"tabs. Investors are strongly encouraged to review this information before investing.
Important Disclosures Required by U.S. RegulatorsDisclosures marked with an asterisk may also be required by at least one jurisdiction in addition to the United States.See Important Disclosures Required by Non-US Regulators and Explanatory Notes.
7. Deutsche Bank and/or its affiliate(s) has received compensation from this company for the provision ofinvestment banking or financial advisory services within the past year.
8. Deutsche Bank and/or its affiliate(s) expects to receive, or intends to seek, compensation for investment bankingservices from this company in the next three months.
14. Deutsche Bank and/or its affiliate(s) has received non-investment banking related compensation from thiscompany within the past year.
15. This company has been a client of Deutsche Bank Securities Inc. within the past year, during which time itreceived non-investment banking securities-related services.
Important Disclosures Required by Non-U.S. RegulatorsDisclosures marked with an asterisk may also be required by at least one jurisdiction in addition to the United States.See Important Disclosures Required by Non-US Regulators and Explanatory Notes.
7. Deutsche Bank and/or its affiliate(s) has received compensation from this company for the provision ofinvestment banking or financial advisory services within the past year.
For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of thisresearch, please see the most recently published company report or visit our global disclosure look-up page on our websiteat http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr
Analyst Certification
The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s) about thesubject issuer and the securities of the issuer. In addition, the undersigned lead analyst(s) has not and will not receive anycompensation for providing a specific recommendation or view in this report. Bryan Keane
Equity Rating Key Equity rating dispersion and banking relationships
Buy: Based on a current 12- month view of total share-holderreturn (TSR = percentage change in share price from currentprice to projected target price plus pro-jected dividend yield ) ,we recommend that investors buy the stock.Sell: Based on a current 12-month view of total share-holderreturn, we recommend that investors sell the stock.Hold: We take a neutral view on the stock 12-months out and,based on this time horizon, do not recommend either a Buyor Sell.
Newly issued research recommendations and target pricessupersede previously published research.
Deutsche Bank Securities Inc. Page 15
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