Digital payments giant PayPal (PYPL) is facing short-term headwinds from its declining cash cow partnership with eBay (EBAY) . But longer term, PayPal is scaling its other businesses to profit from the secular growth of the digitization of payments.
Challenges With eBay
After the separation of PayPal and eBay in 2015, eBay went one step further in early 2018, announcing an agreement with Adyen in which the Dutch company will become eBay's primary payments processing partner. In the meantime, PayPal and eBay are still important partners. But the consequences for PayPal are significant. And eBay's challenges accelerate the diminishing revenue stream for PayPal.
The Total Processing Volume (TPV) from eBay decreased from 21% of the total PayPal revenue in 2015 to 11% in 2018. But with a high transaction take rate, revenue from eBay still represented 17% of PayPal's total revenue in 2018. That high transaction take rate from the eBay business is not easy to replace. As an illustration, the table below compares the revenue from eBay with the revenue from the growing P2P payment application Venmo that PayPal owns.
With a similar TPV, revenue from eBay amounts to more than 10x the revenue from Venmo. During the Q4 earnings call, PayPal management confirmed the transaction take rate was decreasing with the transition of the business away from eBay. Executives noted that:
Growth in our P2P business, continued deceleration of eBay and lower cross-border volumes contributed to the reduction in transaction take rate.
These challenges translate into the earnings. TPV grew by 27% in 2018 while revenue grew 18% and operating income increased only 3%.
The situation is not worrying, though. Generating a lower transaction take rate to grow a business is a sound strategy. But management will have to show the company can generate a higher transaction take rate when the growing businesses mature.
Scaling the Other Businesses
Considering eBay's other challenges, the forced transition is beneficial to PayPal in the long term. The company is focusing on increasing the scale of its other activities while profiting from the high margin business with eBay.
The impressive revenue growth of e-commerce platform Shopify (SHOP) demonstrates the success of online marketplaces. And PayPal is taking advantage of this trend. Excluding eBay, the top 20 partners and marketplaces represented a total payment volume growth exceeding 40% in 2018 at nearly $85 billion. And revenues from merchant services grew by 22% compared with 4% from eBay.
Mobile payments represent another growth opportunity. During Q4, mobile payment volume amounted to 41% of the TPV.
Also, PayPal has been taking advantage of its size to scale its acquisitions. With $10.1 billion of cash, the company has the potential to continue with this strategy.
As a result of these initiatives, active accounts grew by 17% in 2018 to reach 267 million. And management is targeting 300 million active accounts by the end of 2019. Payment transactions and TPV, at 9.9 billion and $578 billion, respectively, both grew by 27% compared to 2017.
In 2019, TPV is expected to grow in the mid-20's percent range, while management forecasted revenue to grow by 16% to 17%. There are some minor adjustments to consider because of acquisitions and divestitures. But the point is to highlight the growth before operating leverage materializes in the next few years to compensate for the declining business with eBay.
The Investing Proposition
PayPal's valuation doesn't cheap with a forward P/E ratio above 30 and an EV/Sales ratio at about 6. But compared with other digital payment companies, the valuation is reasonable.
Thus, PayPal is a company to consider for the investors interested in being involved in the growth of mobile e-commerce and the digitalization of cash payments.