Global Equities

Stock story: PayPal

The company’s brainwave was to invest a way to buy over the internet without handing over credit-card details with every purchase.

In the late 1990s, several tech whiz kids in the US were searching for a way to disrupt finance. Elon Musk’s initial attempt was to create one of the world's first online banks in 1999. The year after, Musk teamed up with Peter Thiel and Max Levchin who had devised a way for people to send money via Palm handhelds. Then came their brainwave – formulate a way for people to buy over the internet without having to hand over credit-card details every time.

Thus, PayPal was born in 2000. Nowadays, the company is the biggest global digital wallet and a leader in mobile payments. The company operates across more than 200 markets, processing transactions in more than 100 currencies. In fiscal 2016, PayPal’s 188 million ‘active’ account holders conducted more than 6.1 billion transactions worth US$354 billion in payments on PayPal’s digital platform, a 28% increase from the previous year. Of this, US$102 billion (two billion transactions) were via mobile devices.

PayPal’s success is built on the way it allows people to purchase online quickly and securely after giving their financial information only once to PayPal. The company never divulges this information to merchants. PayPal allows its customers’ digital wallets to be loaded with credit cards, debit cards and consumers’ transaction bank accounts, so that they can have various payment options. PayPal’s security and ease of use encourages more online shopping and reduces the risk for merchants that people will abandon online-shopping carts because they must enter payment details on the merchant’s website, along with concern that payment details might be hacked from the merchant. PayPal is especially useful for smaller merchants that would find it difficult and expensive to obtain similar payment services through banks.

PayPal’s largest source of profit margin is the spread between negotiated acceptance fees paid by merchants (a percentage of each transaction) and the fees PayPal pays to the consumers’ payment source (say, issuers of credit cards). PayPal’s operating margins are lowest when customers pay with credit cards because the fees charged by the card issuers are notably higher than other payment sources. Margins are highest when customers use transaction bank accounts, as the fees PayPal pays to banks to withdraw payment from a transaction bank account are negligible. PayPal’s revenue in fiscal 2016 reached US$10.8 billion, an increase of 21% from the previous financial year. PayPal is expected to record continued strong revenue growth in coming years as societies become increasingly cashless and ecommerce further penetrates global commerce. The scalable nature of PayPal’s cost structure, along with the network effect benefits for revenue growth, leads us to expect that over time PayPal’s operating margins will expand significantly

PayPal’s earnings outlook would be even stronger if the company could build a presence in physical stores where the American Express, MasterCard and Visa networks dominate. The lack of an offline presence stymies PayPal’s ability to create the habit among its customers of making PayPal their default payment instrument, no matter the merchant or location. Another challenge for PayPal is that competition in the digital-wallet space is increasing. MasterCard and Visa have introduced digital wallets, MasterPass and Visa Checkout, which mimic many of PayPal’s user-friendly features. Android Pay, Apple Pay and Samsung Pay now offer mobile and in-app payment facilities via their mobile handsets and through more than 1,000 applications. Microsoft and Facebook have plans to develop payment methods, particularly for mobiles. PayPal, however, with its existing infrastructure and trusted brand, is well placed to fight off such threats and build an offline presence.

Leading the digital-payments revolution

PayPal’s big break came in 2000 when eBay allowed the company to promote its services on the online shopping and auction site. PayPal’s ease of use for eBay customers and small merchants that had previously found digital payments difficult, particularly across borders, fostered the rapid growth of eBay’s small merchants and transactions; so much so that eBay bought PayPal in 2002 only months after PayPal listed on the Nasdaq. The mutually beneficial relationship between eBay’s marketplace and PayPal’s enablement of digital payments allowed PayPal to become the only new successful global payment network since the launch of MasterCard in the 1960s.

In 2015, PayPal was spun out of eBay and re-listed. This renewed independence has allowed PayPal to focus on its core capabilities in an increasingly fluid and competitive market. Independence from eBay also permits PayPal to target new clients, such as large retailers, that would have previously been reticent, as eBay is a competitor. PayPal still benefits from a service agreement with its former parent, which provides some 16% of PayPal’s total payments volume.

It is extremely hard to establish a payments network that could compete with American Express, MasterCard and Visa because an entrant would need to be simultaneously accepted by consumers and merchants. This requires mass awareness, simplicity of payment, technology ubiquity and an ability to meet arduous customer and merchant servicing needs and regulatory requirements. Many companies and large consortia, including groups of very large merchants and some of the world’s largest telecoms, have tried to create payment networks over the years and all have failed.

Now that PayPal belongs among the global payment networks the company stands to benefit from the decades-long global trend towards a cashless society. The means of payment has shifted from cash and cheques towards electronic payments due to convenience, necessity as commerce shifts to online, and public policy.

This trend has a long way to go. Cash still comprises 50% of all payments in many developed economies and more than 90% in developing countries.

PayPal’s competitive strength is in online payments, where it has built a strong brand position with consumers and merchants. Indeed, it has recently been recognised as a top-100 global brand by Interbrand. Recognition and increasing usage are reflected in sustained extraordinarily high payments volume growth. Over the past three years, PayPal has experienced more than 20% compound growth in revenue and operating profit.

PayPal has invested in online and mobile capabilities by buying Braintree and Paydiant, which provide merchants with leading capabilities in mobile payments and loyalty programs. It is rolling out its One Touch functionality globally, which further simplifies the payment process on devices and operating systems to just that; one touch of a button to process a purchase, with no further details entered by the customer. While PayPal’s founders have moved on from their creation, their ambition to shake up the payments industry still drives PayPal.

Important Information: This material has been prepared by Magellan Asset Management Limited trading as MFG Asset Management (‘MFG Asset Management’) for general information purposes and must not be construed as investment advice. This material does not constitute an offer or inducement to engage in an investment activity nor does it form part of any offer or invitation to purchase, sell or subscribe for in interests in any type of investment product or service. This material does not take into account your investment objectives, financial situation or particular needs. You should read and consider any relevant offer documentation applicable to any investment product or service and consider obtaining professional investment advice tailored to your specific circumstances before making any investment decision. This material and the information contained within it may not be reproduced or disclosed, in whole or in part, without the prior written consent of MFG Asset Management. Any trademarks, logos, and service marks contained herein may be the registered and unregistered trademarks of their respective owners. Nothing contained herein should be construed as granting by implication, or otherwise, any licence or right to use any trademark displayed without the written permission of the owner.

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