So Many Irons in the Fire

PayPal’s octopus-like strategy covers everything from P2P payments, bill pay, and the point of sale to parting ways with eBay. Can Schulman and Co. keep all the balls in the air?

PayPal Holdings Inc. president and chief executive Dan Schulman can’t be accused of making small plans.

“We aspire to be the de facto operating system for mobile and digital payments around the world, creating value for all of our partners and customers across the entire payments ecosystem,” Schulman said Jan. 30 during PayPal’s fourth-quarter 2018 conference call with analysts.

Action is backing up those words. Few financial companies have more going on at once than San Jose, Calif.-based PayPal. Just a few items on PayPal’s to-do list include making its popular Venmo peer-to-peer payment service profitable, establishing a strong presence in bill payments after its acquisition of TIO Networks bombed, getting its halting effort to come to the point of sale into gear, successfully completing its separation from long-time parent company eBay Inc., and offering credit without getting burned.

What’s the overarching strategy behind all this?

“They’re trying to be relevant for the future,” says Lawrence Berlin, a senior vice president at Chicago-based First Analysis Securities Corp. who follows payment companies. “That’s the key to everything.”

Somewhat more ominous forces may be motivating PayPal, too.

“What we’re seeing right now is a lot of evidence that PayPal realizes this is their game to lose,” says Jordan McKee, research director of emerging payments technology at New York City-based 451 Research. “There’s no shortage of threats.”

Indeed, it seems everybody from fintech startups to established online processors such as Square Inc. and Stripe Inc. to big banks and Visa Inc. and Mastercard Inc., with whom PayPal has made peace recently, has some product or products that compete directly with PayPal. In the world of online and mobile payments, competitors can work with each other when their interests align, but interests can change rapidly.

Mobile Drives Growth

For now, however, PayPal holds a commanding position. Total payment volume (TPV) rose 27% year-over-year in 2018 to $578 billion on nearly 10 billion transactions (chart, page 28). Net income for the year hit $2 billion, up 15% from 2017’s $1.8 billion. Quarterly revenues surpassed $4 billion for the first time in the three months ended Dec. 31.

The worldwide active-account base expanded by about 38 million to 267 million, and some 21 million merchants now accept PayPal.

PayPal expects the good times to keep rolling. Chief financial officer John Rainey predicted on the January call that TPV will grow in the mid-20% range in 2019 and revenues will increase 16% to 17% on a currency-neutral basis.

And at a time when Apple Pay, Google Pay, and Samsung Pay are still struggling to win acceptance from consumers and merchants, PayPal racked up $227 billion in mobile-payment volume in 2018, up 46% from $155 billion in 2017, on 3.7 billion transactions.

“Mobile continues to drive our growth, with $67 billion of mobile TPV in [the fourth quarter] alone, representing 41% of our total TPV,” Schulman said.

Despite those achievements, Pay­- Pal’s leadership believes much remains to be done to secure the company’s position. One of its top priorities is generating revenue—and profit—from Venmo, PayPal’s P2P payment service, which also features a social-networking platform. Venmo’s volume jumped 79% in 2018 to $62 billion, and Schulman expects volume to approach $100 billion this year.

PayPal, which did not make an executive available to Digital Transactions to comment for this story, doesn’t disclose the number of Venmo users. Payments researcher Richard Crone of San Carlos, Calif.-based Crone Consulting LLC estimates Venmo had 39 million active users at year-end 2018 versus 29 million for Zelle from bank-owned Early Warning Services LLC (chart, page 30).

Flywheel Effect

Venmo gains customers every time senders want to zap funds to non-Venmo users, who will need to open a Venmo account to access their money.

“They’re growing their user base virally, all courtesy of the users,” says Crone. “The flywheel effect is tremendous.”

Zelle, however, has a larger average payment amount and is closing the gap due to rapid adoption from Early Warning’s big-bank owners and from third-party processors offering it to smaller financial institutions.

But Venmo’s biggest problem, like that of most P2P services, has been that consumers have proven highly resistant to paying fees to transfer money electronically. Providers are looking to monetize, in industry-speak, their systems by persuading merchants to accept them for payment of goods and services, and by charging fees for value-added services such as real-time funds availability.

Venmo’s Instant Transfer service, for example, enables users to get money out of their Venmo balance by transferring funds to an eligible debit card for a 1% fee, with a minimum fee of 25 cents and a $10 maximum. Funds typically arrive within 30 minutes, compared with one to three days for standard transfers that go through the automated clearing house network.

Some 29% of Venmo account holders have made a “monetizable” transaction, producing a $200 million revenue run-rate going into 2019, Schulman reported. A number of merchants, including Uber, the Grubhub food-ordering service, the movie and TV streaming service Hulu, and the Tidal music-streaming service, now accept Venmo for payments. About half the monetizable volume is coming from Instant Transfers, with the rest from payments on the Venmo Mastercard debit card and merchant sources.

Venmo’s losses evidently were getting to be serious. Before the monetization effort kicked in in 2018, “we effectively were providing a service that we weren’t monetizing in any way. And so the losses were growing as volume grew,” Rainey said. He added that the immediate goal is to break even, a target PayPal probably won’t hit within two quarters.

Another big market PayPal is eyeing is bill payments, a niche where it made a rare misstep. PayPal thought its $238 million acquisition of Vancouver, British Columbia-based TIO Networks in 2017 would help it establish a major presence in electronic bill-pay thanks to TIO’s connections with 10,000 billers through a network of 900 kiosks, 65,000 walk-in locations, and 14 million consumer accounts doing $7 billion in annual volume.

But before the year was out, a data breach that potentially affected 1.6 million customers forced PayPal to suspend the network’s operations. Last March, PayPal said it would shut TIO down.

Now PayPal is trying again by forming a partnership with Paymentus Corp. The company didn’t disclose details of its agreement with the Charlotte, N.C.-based processor, but on the January call PayPal chief operating officer Bill Ready said the partnership potentially could generate “tens of billions” of dollars in bill-payment volume. Paymentus’s Web site says the firm was founded in 2004 and has 1,300 clients, including “some of the largest billers in North America.”

A Bet That Didn’t Work Out

PayPal’s top brass clearly hopes Paymentus will help the company recover its bill-pay mojo. Surprisingly, PayPal received little public thrashing from Wall Street over the TIO flame-out.

“They were not really punished because it was small,” analyst Berlin says, noting that the $238 million PayPal plunked down for TIO Networks was tiny compared with its revenues and market capitalization.

Adds McKee of 451 Research: “Not all bets are going to work out. Some might end up like TIO Networks, and some might work out like Braintree.” The latter, of course, is the highly successful online-commerce processor and Venmo owner, headed by Ready, that eBay bought in 2013 for $800 million and put under PayPal’s wing.

Another problematic area PayPal continues to work on is bringing its service to the point of sale. The company has deployed various strategies. At one time or another, it has worked with partners, including Discover Financial Services, in pursuit of this elusive goal, so far with little to show for its efforts.

“The one thing they haven’t figured out is the physical world,” says Thad Peterson, senior analyst and e-commerce researcher at Aite Group LLC, Boston. “As near as I can tell, they still don’t have a clear strategy on what they want to do, or if they have, they haven’t revealed it yet.” But he adds: “It’s probably the latter, not the former.”

At times, however, parts of the strategy reveal themselves. In its biggest acquisition ever, PayPal last September bought Stockholm-based payments firm iZettle AB for $2.2 billion. Founded in 2010, iZettle often is called the “Square of Europe” for the similarities of its business model with that of San Francisco-based Square, which started out by providing tiny businesses and part-time sellers with a dongle for smart phones so they could accept credit and debit cards.

IZettle targeted small and mid-size businesses with its mini chip card reader and has branched into other payments niches, including POS software, e-commerce, and contactless payments.

Today iZettle serves about 500,000 merchants in 11 European and Latin American countries. The acquisition doesn’t do much for PayPal’s POS expansion in its home country, but it does advance yet another company goal, that of being a major international payments player.

‘Common Thread’

PayPal took a further step in that direction last year when it bought San Francisco-based payout provider Hyperwallet for $400 million in cash. Hyperwallet is an international specialist in provisioning payments, commissions, and royalties to drivers, recording artists, and other groups of independent workers.

The iZettle and Hyperwallet acquisitions show PayPal is “trying to move … offline and international, that’s the common thread,” says Berlin.

In some ways, PayPal finds itself haunted by its own history. It is in the final stages of separating from eBay, which owned it for 13 years but spun it off in 2015. Under a five-year operating agreement, PayPal has remained the online marketplace’s payments provider.

But that picture started getting murky last year. In September, eBay said it has “begun managing payments” on its massive marketplace and that it expects to have a majority of sellers converted to the new program by 2021. Earlier in the year, eBay contracted with Adyen, a Netherlands-based gateway with U.S. operations based in San Francisco, to relay transactions to a wide range of payment methods and relegated PayPal to the role of just one of those payment choices.

EBay in January revealed that some 3,500 sellers had migrated to its new payments platform by year’s end at an average 25% discount to PayPal’s published transaction fees.

PayPal’s top brass says all of the company’s non-eBay businesses are filling the eBay void. Schulman noted on the recent call that eBay generated “zero growth” for PayPal in the fourth quarter and that it accounted for only 10% of TPV, down from 13% a year earlier.

“We’re able to absorb that because of the breadth of our portfolio,” he said, adding that “eBay is going to be a much smaller part of our business than any of us thought it would be” by 2020, when the operating agreement officially expires.

“The message that I got out of that was, ‘we’re not dependent on them in any way whatsoever any more, we’ve got so much going on,’” says Aite’s Peterson.

Exiting the ‘Risk Business’

PayPal has shown in other ways that it will step back from a business it’s in, even if it doesn’t exit it entirely. The company, which offers the PayPal Credit service to consumers and PayPal Working Capital to merchants, recently noted that it has lent $50 billion to American consumers since eBay acquired the BillMeLater lending service 11 years ago, and, as with Braintree, put it under PayPal’s wing.

While fintechs like PayPal and its competitors want to give consumers and merchants access to credit, PayPal has concluded it doesn’t want the exposure of being a lender. Last July, it sold its U.S. consumer credit portfolio to Synchrony Financial for about $6.5 billion in cash.

“That tells me they want to be out of the risk business,” says Peterson. “Given the potential for a downturn in the economy, I think it was the right move.”

But as its longstanding relationship with eBay sunsets and it treads carefully with credit, PayPal is elevating so-called “partnerships” with online marketplaces, merchants, networks, banks, and others into the top tier of its growth strategy. The company has struck no fewer than 38 “strategic agreements” since 2016 with everyone from Visa, Mastercard, American Express, and Discover to Facebook and more recently Walmart Inc., according to a recent investor presentation. Under a service launched in November, PayPal account holders can go to 4,700 Walmart locations to load or withdraw money from their PayPal accounts.

PayPal’s accords with Visa and Mastercard essentially called for PayPal to encourage account holders to use more card-based funding for their accounts in contrast to PayPal’s traditional preference for funding through the low-cost ACH. The change put some pressure on PayPal’s transaction margins but resolved what appeared to be a growing conflict with the card networks.

“I don’t think you want to go to war with Visa and Mastercard,” McKee says.

McKee notes that many observers had doubts about PayPal when eBay spun off it off. Those doubts are largely settled. “Right now, they’ve kind of proven that they’re able to stand on their own,” he says.