- Payment processing service provider PayPal is expected to spin-off from eBay in Q2’15.
- Continuous Total Payment Volume increase that is followed by constant rise in net revenues is PayPal’s real growth story.
- Separation agreement lifts PayPal restrictions for working with other e-commerce platforms.
- Long-term investors looking for growth could gain from a direct investment in PayPal stock.
Thirteen years after it was acquired by eBay (NASDAQ:EBAY) and a couple of years after activist Hedge Fund manager Carl Icahn started his separation campaign, PayPal (PYPL) is getting ready to spin off soon from eBay. The two companies released the operating agreement between them after the Paypal spin-off and passed another important milestone on the path to the PayPal IPO. Many of the terms are still unclear, such as the distribution ratio between PayPal and eBay’s stocks, distribution date, and PayPal IPO date; however, they are supposed to be solved soon, and the IPO is expected in Q2’15.
PayPal spin-off from eBay will allow PayPal to explore new markets and new revenue streams that it could not explore under eBay’s management. In the separation agreement, PayPal loses its unique position in eBay’s marketplace as the platform’s exclusive e-payment processing service and the default payment provider on eBay. However, the restriction from working with competing e-commerce platforms and marketplaces is now lifted, and PayPal can create new revenue streams from this booming industry.
PayPal Business Model
PayPal generates revenues from fees charged to consumers and merchants for different payment-related services. PayPal allows consumers to transfer funds to merchants in a secure manner through the PayPal digital wallet, which includes internal resources such as the PayPal account balance and PayPal credit account and external resources such as bank transfers or credit and debit cards. PayPal does not charge consumers for funding or withdrawing funds that are not charged to any transaction fees; the only fees charged to consumers are related to the loans originated by PayPal Credit.
Most of PayPal’s revenues are generated from transaction fees charged to merchants that vary from 2.2% + $0.3 per transaction for eligible merchants to 3.9% + a fixed fee based on currency received for international fees. PayPal also offers in-person transaction processing services for brick-and-mortar small businesses under the brand PayPal Here, which competes directly with other minor payment processing services. PayPal Here charges a transaction fee of 3.5% of the transaction value and offers a free point-of-sale station for small businesses to process credit/debit cards in their stores.
All fees presented above and the rest of the fees that PayPal charges are all gross figures. Around 40% of the fees collected are paid to third-party payment processors, financial institutions, and cover losses due to fraud, chargebacks, and merchant credit losses. The net transaction revenue rate after all expenses and losses, deducted from the take rate, was 2.19% in Q1’15; that is a 10 bps decline from Q1’14.
Even though the net transaction revenue rate declines over time, PayPal total payment volume (TPV) increases each quarter at a faster pace than the net transaction rate declines, as shown in Chart 1 below.
The declining net transaction revenue rate suggests that PayPal offered more ad-hoc preferred terms to merchants that attracted merchants to increase their use of PayPal services. This drove more transactions to more merchants, and in the end, it drove more net revenues for the company.
PayPal’s increase in total payment volume is also reflected in the company’s revenues. Over the years, eBay has been reporting PayPal revenues as a separated segment from the marketplace segment and has been allowing investors to track PayPal’s impressive growth. Investors attracted by PayPal’s leadership position in the electronic payment market and its rapid growth had to buy eBay’s stock to benefit from PayPal’s performance. Moreover, as shown in Chart 2 below, PayPal’s growth outperformed eBay’s core business growth on a quarterly and yearly basis.
As mentioned above, the PayPal-eBay separation agreement removes any restrictions on PayPal providing processing services for other e-commerce sites and marketplaces. This will be a huge growth driver for the company in light of the shift from in-person transactions to online shopping that has happened in the recent years. With the rising e-commerce activity in China, PayPal will be able to penetrate the Chinese market that is currently dominated by Alibaba’s (BABA) Alipay.
Investors interested in PayPal’s growth and future potential could purchase the PayPal stock directly after the separation. Until the separation, investors attracted to PayPal had to invest in eBay’s stock; however, once the separation is done, those investors will most likely hurry to dump eBay’s stock and increase their stakes in PayPal stocks. This will probably drive some short term fluctuations in eBay’s stock price that sophisticated investors could use for short term gain. For the long-term growth, investors will be able to grab their piece of PayPal directly and not go through eBay.
The long-awaited PayPal IPO is expected to take place in Q2 of 2015. PayPal’s impressive TPV and net revenue growth rates on top of the promising expansion potential make the newly traded PayPal stock an attractive growth investment. Sophisticated investors could gain some short-term profits from the expected fluctuations in eBay’s stock price around the separation and PayPal IPO dates.
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