PayPal Holdings, Inc. — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. The filing also reports unaudited quarterly results, including Q4 2018.
Business context
PayPal operates a global digital payments platform serving consumers and merchants through PayPal, Braintree, Venmo, Xoom, PayPal Credit and, following its 2018 acquisition, iZettle. At year-end, it reported 267 million active accounts, including 21 million active merchant accounts, and processed $578.4 billion of total payment volume (TPV) across more than 200 markets.
Financial performance
| Metric | FY 2018 | FY 2017 | Change |
|---|---|---|---|
| Net revenue | $15.451 billion | $13.094 billion | +18% |
| Operating income | $2.194 billion | $2.127 billion | +3% |
| Operating margin | 14% | 16% | Down 2 percentage points |
| Net income | $2.057 billion | $1.795 billion | +15% |
| Diluted EPS | $1.71 | $1.47 | +16% |
| Operating cash flow | $5.483 billion | $2.531 billion | +117% |
| Free cash flow (non-GAAP) | $4.660 billion | $1.864 billion | +150% |
Transaction revenue rose 19% to $13.709 billion; other value-added services revenue increased 9% to $1.742 billion. TPV grew 27%, payment transactions rose 27% to 9.871 billion, and transactions per active account increased 9% to 36.9. Revenue grew more slowly than TPV partly because P2P transactions, which generally earn lower fees, represented a larger share of activity; cross-border TPV also declined as a proportion of total TPV.
Operating expenses grew 21%, faster than revenue. Transaction expense increased 26%, while transaction and loan losses rose 26% to $1.274 billion; the transaction loss rate remained 0.18% of TPV. The operating-margin decline reflected transaction-cost growth and acquisitions, partly offset by efficiencies. The 2017 comparison also included a one-time benefit from reversing allowances on the U.S. consumer credit portfolio after its designation for sale.
Q4 2018 revenue was $4.226 billion, versus $3.744 billion in Q4 2017; net income was $584 million, versus $620 million. Quarterly diluted EPS was $0.49 versus $0.50.
Cash, liquidity and debt
- Cash, cash equivalents and investments available for corporate purposes were $9.710 billion at year-end, excluding customer-account assets and restricted cash. The company cautioned that not all cash is available for general corporate use because of operating and regulatory requirements; 89% of this cash and investment pool was held by foreign subsidiaries.
- Operating cash flow and free cash flow were materially boosted by the July 2018 sale of the U.S. consumer credit receivables portfolio. Management disclosed an approximately $1.4 billion positive cash-flow impact from the sale; free cash flow is a non-GAAP measure.
- PayPal had $2.0 billion outstanding under its delayed-draw term loan facility at year-end, at a weighted average rate of 3.34%. It reported $3.0 billion of remaining capacity under that facility, plus a $2.0 billion undrawn revolving facility and approximately $300 million of other available facilities.
- The company said existing liquidity, operating cash generation and expected access to capital were sufficient for foreseeable needs. It had no material off-balance-sheet arrangements and maintained investment-grade ratings.
Material changes, outlook and risks
- In July 2018, PayPal completed the sale of its U.S. consumer credit receivables portfolio to Synchrony Bank for $6.9 billion in total consideration, including $6.5 billion cash and a long-term receivable. Synchrony became the exclusive U.S. PayPal Credit issuer; PayPal continues to earn revenue share and provide transition services. Management expected the transaction to reduce total revenue growth by 6%–8% in each of the first two quarters of 2019.
- PayPal acquired iZettle, Simility and Hyperwallet, among other businesses, in 2018. The iZettle acquisition was under a UK Competition and Markets Authority Phase 2 review at year-end; the businesses were being held partly separate pending the review, which could impose remedies or restrictions.
- TIO Networks, acquired in 2017, was suspended following discovery of security vulnerabilities and evidence of unauthorized network access. The company reported potential compromise of personally identifiable information for approximately 1.6 million people and decided to wind down TIO. A securities class action was ongoing; the amended complaint had been dismissed without prejudice, and a second amended complaint was filed in January 2019. The filing does not provide a clear estimate of potential losses from this matter.
- Other notable exposures include intense competition, cybersecurity and service interruptions, fraud and customer-protection losses, evolving payments and privacy regulation (including GDPR and PSD2), foreign-exchange risk, Brexit uncertainty, credit risk in growing merchant lending, and dependence on financial-institution and technology partners.
- Revenue from eBay’s marketplace declined to approximately 17% of total revenue in 2018 from 20% in 2017. The eBay operating agreement was due to expire in July 2020; PayPal cited the possibility of reduced eBay volume or payment-option availability and the need to offset any resulting decline.
- PayPal reported a 13% effective tax rate, compared with 18% in 2017, and completed its accounting for the U.S. Tax Act, recording $200 million of discrete net tax expense across the two years. Tax rulings, primarily in Singapore and Luxembourg, generated approximately $465 million of tax savings in 2018 and were due to expire in 2020.
Most important facts for investors to verify
- How much of reported 2018 cash-flow growth reflects recurring operations versus the consumer-credit portfolio sale and related accounting presentation.
- The realized revenue and earnings effects of transferring U.S. consumer credit to Synchrony, including revenue-share terms and the expected 2019 growth headwind.
- Integration progress and final UK regulatory outcome for iZettle, and the financial, customer and legal consequences of TIO’s shutdown and data incident.
- Whether payment costs, transaction losses and merchant-credit receivables continue to rise faster than revenue, and the resulting effect on margins and credit quality.
- Exposure to eBay as the operating agreement approaches expiration, and the company’s capacity to maintain growth through other merchants and products.