PayPal Holdings, Inc. — Q3 2016 Form 10-Q
Business context and period: PayPal operates a global digital payments platform, including PayPal, PayPal Credit, Braintree, Venmo and Xoom. This unaudited quarterly report covers the three and nine months ended September 30, 2016. PayPal became independent from eBay in July 2015, so certain year-to-date comparisons reflect periods before and after separation and may not be fully representative of a standalone company.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net revenue | $2.667B | $2.258B | $7.861B | $6.692B |
| Operating income | $348M | $330M | $1.126B | $1.050B |
| Operating margin | 13% | 15% | 14% | 16% |
| Net income | $323M | $301M | $1.011B | $861M |
| Diluted EPS | $0.27 | $0.25 | $0.83 | $0.70 |
- Q3 revenue rose 18%; total payment volume (TPV) increased 25% to $87.4B. Active customer accounts grew 11% to 192M and payment transactions increased 24% to 1.512B.
- For the first nine months, revenue rose 17% and TPV grew 27% to $254.7B. Operating income increased 7% and net income 17%.
- Transaction revenue grew 17% in both comparison periods. Management attributed slower growth than TPV to more lower-rate person-to-person payments and a greater share of volume from large merchants. Other value-added-services revenue rose 28% in Q3, primarily on PayPal Credit interest and fee income.
- Operating expenses rose 20% in Q3 and 19% year to date. Transaction expense and transaction-and-loan losses grew faster than revenue, contributing to lower operating margins.
Cash flow, balance sheet and liquidity
- For the nine months, operating cash flow was $2.235B versus $1.818B; capital expenditures were $517M versus $558M. Reported non-GAAP free cash flow was $1.718B versus $1.260B. Q3 operating cash flow was $801M versus $652M.
- Cash and cash equivalents were $1.369B at September 30, 2016; short-term investments were $3.719B and long-term investments $1.339B. Management reported $6.359B of cash, cash equivalents and available-for-sale investments available, excluding customer-account assets.
- Total assets were $31.356B and total liabilities $17.164B. Funds receivable and customer accounts of $13.320B were substantially matched by funds payable and amounts due to customers of $14.120B; customer funds are subject to regulatory safeguarding requirements.
- No borrowings or letters of credit were outstanding under the $2.0B revolving credit facility. PayPal repurchased $945M of stock in the first nine months, with approximately $1.055B remaining under its authorization.
- Loans and interest receivable, net, were $4.815B, including a $314M allowance. Consumer and merchant credit balances expanded; management cited higher loan-loss reserves and forecast delinquency rates. It designated $800M of European customer balances for use in extending European credit, subject to local regulation.
Changes, outlook and risks
- Management attributed growth to higher customer engagement, payment transactions and Braintree activity. Xoom contributed to expenses, but management said it did not materially drive current-period TPV or revenue growth.
- Management expects transaction-revenue growth to remain below TPV and transaction growth because of payment mix, including P2P and large merchants. It stated that available liquidity, operating cash generation and expected capital-market access should fund operations, capital expenditures and credit products for the foreseeable future. The filing gives no specific numerical earnings or revenue guidance.
- Credit losses rose: Q3 loan losses increased 68% to $114M; nine-month loan losses rose 52% to $310M. Consumer net charge-off rate was 6.0%, versus 5.6% a year earlier. Merchant receivables past their original expected repayment period and more than 90 days outstanding also increased year over year.
- Key exposures include payment-card funding costs, fraud and transaction losses, credit performance, foreign-exchange movements, cybersecurity and extensive changing regulation. Brexit could affect currencies and regulatory permissions. PayPal suspended operations in Turkey in June 2016 after its e-money license application was rejected.
- Regulatory matters include an FTC investigative demand concerning Venmo and additional OFAC inquiries into self-reported transactions. The company said accrued legal and regulatory liabilities were not material, but outcomes and potential non-monetary remedies may be uncertain.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether TPV and customer growth can translate into revenue and profit growth despite lower monetization of P2P and large-merchant volume.
- Whether transaction expense and credit-loss growth moderate, and how loan delinquencies, charge-offs and allowance adequacy develop.
- How the $800M European customer-balance designation and broader credit expansion affect safeguarding, funding and liquidity.
- Developments in the FTC/Venmo inquiry, OFAC matters, Turkey restrictions, Brexit-related regulation and other disclosed legal proceedings.
- Cash generation and share repurchases relative to investment needs; assess non-GAAP free cash flow alongside GAAP cash flows and the filing’s stated reconciliations.
- Comparability of 2015 results, given the July 2015 separation from eBay, and the filing’s reclassification of certain operating expenses.