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The payments behemoth
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In 1998, Max Levchin, a serial entrepreneur even before graduating from college, met Peter Thiel. Levchin had an idea to cryptographically secure data on the popular mobile phone of the time (Palm Pilots anyone?). The company was named FieldLink. After a few months of struggling to find any demand, the pair pivoted to sending money via Palm Pilots — Confinity was born. After recruiting 4 friends, Confinity was becoming more popular, allowing people to “beam” money to their friends. However, there was a competitor. A young Elon Musk was working on the same idea, under the company name: X.com.
Confinity and X.com were going back and forth. When the Confinity team came up with the idea of incentivizing users with $10 to use the service, Musk ramped up the cash bonus to $20. With both companies bleeding cash, in March 2000, they decided to merge. Later in 2000, Thiel pushed Musk out of the CEO position, and subsequently, the company was renamed: PayPal. In 2001, the company went public after turning down a few buy-out offers from eBay. Just a year later, eBay bit the bullet and bought PayPal for more than 3x the amount they first offered just a year earlier.
Now, two decades later, the company does $27 billion in revenue on more than $1.35 trillion in gross payment volume and $5 billion in free cash flow. Safe to say that Levchin and Thiel’s pivot was a good idea.
PayPal, at its core, is a company that uses the internet to send money around the world.
While PayPal can be confused as a payment processor it is more of a payment aggregator, aka payment facilitator, aka payfacs (remember how confusing the payments ecosystem is?)
PayPal came under some scrutiny a few years because Adyen, became eBay’s go-to partner. While eBay has been less important to PayPal’s business for a long time, investors viewed it as worthy competition. On top of this, direct competitor, Stripe, raised a peak funding round at a $100 billion valuation, though its latest $6.5 billion capital injection was raised around $50 billion. Founded in 2010, Stripe’s aim was basically to create a better PayPal, where the merchant sign-up process was as easy as possible. As a personal user of both platforms, Stripe is much more customizable and the user interface is far more intuitive.
Layer on the fact that cross-border payments, which are more accretive to PayPal, have shrunk a little as a percentage of total volume. And top it off with the lower take rates from peer-to-peer payments through Venmo and it’s no wonder that gross margins have decreased over the decade from 53% in 2014 right before the spin-out to 42% last year.
To talk a little more about Venmo, In 2013, PayPal acquired Braintree for $800 million. Just a year before that, Braintree had acquired Venmo for just under $27 million. So PayPal got sort of a 2-for-1 deal. Now, Venmo, alone, accounts for 18% of PayPal’s GPV (gross payment volume). Just 8 years ago Venmo was acquired for $27 million and now it a quarter of a trillion in annual GPV. While P2P (peer-to-peer) margins are lower because the real money is in the merchant fees, the acquisition was an amazing deal.
The product got off to a viral start but payment volume has slowed down a bit. It grew from $34 billion in payment volume to $230 billion in just four years but last year growth sort of hit a wall. The growth of Zelle within the big four banking apps has certainly put a governor on Venmo’s growth as well as some competition from Cash App.
I’m starting to see Venmo being accepted by more and more merchants though. Imagine if you could type in a restaurant’s name and “beam” money to it immediately. I wouldn’t be surprised to see this start cropping up soon. In China, AliPay and WeChat Pay have been doing this for a long time. Without the complexity of the payment value chain, Alibaba and Tencent (owner of WeChat Pay) have cracked the digital wallet code that US companies have struggled to figure out.
For example, in China, even at a local coffee shop, you’ll take out your phone, scan a little QR code and type in the amount you owe. But in the US, credit cards are the default. Sometimes it even takes longer to pull out your phone, unlock it, open an app and type in an amount. One method that is easier than physical cards is Apple Pay. However, though the consumer experience is similar to AliPay, the underlying economics are different. This is because the Chinese companies didn’t have the massive card network to compete with. If, for instance, Apple wanted to cut out the card networks and the issuing banks, it would have to go around and sign up every merchant they could and then take on the credit or at least sell it off to a bank. This would be incredibly difficult and not in Apple’s core competency.
This is the card network’s competitive advantage; that the consumer value prop for a digital wallet is really not that much better. The consumers don’t pay the fees, the merchants do. What would be interesting is if Apple or Google (with Android) created a way for merchants to self-onboard very easily and they could cut down the interchange fees by vertically integrating. Instead of the typical 2.9% + 30 cents, merchants could only pay maybe 1.5% + 20 cents. Adding more than 1% to a company’s bottom line would be an amazing value prop. I’m sure Apple and Google have thought of this and the economics likely don’t make sense. Again, it ultimately comes down to the consumer. American consumers love their credit card rewards and credit scores are such an important piece of the lending ecosystem. After needing to rethink all of this and undercut banks/credit networks while they are lobbying against you, it’s not tough to really understand Visa/Mastercard’s moat in the US. If Apple or Google or PayPal can figure out each of these problems over time, digital wallets could gain acceptance. But it’s a tough road. Visa/Mastercard have faced this head-on, creating valuable partnerships with digital wallets to make sure the payment rails aren’t circumvented.
PayPal has a strong start though. It has 435 million active users that, on average, transact on the platform 17x per month. The sheer scale of PayPal, on both the consumer and merchant sides give the company the ability to layer on services that other sub-scale competitors can’t really do. For instance, Square went and bought Afterpay for $29 billion while PayPal already done 200 million buy-now-pay-later transactions spread across 30 million consumers. The vision of a closed-end network may only be a fantasy because of how entrenched credit cards are, but PayPal has a solid position to grow towards this goal. While Adyen is eating into margins on the larger merchant side, Stripe is gobbling up the small internet entrepreneurs, Cash App is signing on quite a few users and Wise is providing some international competition, PayPal is still keeping its head above water. The payments space has shifted quite a bit even over the past few years and PayPal, in my opinion, doesn’t quite have the dominance it once had.
With that said, engagement from the current users is still trending upwards, suggesting that PayPal still fulfills a valuable role.
The power of its global brand and its sheer scale makes me hopeful for the company but it certainly is getting attacked from all sides.
I’ll end with a fun fact:
These are all the people that worked at PayPal in the early days. They are affectionately called the “PayPal Mafia” and the talent level is ridiculous. Just look at how many of them went on to start/work on incredibly high profile businesses.
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