Explaining PayPal's Latest Acquisition

PayPal (NASDAQ: PYPL) just spent a whopping $2.2 billion on European payments company iZettle.

In this segment from Industry Focus: Technology, analyst Dylan Lewis and Motley Fool contributor Matthew Cochrane explain what iZettle does, how it's become "the Square of Europe," and why PayPal wanted it so bad. Watch the video find out exactly what iZettle brings to the table for the digital payments giant, and why PayPal investors shouldn't sweat the acquisition price too much.

A full transcript follows the video.

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This video was recorded on May 25, 2018.

Dylan Lewis: Alright, Matt, the legacy payment companies might be turning up the heat a little bit, but PayPal is not going to just sit by and watch. They're getting a little bit more aggressive. Our second news item here is that they went shopping.

Matthew Cochrane: That's correct. Just earlier this week, they actually acquired iZettle for about $2.2 billion in an all-cash deal. That represented about one-third of PayPal's $7.8 billion war chest.

The shortcut to understanding what iZettle does is to call it the Square of Europe. Why is it called the Square of Europe? Well, Square first got on the map by, for small merchants that didn't have the resources to buy expensive hardware to accept card payments -- think food trucks or farmer's markets -- they came up with a simple and elegant design with a dongle that can attach right to a smartphone, and within minutes, that merchant could then start accepting card payments.

Well, remember, Europe switched over to EMV chip credit cards years before the United States did. And iZettle was the first company to come out with a solution that could plug into a smartphone and accept chip card payments. So, they both got on the map with very similar solutions that met the needs of small merchants in their respective markets.

Also, the other day, Global Payments Incorporated, another payment processing company, their CEO was on CNBC right after the acquisition. They asked him, "Are you guys competing with iZettle in Europe?" And he said, "You know what, not really. iZettle goes for the smaller merchants. Global Payments, we're into merchants who make more than $250,000 in sales. iZettle goes for those smaller, almost micro-merchant types." Who does that remind you of? It reminds you of Square.

So, the shortcut to understanding this acquisition is to call it the Square of Europe, which is pretty much what the media has been doing. Last year, iZettle facilitated $6 billion in total payment volume, and they've been increasing their revenue at about a 60% rate since 2015, which is incredible.

Lewis: Yeah. This was not a cheap acquisition for PayPal. They should be generating about $160 million in revenue in 2018. So, they paid a hefty premium for iZettle. The idea here is, it opens up some new business for them, both in terms of business operations and also geography.

Cochrane: Correct. This acquisition was not made to be immediately accretive to PayPal's earnings. In fact, I would not look at this acquisition saying, "Look, oh, my goodness, PayPal paid almost 20X sales for this small European payment processor!" It's a strategic acquisition, for two reasons.

Yesterday, at the investor day, the CFO for PayPal, John Rainey, he was saying, "All of our acquisitions have to have a compelling strategic rationale." And what PayPal believes now is that this gives them the best in class omnichannel offering to merchants to provide payment processing services. They can cross-sell iZettle to PayPal merchants, and vice versa.

The second strategic reason that this makes sense for PayPal is, it gives them an in-store payment processing presence in geographic markets where they really did not have any presence before. That includes Brazil, Denmark, Finland, France, Germany, Italy, Mexico, Netherlands, Norway, Spain and Sweden. This gives PayPal a more global presence. Merchants with a global presence want that, obviously. And, it just makes sense for what they can now offer to a merchant, the payment processing services they can offer to a merchant.

It's a very strategic acquisition. I wouldn't look at it from a numbers perspective.

Lewis: Yeah. If you're getting hung up on the details of the deal here, you look at that $2.2 billion and think about PayPal's overall market cap, it's a tiny, tiny fraction of what the business itself is worth. So, this is very much something that will plug in and be worked into their operations, not something that's immediately accretive.

Dylan Lewis owns shares of PayPal Holdings. Matthew Cochrane owns shares of PayPal Holdings and SQ. The Motley Fool owns shares of and recommends PayPal Holdings and SQ. The Motley Fool has a disclosure policy.