For PayPal, the Choice Is Clear

When PayPal Holdings Inc. (NASDAQ: PYPL) reported its fourth-quarter earnings three months ago, the only thing investors seemed able to focus on was that PayPal's relationship with eBay would be drastically changing after its contract expired in 2020. Despite PayPal management's assurance that this change in relationship would not affect its mid- or long-term guidance, analysts still seemed to have a hard time digesting the news. The day the company reported its fourth-quarter earnings, PayPal's shares sank by a double-digit percentage and they have largely been trading sideways since.

Lost in the eBay news was that the rest of Paypal's results were positively glowing: Net revenue, adjusted earnings, and payment transactions all grew well north of 20% year over year.

When the company recently reported its first-quarter earnings, the strong growth continued; this time, there were no storm clouds overshadowing the results. Net revenue grew to $3.69 billion, a 24% increase year over year, while adjusted earnings per share rose to $0.57, a 29% increase year over year. The strong top- and bottom-line growth figures during the quarter were driven by a 15% increase in active customer accounts to 237 million, and a 25% increase in the number of payment transactions to 2.2 billion. Best of all, PayPal account holders are using their accounts more than ever before: Payment transactions per active account rose to 34.7, an 8% increase year over year.

Metric Q1 2018 Q1 2017 Year-Over-Year Change
Net revenue $3.69 billion $2.98 billion 24%
Adjusted earnings per share $0.57 $0.44 29%
Active accounts 237 million 205 million 15%
Payment transactions 2.2 billion 1.8 billion 25%

What is driving this robust user growth and engagement? While there are several factors contributing to PayPal's success, the one that stands out the most, after reviewing the company's first-quarter conference call, is its Customer Choice initiative. Let's take a closer look at how offering its account holders more choice has driven growth for the digital payments platform.

When the choice is clear

Since being spun off from eBay in the summer of 2015, PayPal has announced dozens of partnerships with credit card networks, banks, and larger tech companies. These agreements benefit everyone involved, especially the account holders -- who can then use PayPal's platform in the ways that best suit them. Typically, these deals enable customers to use their own credit card's reward points on PayPal's platform, opening up a world of options for use of these rewards at merchants that were not previously available. For instance, earlier this year, JPMorgan Chase introduced PayPal as a quarterly rewards category for its popular Freedom credit card.

PayPal's Customer Choice initiative allows consumers to easily pick which credit or debit card they want to use for each transaction, and it includes tokenization, which empowers offline and more-secure transactions.

Since pushing customer choice options, PayPal CEO Dan Schulman says customer acquisition is up and overall churn is down, both reflected in PayPal's strong active user account growth. But it's not just PayPal's customers who love the increased options; the company's partners also seem enthusiastic about the new opportunities it offers them. In the conference call, Schulman said there has been a noticeable shift from the "uneasy frenemy environment" of two years ago to one in which its partners now see themselves as "close allies in ... the war on cash and the advancement of digitization."

The benefits of partnerships

When PayPal first began announcing its partnerships in late 2016, one of the primary concerns was that they would adversely affect the company's margins. More than a year into this strategy, that no longer seems to be a concern. In the first quarter, for example, PayPal reported an operating margin of 22.5%, the highest margin it has ever achieved as an independent company. While many factors drove this expansion, one is that the company's partners have provided low-cost means of acquiring new customers. In the conference call, chief operating officer Bill Ready said:

Energized by enthusiasm for the digital gateway to growth offered by PayPal, its partners are pushing customers in PayPal's direction, making it easier than ever for consumers to sign on to the platform. This quarter, Bank of America Corp. (NYSE: BAC) introduced a streamlined option for its account holders to sign up for a PayPal account on its mobile and online channels.

Choice goes international

Nor is it only domestic partners embracing PayPal's Choice strategy: This quarter, the company announced a host of new partners from around the world. Schulman said: "We expanded the global rollout of Choice by launching in China and nine additional countries across Southeast Asia, and further expand[ed] into Europe by launching in France, Germany, Italy, and Spain."

In Kenya, 28 million consumers can now seamlessly integrate their M-Pesa accounts with PayPal. In Spain, CaixaBank and Bankia both further integrated their online sites with PayPal. HSBC Holdings PLC (NYSE: HSBC) now allows corporate customers in the U.K. to pay distributions to beneficiaries through PayPal, a capability to be rolled out across Europe in the coming months. Barclays PLC (NYSE: BCS) announced a strategic partnership that enables its customers to more easily link their accounts to PayPal, and soon to use their reward points on PayPal's digital platform.

Choice is driving PayPal's network effect

With a growing line of ready and willing partners, PayPal is having no problem growing its ranks of active account holders. Deals with outside financial institutions and tech partners also make it easier for PayPal's existing customers to increase their engagement with the platform. The more PayPal's ranks grow, the more attractive the platform becomes to additional partners and merchants. This type of growth soon begins to drive itself, creating one of the more powerful economic moats: the network effect.

Since being spun off from eBay almost three years ago, PayPal has trounced the S&P 500 index, returning about 108% to the index's 29%. With top- and bottom-line growth still going strong and fed by PayPal's growing network effect, I don't believe PayPal's market-beating days are even close to being finished.

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Matthew Cochrane owns shares of JPMorgan Chase and PayPal Holdings. The Motley Fool owns shares of and recommends PayPal Holdings. The Motley Fool recommends eBay. The Motley Fool has a disclosure policy.