PayPal Isn't Letting Its Visa and MasterCard Deals Bring It Down

Image source: PayPal.

Investors punished PayPal (NASDAQ: PYPL) after it separately announced partnerships with Visa (NYSE: V) and MasterCard (NYSE: MA) earlier this year. Most feared that the deals would negatively affect PayPal's margins as more of its transactions are made with credit cards instead of less-expensive direct transfers from customers' bank accounts.

But with the release of its third-quarter results on Oct. 20, PayPal indicated that it expects both revenue and margins to improve over the next three years. It now expects 16% to 17% revenue growth per year over the next three years, compared with guidance of 15% it provided in May. What's more, it still expects "stable to growing" operating margin.

While management expects an increase in credit card transactions to have a negative impact on margins, it plans to more than make up for it in other ways. Let's take a look at how.

Cutting costs

One area where PayPal will benefit from making it easier to fund purchases with whichever payment type customers prefer is that fewer customers will need to call customer service. On the company's earnings call, CEO Dan Schulman noted that a large percentage of the calls to its service center are focused on funding type. The new deals with Visa and MasterCard drastically reduce the need for those types of calls.

PayPal is already noticing some efficiencies in its customer service expenditures. PayPal's customer support and operations expense increased 14% year over year last quarter, while revenue increased 18%.

That was one of the few areas where PayPal saw margin improvements, however, as non-GAAP operating margin declined 150 basis points to 18.4%. One of the biggest factors was an increase in PayPal's transaction expenses. During the earnings call, management noted that the drivers of that growth mainly stemmed from a mix shift to mobile-payments service Braintree, partially offset by Xoom in its international remittance business.

As Braintree and credit card transactions grow as a percentage of total payment volume, PayPal will have to find operational efficiencies elsewhere. Its third-quarter results show that it's capable of cutting costs in other areas, but it still saw a decline in operating margin. It will have to do a better job controlling costs going forward to meet its outlook.

Growing revenue might be more important

During the company's earnings call, management noted that the Visa and MasterCard deals won't have a significant impact on revenue next year. That's not to say the deals won't provide long-term opportunities for revenue growth from in-store transactions and integration with its Braintree properties. Still, PayPal's biggest opportunities for revenue growth come from taking matters into its own hands.

Management held up One Touch as an example of a new product it introduced that's improving engagement and providing incremental lift to transaction volume. One Touch allows users to remain securely logged in to PayPal for up to six months, removing the need to provide login information every time a user wants to make a purchase. PayPal boasts 32 million active users and 4 million merchant accounts using One Touch.

Xoom provides another opportunity to grow its revenue. PayPal continues to innovate around the remittance service. Most recently, it integrated it with PayPal, allowing customers to link their accounts. Additionally, it's still expanding the number of countries customers can send funds to.

While Xoom's operating margins are below the company's overall margins, management says there's a lot of leverage in its operations. So as Xoom grows revenue and becomes a larger part of PayPal's business, it will see improving margins.

The improved outlook from PayPal for its revenue growth is a great sign. It indicates that the short-term impact from customers choosing to pay more often with credit cards will be somewhere between practically nonexistent and extremely muted. Long-term, it could have significant benefits to growing its business.

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Adam Levy has no position in any stocks mentioned. The Motley Fool owns shares of and recommends MasterCard, PayPal Holdings, and Visa. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.