Square vs. PayPal: Can David Beat Goliath?

By Evan Niu, CFAFool.com

Image source: PayPal.

Square has now filed its S-1 Registration Statement with the SEC, laying the initial groundwork for the long road that is becoming a publicly traded company. Just months ago, PayPal was spun off as an independent entity and as such will be better able to focus on its massive payments platform. PayPal is much larger than Square, which underscores the challenges that Square will inevitably face in the years ahead as it competes with a dramatically larger, better-funded, and more experienced rival.

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David vs. GoliathLet's start by comparing some pertinent metrics for both Square and PayPal for context on each company's scale.

Source: SEC filings. TTM = trailing 12 months. MRQ = most recent quarter.

Let's note a quick distinction with that last data point. Square's and PayPal's platforms are fundamentally different in a few ways. Square only requires sellers to register, and then they can accept payment from any buyer with a credit card. PayPal has historically required users to sign up for an account in order to access a wide array of services. For this reason, Square's seller account figure isn't directly comparable to PayPal's customer account figure.

PayPal keeps more for itselfI recently calculated Square's spread (the difference between what it collects on transactions and the costs directly related to processing transactions) as ranging between 1.04% and 1.08% over the past three years. For 2014, Square took a 2.98% cut on average of all transactions and paid out 1.9% in transaction expenses, keeping 1.08% for itself.

Since PayPal was just recently spun off, there is less data available since eBay didn't provide this level of detail when PayPal was a subsidiary. But now investors can perform a similar exercise, at least for one quarter's worth of data.

Source: PayPal 10-Q.

This means that PayPal's net spread after everything is said and done is nearly twice that of Square's. The amount that each company collects is quite comparable, in the ballpark of 3%. This makes sense since their fee structures are fairly similar. PayPal Here costs 2.7% per swipe, Square costs 2.75% per swipe, and both companies have the same rate for card-not-present transactions (3.5% + 15 cents). PayPal's regular money transfer service costs 2.9% plus 30 cents.

It's on the expense side of the equation that PayPal really flexes its muscles compared to Square. PayPal's 0.94% expense rate crushes Square's 1.9%. This is where PayPal's larger scale and operating leverage come into play. Since PayPal has processed almost 9 times as much in total payments volume over the past year, it can scale better and spread those costs out efficiently.

While Square is putting up much higher growth rates than PayPal in terms of payments volume, the smaller payment processor still has a long way to go before it can catch up in scale, cost efficiency, and global reach.

The article Square vs. PayPal: Can David Beat Goliath? originally appeared on Fool.com.

Evan Niu, CFA has no position in any stocks mentioned. The Motley Fool owns shares of and recommends eBay and PayPal Holdings. 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.

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