Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche


PayPal and the Future of Payments

Payment technology is evolving faster than most of us realize. That makes PayPal Holdings (NASDAQ: PYPL) both a tremendous opportunity and an incredible risk from a valuable-investment standpoint.

PayPal is a tremendous opportunity because it has built one of the world’s fastest-growing payment infrastructures. PayPal had 227 million active accounts at the end of 4th Quarter 2017, an increase of 30 million from 197 at the end of 4th Quarter 2016, Statista reported. PayPal is one of the few widely-accepted and trusted brands in an industry that is being disrupted beyond recognition by new technology.

PayPal lacks the political baggage and legacy infrastructure that holds traditional banks back. Yet, it may not be nimble and flexible enough to adopt new payment channels, particularly cryptocurrency and payment apps.

PayPal may have a huge advantage over giants like Visa (NYSE: V) and MasterCard (NYSE: MA) and banks like Capital One (NYSE: COF) because it is not tied to plastic cards. It is not wedded to vast networks that support products like American Express (NYSE: AXP).

PayPal CEO Credit Cards will be dead in 20 years

Interestingly enough PayPal CEO Dan Schulman believes credit cards will not exist 20 years from now.


“Twenty years from now, there will be no more credit cards, really,” Schulman said at the Street’s Investor Boot Camp in New York on 5 May 2018. “Why have them when you can have a QR code or NCR tablet?”

Schulman is not predicting the demise of Visa, MasterCard, or Amex; those brands will exist for generations to come. Instead, he is forecasting the end of the use of plastic cards as a payment mechanism.

Schulman thinks that quick read (QR) code applications like Alipay and Walmart Pay will replace credit and debit cards. A QR code app uses a phone’s camera to scan a printed barcode.

QR code can provide a far higher level of security than plastic because a unique code can be generated for each transaction. An advantage to that is the system can be changed and updated quickly to deal with new security threats.

One has to wonder if PayPal is about to bring out a QR code solution. Alphabet (NASDAQ: GOOG) and the National Payments Corporation of India are testing a QR code-based payment called Google Tez. PayPal would be well-advised to bring out something like Tez before Alphabet brings Tez to America.

America’s largest retailer; Walmart Stores Inc. (NYSE: WMT) accepts QR-code based wallets and offers its own QR-code app called Walmart Pay. One reason for PayPal to offer a QR code solution would be to get its payments accepted at Walmart.

Is PayPal Making Money?

Okay, so PayPal is up on the technology, but value investors will ask is it making money? The answer to that question is yes, it is.

PayPal generated a gross profit of $1.754 billion for 1st Quarter 2018, down slightly from $2.071 billion in 4th Quarter 2017, but up from $1.371 billion in 1st Quarter 2017, Stockrow data indicates. PayPal was able to generate an operating income of $534 million and a net income of $511 million from that gross profit.

PayPal’s business fell slightly in 1st Quarter 2018; the company reported $3.685 billion in revenues, down from $3.774 billion in 4th Quarter 2017. That was a substantial increase over $2.975 billion in 1st Quarter 2017.

Disturbingly, PayPal has reported a negative free cash flow for the past two quarters. The company reported -$527 million in free cash in 1st Quarter 2018 and -$327 million for 4th Quarter 2017. That contrasts sharply with $603 million for 1st Quarter 2017 and $771 million for 4th Quarter 2016.

Is PayPal Losing Money?

It looks as if some of PayPal’s investment in infrastructure is not paying off. PayPal also appears to be losing money off of operations. It reported a negative operating cash flow of -$349 million for 1st Quarter 2018 and -$147 million for 4th Quarter 2017. Those numbers $751 million in 1st Quarter 2017 and $923 million in 4th Quarter 2016.

PayPal’s business looks far less profitable than it was just last year. The cause of those negative numbers is not apparent yet, but a likely cause is an expansion of lending.

Despite the negative cash flow numbers, PayPal still has a lot of cash. It reported $14.22 billion in cash and short-term investments on March 31, 2018. That was nearly $5 billion more than the $9.049 billion it reported a year earlier.

PayPal is still a cash-rich business but it faces some serious threats. Staving off new competitors will cost a lot of money.

The Threats to PayPal

So what are the threats to PayPal and how serious are they? They are many, and some of them are not apparent to investors.

The greatest threats to PayPal:

  1. Central Banks. The biggest danger to PayPal is that Central Banks will launch their own payment solutions in direct competition with it. This is already occurring in India where the National Payments of Corporation of India; which is part of the Reserve Bank of India, is operating a payment system called the United Payments Interface (UPI). Alphabet’s QR-code based payment app, Google Tez is supported by the UPI.


PayPal might be shut out of markets by central banks like the People’s Bank of China (PBOC), or find itself competing with banks like the Federal Reserve. Something to remember is the paper money was developed by private banks and appropriated by central banks. The appropriation of electronic payments networks by central banks is beginning in countries like China and India, and it is likely to spread around the world.

The Ebay Inc. Venmo application (app) is arranged for a photograph on an Apple Inc. iPhone 5s in Washington, D.C., U.S., on Friday, Aug. 22, 2014. After downloading the Venmo mobile-payment app onto a smartphone, users can connect them to bank and credit-card accounts, and then link up with friends to send and receive money on-the-go. Venmo, based in New York, alone handled $314 million in mobile payments in the first quarter of this year, up 62 percent from the prior quarter. Photographer: Andrew Harrer/Bloomberg via Getty Images
  1. Proprietary payment solutions offered by retailers. The biggest menace here is Amazon Pay but Walmart Pay is also problematic. A major threat to PayPal would be retailers offering discounts, free shipping, store credit; or rewards points, for customers that switched to their QR-code payment solutions. American retailers like Kroger already reward customers that use their credit card brands with rewards points and discounts.


  1. Payment solutions with deep-pocketed backers. The biggest menaces are China’s Ant Financial; which owns Alipay and is backed by Alibaba (NYSE: BABA) and WeChat Pay, which is backed by Tencent Holdings (HKG: 0700). A huge problem for PayPal would be Walmart Pay or Amazon Pay growing as popular, and as big, in the United States as WeChat and Alipay are in China.


  • WeChat Pay 963 million users in 2nd Quarter 2017, up from 806 million 2nd Quarter 2016, Statista calculated.


  • Alipay had 731.25 million users in China alone in 2017 according to Statista.


  • Both Alipay and WeChat Pay have entered the North American market.

  1. Large banks. The monster banks’ efforts in peer-to-peer (P2P) payment and similar tech have been a flop, but they have lots of money and vast resources and they keep trying. The best threat to PayPal here is JPMorgan Chase (NYSE: JPM) which is slowly ramping up and quietly rolling out its Chase Pay QR code product.


  1. New players with disruptive technologies. The biggest potential menace here is cryptocurrency where a wide variety of players including; Ripple (XRP), the Bancor Network (BNT), RCN (RCN), the Request Network (REQ), TenX, Nebeus, BABB (BAX), SALT (SALT), Celsius, and BitMinutes, are working on consumer-finance solutions. None of them are close to deployment, but the potential for disruption is vast.


  1. The greatest menace is a blockchain-based cryptocurrency solution that has the backing of a major central bank. Several central banks; including the PBOC and the Bank of England are experimenting with blockchain and cryptocurrency but have revealed details of their efforts. Something investors and PayPal need to watch for is a well-financed blockchain platform that is actually a front for one of the central banks. A candidate for such a product is BABB which promotes itself as a “central-bank issued cryptocurrency.”

PayPal has a bright future but that future is fraught with peril. Despite all the threats, PayPal is still a good value investment in the payments sphere because it is still the gold standard in payment technology infrastructure. PYPL is still a worthy addition to a cutting-edge value-stock portfolio.