How Did PayPal Score Record Margins While Their Customers Went Bankrupt?

Payments processing has gotten extremely popular in investment communities because, well, what’s not to love?

• Zero COGS
• Guaranteed demand: merchants must take cards from someone
• First claim to money: paid immediately on every swipe, even if customer goes bankrupt
• Infinite upside: customers have no idea how pricing works so you can invent whatever fees necessary for growth

And now they get to add a new one to this list:

• Pandemic resistant

The below from Paypal’s CEO Dan Schulman on their latest earnings call:

Revenues grew by 25% on an FX-neutral basis to $5.26 billion, accelerating after our strong 20% revenue growth in April. This is the first time our quarterly revenues have exceeded $5 billion. Due to the strength of our PayPal branded transactions our non-GAAP operating margin increased by a record 500-basis-points to 28% this quarter.

Dan Schulman, PayPal CEO

Virtually all the acquirers beat earnings expectations, which were lowered due to the pandemic. Still, the real tailwind here is how acquiring works.

Card Not Present Margin Bonanza

As consumers nearly exclusively shopped off premises, merchants were being charged card not present fees. Look no further than Toast POS to see how much margin acquirers bake into this type of consumer behavior:

Card not present, which Toast terms “keyed”, is virtually all of the card volume anymore. Quoting our previous article

We’ll start by giving Toast the most favorable comparison possible. The most expensive Visa card is a business card at 2.95% and $0.20 per swipe. The difference between Toast’s keyed fee is thus 0.55% and -$0.05 per swipe…

The difference between Toast’s card-present Amex fee (3.29% and $0.15 per swipe) and the highest possible Amex category for on-premises restaurant (2.75% and $0.10 per swipe) is a difference of 0.54% and $0.05 per swipe. 

ReformingRetail

Even if transaction volume declines, companies like PayPal stand to make more money. Further, with cash in retreat, card transactions are cannibalizing fee-free transactions that previously came from other tender types, only bolstering payments margins.

Debit Card Pay Day

It’s amazing that you can be a sitting legislator, pass laws, and have no idea how the markets work. But that’s what Dick Durbin has done with his Durbin amendment. There are three parties involved in every card transaction:

1. The bank who issued the card (Bank of America, etc)
2. The card network (Visa, etc)
3. The acquirer (First Data, etc)

The bulk of the fees go to the issuing bank (who has to spend considerable money competing for consumers and paying for points, which is increasingly a loser business model) and the acquirer (who often adds fake fees to make more money for doing nothing). The card networks make very little on each transaction, relatively speaking. A decent rule of thumb is 1.5% for the issuing bank, 1.5% for the acquirer, 0.2% for the network.

Dick Durbin didn’t understand that. His amendment lowered the interchange fees on debit cards charged by the card networks. Sounds great in principle, but the acquirers didn’t give two shits: they just charged the merchants the same amount as before and kept whatever savings might have been had by lower network fees for themselves.

In other words, merchants saw no benefit.

With that as background, it matters because COVID is pushing more people to use debit cards over credit cards. This becomes a new profit stream for acquirers like PayPal, thus boosting margins without doing anything.

#Valueadd

Without access to PayPal’s full financials we don’t know precisely the magnitude of this benefit, but we’re confident this undoubtedly played into the hands of acquirers this last quarter, and it’s a growing trend to watch. Without transparency, this will only continue.