Finance

Michael P. Regan is a Bloomberg Gadfly columnist covering equities and financial services. He has covered stocks for Bloomberg News as a columnist and editor since 2007. He previously worked for the Associated Press.

PayPal Holdings has buried another hatchet

The digital payments company spun off from eBay last year ended another quarrel with a rival, this time Mastercard. 

The tension between the card networks and PayPal stemmed from a turf war staged in the plumbing of the financial system. PayPal had encouraged its 188 million users to fund their accounts by connecting them directly to their banks. That allowed the company to utilize what's known as the Automated Clearing House, which is a much cheaper way to move money through the pipes than the systems run by credit and debit card networks.

No Cash, No Problem
PayPal had almost 190 million active accounts at the end of the second quarter
Source: Bloomberg Intelligence

Much like the armistice reached with Visa in July, the deal means PayPal will no longer encourage users to connect accounts directly to their banks. In return, it means PayPal will be accepted in more brick-and-mortar stores that allow payments from cards by mobile phones. PayPal also receives incentives for increased volume and greater long-term certainty on the fees levied by the card network.

Investors reacted angrily to the deal with Visa when it was announced on July 22, sending the shares down almost 7 percent on concern that profit margins would be eroded by the higher costs of dealing with card networks. The reaction to the Mastercard deal announced Tuesday was much more muted, with the stock little changed. But the shares are still languishing more than 7 percent below where they were before the Visa deal was announced.

Pays to Play
Shares are still languishing below where they were before PayPal settled its dispute with Visa
Source: Bloomberg

It's easy to understand the anxiety stemming from these new relationships among frenemies. PayPal's profit margins on transactions are sure to narrow whenever customers choose to link their accounts to a credit or debit card instead of their banks and the cheaper ACH system.

What's far less certain is the upside for PayPal. Will the increase in transaction volume from brick-and-mortar stores be enough to make up for the lower margins? It depends on several things, including how many merchants decide they want to accept PayPal and how likely consumers are to use the PayPal option when deciding how to pay at a store. 

That said, it seems as if PayPal CEO Dan Schulman is making a wise bet on the future by teaming up with the card networks, even if it risks some dreaded uncertainty in the near term.  

With competition in digital payments coming from all sides, it's hard to see how PayPal would be able to maintain both those high margins and high growth rates for long anyway.  

As Bloomberg Intelligence analyst David Ritter has pointed out, PayPal's transaction revenue as a percentage of volume has already come under pressure -- dropping to 2.88 percent in 2015 from 3.35 percent in 2012. The decline came as PayPal added larger merchants, which demand lower rates, and expanded its Braintree business, which processes all payment types for online merchants including Airbnb, Pinterest and Uber.

Pay Stub
PayPal has been earning less for each dollar of volume that goes through its payment systems.
Source: Bloomberg Intelligence

PayPal's chances of thriving and protecting its market share are bolstered by reducing friction between itself and competitors and becoming more of an integral part of the payments ecosystem rather than trying to be a maverick. The option to use PayPal in more physical stores has the potential to vastly increase users' reliance on it and its sister app, Venmo.  

And the thaw in relations with Visa and Mastercard may bolster the appeal of Braintree as the technology of choice for online merchants looking to accept a variety of payment options. Both Mastercard's Masterpass and Visa Checkout will now be available as payment options for Braintree. 

Sometimes burying the hatchet is the best way to plant new seeds of growth.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Michael P. Regan in New York at mregan12@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net