Motley Fool Money - PayPal's Growth Story

Episode Date: June 20, 2023

DraftKings wants to consolidate the sports betting market, but it still has a long road to profitability. (00:14) Ricky Mulvey and Nick Sciple discuss:-PayPal selling off more than $40 billion of buy now, pay later loans. -The payment processor's capital allocation strategy. -The DraftKings bid to buy a rival operator. -Why sports betting companies have a customer stickiness problem. Plus, (12:20) Alison Southwick and Robert Brokamp answer listener questions about 401(k)s, investing, and cash management. Companies/tickers mentioned: PYPL, KKR, AFRM, DKNG, TQQQ "Women Power Rule Breakers - A Sparks Conversation" event registration https://fool.zoom.us/webinar/register/WN_BbdTqNGmQXKbWOx_zlb7bw#/registration Host: Ricky Mulvey Guests: Nick Sciple, Alison Southwick, Robert Brokamp Engineers: Tim Sparks, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

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PayPal sheds assets while Draft Kings doubles down. You're listening to Motley Full Money. I'm Ricky Mulvey. Joining us now is Nick Seiple. Nick, good to see you. Great to be back here with you, Ricky. So private equity firm KKR is purchasing up to 40 billion euros of PayPal's Buy Now Pay Later Loans in Europe. PayPal's doing this spinoff to a private equity giant. Why are they getting rid of this growth story for them? Long story short, the Buy Now Pay Later segment just grew too big, too fast for the company. PayPal has said in recent years that it's going to remain an asset light company and that it would sell its credit portfolio if and when the balance sheet became

credit heavy because of the growth of some of these assets. You look back to 2016, sold its consumer credit portfolio to Synchronic for about $7 billion. Think about that. That's credit cards, things like that. This year selling off its Buy Now Pay Later business. Really seen incredible growth process, more than $20 billion in Buy Now Pay Later volume, Global. last year up 160% from 2021 for context. That's bigger than a firm who actually, that's all they do is buy now, pay later. So just incredible growth for PayPal and it became a weight on the balance sheet. They wanted to take off. There's probably a macro indicator story in there as well, Nick. Gabrielle Rabinovich is the acting chief financial officer of PayPal and says that this deal will

quote, accelerate our PayPal pay later originations alongside market demand in Europe. Europe while preserving free cash flow for other strategic initiatives. This transaction is yet another example of our disciplined approach to capital allocation. Nick, do you agree with her? PayPal is using a lot of these proceeds to buyback shares. Sure, yeah. And maybe underline that for your previous guidance had called for $4 billion in share buybacks, now bumping that up to $5 billion.

I do agree with her. I think PayPal is great at being a consumer portal, really linking their dedicated users to all the payment solutions. may not need. Not necessarily great at being a bank. We saw that why they sold off their assets to synchrony before by using its capital to really spin up this business. It's created value, but again, this is not the core offering of the business. Actually, you could argue by linking up with KKR and their ability to underwrite some of these. You could grow even faster, originate more on the buy now, pay later side, not having to take on the capital requirements there yourself.

Now, without the need to use cash to fund this part of the business, they've got more cash available. If you look at the stock today, Non-GAP, EPS guidance calls for 20% growth. This year, the stock trades at about a 14x forward multiple price to earnings. This is not a super expensive stock today. It's also not a capital-intensive business. We shouldn't want it to be. So I'm excited to see them take some of this cash, put it towards share buybacks instead of becoming a much bigger banking business.

Yeah, you referenced earning growths, but revenue growth for PayPal seems to be a little bit harder to find its expectations for this year. about 7, 7.5%. A lot of Wall Street investors kind of booed those projections. Should shareholders be rooting for PayPal to become this stock buyback machine? Sure. I think that would be at today's prices. It's an attractive place to be buying PayPal stock. Five billion dollars in share repurchases gets you about six and a half percent of shares outstanding. If you want to take into account stock-based comp, probably closer to four and a half percent of shares getting retired. If you just want to talk about, you know,

low to mid single digit sharebacks on an annual basis and just low double digit earnings growth. You could look at a company that doubles over the next five years without multiple expansion. I'm a dedicated PayPal user. I think there's lots of other folks on the platform. While there is some concern about slowing accounts growth on the platform, I think there's lots of ability to attach additional services to those users and continue to grow earnings year over year. I think an example of that is what we've seen with Buy Now Pay later the past few years.

I want to stay on private equity for a sec because they seem to have their own debt problems. Many private equity firms have financed buyouts over the low interest rate era with this floating rate debt and they didn't really hedge it firms like KKR. Now there's $3 trillion of that floating rate debt out there. What are the consequences of this? It means finance costs are going up is really the short answer. Flooding rate simply means that the rate you're paying on your loan increases as rates go up over time, been well documented over the past year.

or so, the Federal Reserve's activities, increasing interest rates. You've got folks that might have been paying three or four percent interest two years ago, paying seven or eight percent today with your underlying payment just to support debt service up more than double, some real concerns for the business. You need to find some way to make up that cash difference or eat it in your margin. Let's move on to a gambling battle that's heating up. The sports betting company, Draft Kings, submitted in all-cash offer of about $200 million to buy PointsBets U.S. assets. PointsBet is the the seventh largest sports betting operator in the U.S. Set the table, Nick. Why does Draft

Kings want this operation? Well, I mean, Draft Kings arguably would like to own every sports betting operation in the U.S. if it could. But I think the real strategic goal is to make customer acquisition costs as high as possible for competitors and hopefully limit the pool of folks participating in the industry. If you think about online gambling, the business model, it's really a lifetime value to customer acquisition cost business. How much does it cost to bring in a new customer versus how much are they going to spend overtime in the case of these gambling business? How much are they going to lose back to you over time? If you get bigger scale in the case of Draft Kings, buying

points bet, you can run higher scale ads, larger, arguably national ads. Also on the other side of things, if there are more competitors in the market for folks to switch to, arguably you're going to have a lower lifetime value out there because all those folks are trying to acquire your customers as well. In Draft King's case, if Fanatics wins this deal, you now have a new entrant, a well-funded new entrant coming into the market, likely going to force their marketing spending up and maybe bring down lifetime values. You think about this as an industry that looked like it had stabilized over the past few years in the hands of just a handful of companies, your Draft Kings, your fan duels, your MGMs. If another competitor

comes into the market, maybe reignites this competitive spending. a spree that we've seen them past few years. In Draft King's case, maybe they think it's better to spend $200 million now in one chunk than to have a new entrant come in and get milked for that $200 million in increased marketing spend over the next several years. Even if they don't win up the deal by increasing Fanatics cost, that just takes that much more cash out of their war chest to go spend on marketing. Yeah.

So Fanatics is the other bidder for this points bet operation. What's their beef with Draft Kings over the offer? seems kind of like a consequence of just regular old capitalism that you have multiple bidders on an asset. Well, Draft Kings has done similar things in the past. I think it was a couple years ago. Maybe last year, they put out a bid to acquire Entain for $22 billion. Intane is the partner with MGM on their bed MGM app.

Draft Kings ended up pulling that offer back, not actually following through on the deal. So maybe suggests that argument of pushing prices up, but also just on the side of Fanatics, A, they don't want to pay up higher price, but B, they've been wanting to enter this market for quite a while, and there aren't really a ton of other attractive assets out there. You mentioned this is the number seven player on the market. I don't think one through six are that excited to sell today either. They've been hinting it in-inning, entering sports gambling for quite a while. You can argue it's synergistic with their existing business background on Fanatics.

Really the biggest sports licensor out there, partnerships with all the major sports leagues, NBA, NHL, etc. Michael Rubin, the founder, sold his stake in the 76ers back in October. A lot of the commentary around that suggested this was heading up to a move into sports betting. It's a conflict of interest owning a team and also being involved in sports gambling. So you've seen Michael Rubin sell a really important asset to him to get into the space. Key to the strategy also looks like they want to IPO soon. They held an investor day earlier this month.

If this is key to your strategy, a story you've been telling for a number of years and you'd like to go public, It wouldn't be great to have that derailed at this point. That's it. On the Draft King side, this is a company, though, while it has a lot of market share, it's still solidly unprofitable. It's running about a $1.5 billion operating loss on about $2.2 billion in income over the past 12 months. It's also spending a lot more on servicing debt.

So Draft Kings is spending all cash to acquire this company. Can it even afford points bet? Well, that depends on. on your answers to those customer acquisition costs versus lifetime value questions we marked earlier on really depends on customer behavior. If you believe that the competitive intensity, we've seen all this spending trying to do a land grab in sports betting is going to level off here in the next couple of years, this is the last big deal out there. You could tell a story where this is all just about getting to scale and we're going to come out of the tunnel here in the next couple years.

But it really all depends on customer behavior. A lot of money being spent upfront acquiring customers on an uncertain lifetime value over a long period of time. I will say this. Whoever owns the online sports betting market is not going to go away. I think it's probably going to be bigger five and 10 years from now than it is today. There is questions on whether the companies own the market today are going to have the profits to get to that bright future. I mean, I see the growth story. The narrative I've been telling myself, though, is that this is an industry. where there are no switching costs, and in fact, there are switching incentives.

So, it's really tough to build those sticky relationships with customers. I mean, is that enough of a reason for regular investors to just stay away from the industry? I mean, I think so. If you think about game theory, the prisoner's dilemma where if everybody gets along, it's better for everybody else. But the gains of being that person who goes and acquires customers and everybody else isn't spending really leads to a lot of irrational behavior from the overall market. The question is, when does that behavior go away?

You really need to see the market stabilized right now. Looks like we're still likely to see some more entrants from Fanatic. For me, I'm not exactly excited about owning the sports gambling profit pool today. I am very excited about owning the sports gambling marketing line items. I think about WWE is a company that has a relationship with Draft Kings. Lots of media companies out there. That's pure profit for some of these out there on the market. So worth following for that, for that.

But I think today, profits still still still. something relatively far in the future of these companies. I think this potential deal also has to be drawing some regulatory scrutiny. This is a newly legal industry for states, basically, besides Nevada. And Draft Kings is already one of the top sports betting operators in the industry. Yeah, I mean, Draft Kings still, you'd probably be looking at maybe a third of the market after this deal. Point Spet owns a low single digit percentage of the market.

However, in their response to the draft Kings offer, one of the things they mentioned about why they might prefer, the points. the fanatics offer is concerns about having to get through the regulatory hurdles, concerns that antitrust folks might want to block the deal. And actually, they want some real assurances from Draft Kings that they will go, you know, the legal term is, you know, hell or high water, that they want a hell or high water provision saying, no matter what happens, you're going to follow through on this deal. And you know, you asked me earlier, you know, as Draft Kings, or we talked about earlier

whether Draft Kings might be serious about making this transaction follow through. If they're willing to add that hell or high water provision, maybe they are. If not, then maybe this is trying to push the price up. Time will tell. Nick Seiple. Thank you for your time and your insight. Thank you. You've got questions.

They've got answers. Allison Southwick and Robert Brokamp tackle your questions about 401K's insurance and leveraged investing. Our first question comes from Eric. I'm a 28-year-old currently making around $140,000 in New York City. My current employer does not offer a 401K match. After seeing the change in my tax bill this past year, I deeply regret not making contributions toward a retirement account. My question is, am I better off contributing to my existing 401k account for my previous

employers with no company match or is it more beneficial to open up an IRA and make contributions there? Well, Eric, I'm not completely clear on your situation, so I'm going to go on a couple scenarios here. First of all, you talk about contributing to your 401k's with your previous employers, and that is not possible. Once you leave a company, you can no longer contribute to the 401K. You can leave it there, generally speaking, although they might force you out, but you

can no longer contribute to it. So if you have a 401K with no match and you want a tax break, and I can understand why, because you're in the 24% federal bracket, and then you add another 10% for New York State and City. So you would probably still go with your 401K at work. That way you can contribute to the traditional 401K and get the tax deduction. If you don't have a 401k at work, then your option is the IRA because you're not covered by a retirement plan, contributions to the traditional IRA are deductible. If you are covered by a plan at work and you wanted to contribute to a traditional IRA,

you couldn't deduct it. The only reason way you can deduct contribution to a traditional IRA is if you don't have a plan at work or if you do, you make under a certain amount of limit and you make too much. So just to recap, if you are looking for the tax deduction and you have a 401k at work, that's the one to go with. If you don't, go with the IRA. Unfortunately, the IRA has a much lower contribution limit, but that's your best option. Next question comes from Rob.

I am a huge fan of your show. Oh, thanks, Rob. You have taught me so much about investing and have really set me on a path to success. What are your thoughts on long-term investments in leveraged funds, such as the pro-shares ultra-pro-QQQQ-Q-Q. T-QQQ-Q. My logic is that on average these funds go up and to the right. Obviously, there are down markets and a leverage fund would go down significantly in these time periods. But why wouldn't I want to invest in a leverage fund if I have a long-term horizon? Appreciate your thoughts and insight. You guys are the best. Aw, bro, you're the best.

No, you're the best, Allison. You're right. And Rob's the best because he sent us a question. So thank you, Rob. Oh, yeah, thank you, Rob. And so these leverage funds aim to provide, depending on the one, two to three times the performance of an index. In the case, this is an ETF. It's called the TQQQQ because it wants to provide triple the return of the QQQQ.

Cute. Very cute. KQQ being, of course, the NASDAQ 100 ETF, which I think is like the fifth biggest in the world. But here's the deal about these. Like, you have to understand how the return is calculated. And here's a quote straight from the pro-shares' ultra-pro QQQ, QQ, 6 daily investment returns before fees and expenses that correspond to three times the daily performance of the NASDAQ 100 index. So it's trying to triple the performance of the daily performance. And when you look at how that works over longer time periods, the return aren't going to be exactly what you might expect.

So, consider that the last 10 years have been a great time to be investing in the NASDAQ and tech stocks in particular. Yes, the QQQQ is down 33% last year, but over the past decade, this ETF has posted an annual return of 19% a year, according to Morningstar. So that's pretty amazing. So you'd think triple QQQ would be returning about 57%, because you'd do three times that. But actually, no, it's just, and I do emphasize just, it was just 40% a year. And yes, that is a fantastic return. But it's not going to get quite the return you thought. And as Rob points out, the downside is also amplified.

So while the QQQQQ was down 33% last year, this triple Q was down 79%. Or even in 2018, when the QQQQQQ was only down 0.1%, this triple QQQQQ was down almost 20%. And here you have to sort of understand how the mathematics of loss works, right? If you're down 80%, it's not like if you get another 80% upwards, you're back to break even. You need to earn 400% just to get back to where you were. And if you had this, this, this, this, this QQQQ, Q, I'm going to get sure I got all the cues there, did not exist during the dot-com crash of 2000 to 2002. But if it did, it would have been wiped out because you had three straight years of the NASDAQ going down 20 to 40%.

So the bottom line for these types of ETS, this one or the ones that follow the SAB 500 or other indexes is. During a long bull market, or just a regular bull market, that has only minor hiccups, the returns will be very attractive. But all it takes is a string of two to three bad years to almost completely wipe them out. Next question comes from Morrow. It's so nice to say, so long, to a bear market. I bought up some ETFs and tech stocks while they got slammed. I'm in retirement and feel comfortable with the amount of cash I have saved up about two-ish years. Do you have any general advice on rotating out of investment during bull markets so you can buy during the next bear market?

Yes, as Maro points out, that we are technically back to a bull market, which is very nice. So if you had put some cash to work in the summer or fall of 2022, you're looking pretty good right now. So to answer his question, I'd say you start with deciding how much you want to keep out of the market as cash to use opportunistically. here at The Fool, we often talk about having maybe 5 to 10% in cash as what we call like dry powder. So let's say you choose 10%, right? And if your stocks do well so that they grow to be a bigger part of your portfolio, and thus your cash portion will actually shrink as a percentage of your portfolio, that's a hint to maybe

sell some stocks. So maybe if you choose 10%, your cash is shrunk to maybe 5%, because your stocks have done so well, that might be a time to sell some of your stocks. Another thing you could do is just not reinvest your dividends. Let those accumulate as cash that you then use opportunistically. Of course, many of your stocks, especially since Marl pointed out that he bought tech stocks, they don't pay dividends. So maybe once a year you just sell little pieces of them to sort of create your own dividend. And since Morrow's retired, I assume he's doing that anyhow every year, right?

He's selling the stocks a little bit to pay his bills. Maybe he sells a little bit more to build up his dry powder. Now, for those who are still working, what you're doing, what you're doing, you could do is gradually build up your cash with each additional contribution to your 401k and your IRA. So besides using this money to buy stocks when they're down, this is also a great way to sort of gradually de-risk your portfolio once you're within maybe five to ten years of retirement. Next question comes from Skippy. Allison and Bro! Exclamation point. Huge fan of yours. You two are my favorite part of the Motley Fool experience. We won't tell everyone else. There's some nice praise in here.

Yeah. Thank you both for your advice over the years. All right. When switching employers, one has the option to transfer the Roth 401k into the new company's 401k plan or into a Roth IRA. I contacted Schwab about this and they confirm trustee to trustee and that the transfer rollover would not count against yearly contributions. I have two questions. One, why would someone not want to roll over the Roth 401k to a Roth IRA as the IRA gives much more flexibility in investing? And two, are there other opportunities to transfer money from a 401k to an IRA? If so, should more people explore that option? Well, Skippy's right that when you change jobs, you generally can roll your old 401k into the new 401k, but only if your new 401k accepts rollovers.

So most do, but not all of them do. And you can't roll over Roth assets if the new 401K doesn't offer Roth accounts. Most do nowadays, but not all, for example, according to a recent report from Vanguard, about 20% of the plans that they administer still don't offer Roth contributions. And yes, when you transfer money from one retirement account to another, it has no effect whatsoever on your contributions limits. It's not considered a contribution. Skipy's also right that an IRA generally has more investment options and lower costs. So my wife is a professor in her colleges are actually switching their retirement plans this summer. I was reading through the material over the weekend, and they found that the plan charges 0.2% every year,

and that's actually lower than the current expense. So not a big deal, but why pay that if you can just transfer the money to an IRA and avoid that cost? So, yes, generally speaking, I recommend that people, when you can, you move money from your employer account to an IRA. The main reason to stay with the plan is if it has investments that are not available outside of the plan, or maybe at price is not available to individual investors. So just as an example, I'm on a member of the Fools 401K Committee, and we recently added a money market fund to our menu of options that is usually only available to people if you can invest at least a million dollars. But now full employees can just throw a few

hundred dollars in there if they want because the offer, the people who offer the money market fund allowed it to come into our plan because we have so many assets. And that's pretty common, actually, among 401K plans. And then just to answer Skippy's second question about other ways to move money from a 401k to an IRA, you usually have to leave the company. But some plans do allow what's called an in-service distribution, which allows you to transfer money while you'll start working there. Not all plans do this. And in most cases, the plans that do, you have to be age 59 and a half. But that's not set in stone. That's really just sort of a default in the industry. So check with your plan provider to see if it's allowed in your 401k.

All right. Our last question comes from Allen. Like a lot of folks, I've got some tech stocks that are down 60 plus percent in my portfolio. I know that if I sell and repurchase a stock within 30 days, it's simply a wash sale and has no tax benefit. I also know that it's risky to sell a stock and wait 30 days because the stock could rebound and I would miss out on those gains, which could outweigh any tax benefit of selling out of loss. However, my losses are quite large. So even if the stock does rebound to some extent, I think I may still have a net benefit. I don't expect these stocks to recover all their losses in the next 30 days. Any wisdom you can share. I still want to own these stocks long term, but I believe if I do this correctly, I could

not have to pay capital gains taxes for many years to come. Oh, Alan. I'm sorry, buddy. And by the way, we're all in the same boat. I mean, everyone who works here at the Motley Fool has some tech stocks that are down considerably. So let's start with clarifying the whys and rules around wash shales, right? The reason to do it is that the loss offsets any gains on your tax return, which means those gains are tax-free. And the losses in excess of the gains can offset up to $3,000 of ordinary income.

and then even losses beyond that can be carried forward to future years indefinitely. But as Alan points out, you can't buy the stock bag within 30 days or the loss is disallowed. However, even in this situation, not all is lost because the disallowed loss is added to the cost basis of the replacement shares. So you still get a tax benefit, just probably not when you wanted it. It's also important to know that you can't buy the stock 30 days before the sale. So you can't, you know, let's say there's a stock you want to sell right and you buy it in one account, and you can't, maybe it's yours or your spouses, then you sell the stock in the other account at a loss a few days later.

If you do that, the loss will be disallowed. So the whole wash sale period is 61 days, really. It's the day you sell the stock, 30 days before and the 30 days after, and again, you can't try to game this by buying it in your wife's or your husband's account. The whole household is what you have to consider. Okay, so Allen's concerned about selling this stock and being out. of it for 30 days. I'll start by pointing out that since the 1920s, when you look at the stock market's performance on a monthly basis, it's profitable about 60% of time. Of course, that

means it's unprofitable 40% of time. So there's actually a good chance that being out of the stock for 30 days might work out well for you. But if you're really worried about missing out on some upward bounce, then you can sell the stock and invest the cash in something that is similar, but not substantially identical to what you sold. And then that phrase, substantially identical is often debated by tax professionals. But here's one example, right? Let's say you sell a stock. You could buy an ETF that tracks that stock sector or industry for the 30 days, and you're fine.

30 days go buy. You sell that ETF. You use the proceeds to buy that stock back. Now, of course, you've sold that ETF, right? So if you have a gain or loss, that's a short term. Which means if it's a short-term gain, it's counted in taxed as ordinary income, which is the higher rate of long-term capital gains rate. So in the end, is it worth it or not?

I'm not going to tell you, but the times that I have done tax loss harvesting, I've generally just waited to 30 days, and it's generally worked out fun. Well, before we go, I wanted to let our listeners know that I'm taking advantage of a benefit of working at the Motley Fool, and I'm going to go on sabbatical for the summer. So I'm going to spend some time with my family, put up drywall, and probably blow out my knee playing pickleball. Before I go, though, I am hosting. a virtual event for the Motley Fool Foundation as part of their Spark Lab conversation series.

I'll be interviewing Melissa Bradley and Trish Costello, their two remarkable leaders in venture capital. We'll be talking about the challenges and solutions to improving diversity and inclusion in venture capital and entrepreneurship. And you're all invited. So just head over to foolfoundation.org to RSVee. As always, people on the program may own stocks mentioned, and the Motley Fool may have formal recommendations for or against, so don't buy or sell anything based solely on what you hear. I'm Ricky Malvey. Thanks for listening. We'll be back tomorrow.