PayPal's Move Into Offline Retail: Balance of Power Means Cooperation, Not Competition

I've been wondering about the payment value chain. Specifically how PayPal (and to some extent, Square) moving toward offline retail will shape the industry. Specifically, can its P2P apps aggregate consumer attention and lead to less industry power for Visa and Mastercard.

Today's consumer transaction landscape is as follows:

• Peer to peer (P2P). PayPal and Square (with PayPal app, Venmo, and Cash App). Note that P2P transactions do not have to go through Visa and Mastercard's networks.
• Business to consumer (B2C) online. 
• Visa and Mastercard  - consumers puts in their credit card info online.
• PayPal buttons.
• Business to consumer (B2C) offline
• Visa and Mastercard.
• Apple Pay and Google Pay. These wallets mostly just wraps around credit/debit cards. 
• PayPal and Square both have debit cards that consumers can put into Apple/Google Pay.

Note that PayPal already dominate P2P and have solid presence in B2C online, but weak in B2C offline.  

That's why I'm really interested in PayPal's initiatives to use QR codes. Here's a tweet back in February when I was thinking out loud:

Why aren't more physical stores letting people pay with QR codes? (Like Starbucks app). Bypass $V and $MA right? And why wouldn't $pypl and $SQ push this method to extend their reach in offline transaction?
— mspacey (@mspacey4415) February 26, 2020
 

My original thought process was something like this: 

• The P2P apps (PayPal, Venmo, Cash app) already have ability to transfer money without going through V/MA. Brick and mortar retail is the missing piece before theses apps could be used anywhere.   
• You can also store money in these PayPal/Venmo/Cash App. So these apps can technically replace banks and credit cards. 
• The more transactions go through these apps, the more leverage they have. For example, if consumers rely on Venmo for all their transactions, including at retail stores, then Venmo can threaten to steer consumers away from V/MA's networks, and extract fee concessions. 

I've since updated my thinking. Why? Because if the above hypothesis is true, Google Pay and Apple Pay will be circumvented and rendered irrelevant. 

Is that realistic? Probably not. The payment space is so big that Apple and Google are unlikely to step aside without some competitive response.

how does Apple Pay / Google Pay respond to Paypal $PYPL's ambition in brick & mortar payments? it can bypass apple / google Pay with QR codes

— mspacey (@mspacey4415) June 4, 2020

The responses could come in 2 ways - co-op and retaliation. Google Pay and Apple Pay can easily co-opt the QR code movement by adding that features as well. The wallets can also retaliate by pushing into P2P space. In fact Google Pay already has P2P features but doesn't advertise it much. It's not very smooth now, but it works.

The payment sectors has a balance of power that prevents any one player from dominating. 

So what does PayPal really get out of this QR code move? I think it mostly furthers that balance of power - as if to say "hey Google/Apple/Visa/Mastercard, if you try to cut us out of the payment profit pool, we have the means to strike back."

It's building a bunch of nuclear warheads pointing at each other. Threat of mutual destruction upholds industry economics.

In the meantime, PayPal is broadcasting that they are open to cooperation, and not looking to cut any one out.

I now think the multi-player landscape will hold and no one sub-sector or company will dominate. PayPal, Square, Apple, Google, Visa and Mastercard are frenemies that will cooperate instead of compete. They will collectively gain leverage over the banks.

With expensive growth stocks, the key is TAM and strategy. If the TAM is vast, as long as the strategy works, companies can grow into it. I think that describes both PayPal and Square. They are both long term buys.

Week Ending 5/2/2015: Random Notes and Portfolio Review

I missed a home run last month and it hurt. Impac Mortgage (IMH) was the one. I’ve been following that stock on and off for 3 years. A week before earning came out, I had a hunch 1Q15 was going to be a good quarter, so I sat down, went through a rather detailed model and looked over my projected 1Q15 earnings. I passed, thinking the was not worth the risk and reward. When the actual earning came out it was a multiple of my forecast!! I was stunned  (I got the volume pretty much right on but was way off on the margin!). The stock ran up 100%+ in past month alone. Never have I put in that much work in a stock and turned out that wrong before. I mean if I was a portfolio manager at some fund and had a hunch about this stock, and I got my sector analyst to take a deep dive. He comes back saying it's a no go, then the stock goes up 100%...this is the sort of stuff that could get you fired.

So that hurt my confidence. That and the fact that I’ve been very uneasy with the market made me go through my portfolio again.


Healthcare portfolio.  This is a multi-leg investment to capture the long term trend in America’s aging population. I have a mix of managed care, hospitals, pharmaceuticals, and supply chain players that balance out each other.

Managed care ran up a lot in 1Q15 and was a major contributor to my out performance year to date. I decided to cut this down a little bit due to full valuation. I also see near term risk in the next year as we get closer to election year and Republicans will undoubtedly make some noise about Obamacare. But overall this healthcare portfolio is a very long term play and there’s nothing here that I would think of selling if the overall market drops 50% tomorrow.

That said, after a very successful run the past year, my expected return in the next few years is not great – maybe mid/high single digit annualized return. So if something with better risk and reward comes alone I could pare this down further.


Housing portfolio.  This is really more like housing finance and is a mix of title insurance, originator/servicers, mortgage REITS and mortgage heavy banks. The big picture idea is to go long household formation and existing home sales in the next 5-10 years. Unlike the healthcare portfolio, there are some pretty speculative names in here like Nationstar, PennyMac Financial, AGNC…etc. But I’ve cut them down to a point where I’m pretty comfortable for all remaining positions, and certainly on a portfolio basis. 

The core group here is title insurance, which I went through recently thinking about adding. Unfortunately the group look fairly valued. In terms of technicals, Fidelity National Financial (FNF) is a name showing some weaknesses. It is hovering around its resistance level and could see a big break on the downside if next Monday’s earning turn out to be a bust. If that happens I will simply take it on the chin. 

Tankers. I cut down some TNK and bought some more DHT. In the past few weeks TNK stock price has moved up to a point it became too large of a position. I'm also worried that Aframax sector (which TNK is heavy in) will not benefit as much as say VLCC or Suezmax sector. Hence the rotation into DHT, which owns mostly VLCC and Suezmax ships. Luckily, I did this adjustment right before TNK stock took a beating the past few days. The tanker trade is ~6% of my total portfolio and I have 4 stocks sharing the risk. What's preventing me from getting bigger here? 1) This is obviously a very speculative trade and cannot be long term. 2) Global crude oil demand is highly dependent on China, so the tanker trade is to some degree a long China trade -- and I'm already very long China in the portfolio.


Beijing Enterprises Holdings (392.HK). This ran up some 20% and I kept adding to my position on the way up. Although the gain is mostly due to extremely lucky timing, this is a very long term investment for me. I would consider adding more Chinese gas distributors, but only at the right price.


One big China/HK trade basket. Welling (382.HK) has ran up dramatically and I also added on the way up. But I see less upside here and will likely take my profit if the HK market takes a turn for the worse. In recent weeks I piled in and added a mix of indices and (mostly infrastructure) stocks to capture an expected spike in liquidity as well as A-H share premium.

But now that H-shares momentum has flattened out, I’m very worried about the A-share bubble popping and how that might spill over to H-shares. I'm actually investigating ways to short China as a whole while staying long in my current H-share positions, which are all reasonably valued if not outright cheap. I have tight stop losses on every one of these trades and will let the market decide for me.

Updating my views on Apple and Google:

Apple. I’m kind of surprised that the stock did not move that much given the very strong quarter. Demand for the stock could be exhausted. Part of my thesis is a "short squeeze" for those who still don't own AAPL and lags the index as a result. I now see that even a $200bn capital return plan cannot scare the implicit shorts. My original thesis could be flawed and I may cut down or exit instead.

Google. I’m holding on despite the temptation to exit given the persistently negative market sentiments here. I did some rough numbers again. My timeframe is 5 years for this. What’s the worst case? Conservatively, I think EPS can grow 8% a year. It is unlikely to be less given the solid top line growth runway and how much room they have to cut cost, and everything I know of Google.

• 5 years from now EPS would be up 47%. But let’s say 1yr forward multiple (ex-cash) goes down to 17, that would be roughly an -18% hit. Combine EPS gain and multiple loss yields ~29% total return in 5yr, which would be about 5-5.5% CAGR. That is my worst case. 
• On the other hand I think the upside is double in 5yr or about 15% IRR. 
• Given the strong expected EPS growth, forward PE would have to drop to 12x at 2020 for me to lose money. 
• So I’m holding on to this. But maybe get smaller if price moves against me.

The exposures I listed above add up to almost 70% of my portfolio. I’m in the process of revisiting my entire investment approach and don’t expect to add new names. If the market crashes 30% tomorrow, the exposures I'm less sure about (roughly half of what I listed above) would be stopped out, leaving the real long term positions intact. 

Keep It Simple, Buy Apple and Google

I tend to write about smallish and mediocre companies on this blog, but those are just a portion of my portfolio. In fact, about half of my portfolio are highly liquid large caps that I consider high quality and intend to hold over the long run.

The problem with this mixed approach of "cigar butt" versus quality at fair price is I end up spending most of my time on the former. Built to last companies just don't require as much attention as risky ones. When I buy a "quality" company my intention is to let it cruise along, check in once in a while to see if the thesis still holds, and perhaps add on the dips. This has all worked out very well so far. The problem is there's a strong temptation to equate "large" with "safe", and perhaps run the risk of complacency. I hope writing this blog will help prevent that.

I'm under no illusions that I have any unique advantage when investing in these names. The thing is you don't always need an edge. Investing is not a zero sum game. Nor do you get points for creativity. I think some people read Joel Greenblatt and obsessively ask themselves "whats my edge? is this obscure enough?" But sometimes the crowd is right, and the best opportunities are the obvious ones. (more that here.)

With the market being volatile the past few months, I took the chance to get into Google and Apple at the lows. At today's prices (GOOGL at $565 and AAPL at $126), I would still buy them if not for the fact that they're already full sized positions.

Google

There's a decent chance this can double in 5 years. The way this works out, I think, is earnings double in 5 years (implying a a highly achievable 14% earnings CAGR). If earnings are still growing > 10% at the end of that period, then the market will put on a high P/E which doubles the share price.

For a company that grew its net revenue at 20% in 2014, Google is priced very reasonably, (I look at this in terms of GAAP earnings, and back out the value of net cash, which gets me to <20x 2016E earnings). This deal is available due to worries about what mobile means for Google. Google still makes most of its money from text searches, the fear is that with the world shifting toward mobile and "apps", Google's earnings growth will slow or even decline.

That seems exaggerated to me. Google owns Android and YouTube, so they do have a strong presence in mobile. Ok, they have not really monetize those two yet, but is it that hard to imagine they eventually will? Also, there are 2 trends that converges "mobile" together with traditional internet, where Google clearly dominates. One is that websites increasingly serve up the "mobile" versions, which are getting so sophisticated that there's no difference between normal internet site and an "app". Second, as phones get bigger and tablets more functional, there's less of a difference between the "mobile" world and the "desktop" world. In that sense cell phone, tablet, laptop...etc are all just screens where people interact with the internet.

In 2014, gross profit grew 20%+ while adjusted pretax profit was up only 11%. This is due to Google's high R&D and other investments. These are discretionary investments though. If they just keep expenses under control, they can easily "show" a much higher earning growth.

I'm no expert in tech, but Fred Wilson is. In this recent interview (around 37th minute), he was asked "Can YouTube be bigger than Google search?" to which he exclaimed "Yes! Easily!". Wilson also pointed out that Google's strength in data and the fact that it's still run by its founders.

Apple

For years I had a hard time getting comfortable with Apple. With technology changing so fast, I have no idea what products they will be selling in 10 years, so how can I put anything more than a 10x multiple on this? My thinking has changed into this: it doe not matter. Sure, eventually there is going to be tougher competition from Asia, but I just need to make sure 1) in the interim they will rake it in the next 2 years so that cash is worth something, 2) there are no close competitor in the upscale product /ecosystem / "fashion tech" segment.

Apple made an absurd $18bn in the quarter ending December 2014. In one quarter alone, they made more than the entire market value of some large cap companies! Surely this is peak earning, no? I think there could be more. Growth opportunity could come from 1) higher iPhone penetration in emerging market. Apple's market share in China was only 16% at Oct 2014. Could have doubled at this point, but certainly there's some room to run. Similar idea with France, Germany, Italy..etc. 2) the bigger iPhone 6+ has higher price points. 3) Apple Watch opens another revenue stream that could offset iPad weaknesses. 4) Upside options such as Apple Pay, partnership with IBM, healthcare initiatives could all work out. 5) Apple solidifies itself as a "fashion tech" brand and sells eye glasses, hats, or whatever to fanboys for $400 a pop.

What's the upside? Say earnings grow another 30% in a few years, put on a higher multiple and we could see 40-50% gain from the current price. There's a technical aspect that could accelerate the gains. With Apple being some 3.5% of the SP500, fund managers who are underweight Apple (and implicitly shorting it) could face a short squeeze, especially if iPhone 6 continues its spectacular run and Apple start doing some buybacks.

The downside is Apple Watch turns out to be a flop, which not only fails to replace iPad sales, but also disproves the "Apple as fashion/luxury tech" theory and demoralize Apple boosters. Also, if iPhone 6 sales stalls later this year, the market would reasserts that this is a cyclical business unworthy of a high multiple. This is not a stable buy and hold. The downside is real and I would have to risk manage this if prices fall below my cost basis.



Of the two, I like Google better and will allow it more time to play out.