Apple Inc. (AAPL) investors are irate at the $230 billion plus in cash and equivalents the company has on its balance sheet, and CEO Tim Cook’s unwillingness to make a big-splash acquisition.
Many investors feel that AAPL needs to look outside its own walls for innovation, growth and to enter new product categories, and its most recent quarter serves as proof that these investors are mostly correct. What Apple needs to do is buy PayPal Holdings Inc (PYPL).
That may sound crazy, but it won’t if you continue reading.
PYPL and AAPL: It’s Not THAT Crazy
Let me start by saying that PYPL is the real deal, and is here to stay. I was one of the many who said not to buy PayPal, and that the rise of Apple Pay, Android Pay, Stripe and eventually Facebook payments would cripple PYPL due to it having a smaller ecosystem of users.
However, we are now about one and a half years into this whole Apple Pay thing, and PayPal just produced yet another quarter of near 20% revenue growth with transaction growth of 26%. Thus, PayPal isn’t going anywhere.
What PayPal’s success proves is very interesting: It proves that consumers want another option to the duopoly of MasterCard Inc (MA) and Visa Inc (V). PayPal is more of an actual processor … that operates through the web. Companies and consumers use PayPal as a means to transfer currency between two places, the same function of MasterCard and Visa.
Much like MasterCard and Visa, PYPL creates revenue by charging users per use, and people are willing to pay those fees in exchange for PayPal’s security and to make simple payments and transfers over the internet. Now that PayPal is its own entity, we have slowly seen the company migrate into the brick-and-mortar space, which has historically been MasterCard and Visa’s domain.
That said, PYPL might as well be a goldmine for Apple, if Cook & Co. are smart enough to see it. Apple Pay has been by all accounts a complete joke. Sure, people use it, but it is not all that easier than swiping a credit card.
With AAPL receiving royalties of just $0.15 per $100 spent on Apple Pay, it is equivalent to lunch money compared to Apple’s overall revenue. Hence, Apple Pay makes absolutely no material impact to Apple’s top line.
However, Apple Pay is rolled under the Services umbrella that has since become the company’s second largest revenue stream behind iPhones. With Services revenue growing 20% year-over-year during Apple’s last quarter, one could argue that it is Apple’s biggest catalyst moving forward.
Furthermore, I suggested something very simple for Apple back in February: It should tell MasterCard and Visa “thanks, but no thanks” for the $0.15 royalty, and make a run at actually competing against MasterCard and Visa as a processor. If so, Services revenue and profits would skyrocket, as would Apple stock behind the Services growth.
That’s where PayPal comes into play. PayPal could be that processor to compete with MasterCard and Visa that Apple is missing, and by combining PayPal with Apple, it would add a web and mobile element that would be unmatched.
Currently, Apple has the mobile side on lock down, but adding PayPal would give Apple the web, and also the much needed processor, or middleman, as explained back in that February article.
So while investors may think that PayPal’s valuation is too rich, it could be the gateway for Apple to provide end-to-end payment processing without the use of Visa or MasterCard. If Apple would make this move, it would be a huge catalyst for AAPL stock and its Services business over the next few years.
How PayPal Helps Apple stock
I’ll conclude with the fact that mobile payment transactions are expected to reach $600 billion this year. With far more transaction dollars on Apple devices versus Android, I’ll go as far as to assume that half of that dollar value is spent on iOS. If AAPL could eventually capture a 50% share of spending on iOS, then AAPL could easily add an extra $9 billion in annual revenue by making this move (3% take rate).
Given the low costs associated with payment processors, $5 billion could very well be profits based on Visa and MasterCard margins. That would be a near 8% increase on Apple’s expected operating income next year. Not to mention, PayPal’s existing business would not lose business from this move, thereby adding another $2 billion in operating income by 2017.
Perhaps best of all is that AAPL could achieve a 50% share of iOS transactions with little work on behalf of the consumer, or little reliance on Apple Pay. Currently, iOS users have saved credit cards on their devices that pay for apps, subscriptions, content, etc.
AAPL would simply eliminate Visa or MasterCard, incorporate PayPal as the processor, assuming it could maintain the support of banks, and then it collects the 3% fees on transactions that MasterCard and Visa currently charge to merchants. It makes too much sense to ignore given the payments infrastructure and top-notch security profile that PayPal has built over the last decade.
At the end of the day, AAPL must put some of its money to work in mergers and acquisitions, and besides purchasing Fitbit Inc (FIT), I don’t think there is a better M&A target in the market than PayPal for Apple.
Hopefully management sees the upside, and realizes the need to put money to work and grow market share in industries that are both growing and large. Whether it be mobile payments or wearables, Apple just needs to do something to spark excitement and drive profits higher, and PYPL could help.
As of this writing, Brian Nichols owned shares of both AAPL and FIT.
