Last week, both Visa (V) and MasterCard (MA) released their quarterly earning results. Here are some thoughts on their reports and the conference calls.
1) Economic Indicator
For a long time, consumer spending has been the driving force of American economy. Albeit the arguments that now finally comes the end of such an era, it is fair to say the consumer spending remains as the most accurate indicator of the economy. Many researchers publish reports, articles, statistics, etc. to track the economic activities, looking for all sorts of signs of the economic trend. But as a matter of facts, no indicators are more accurate than the financial results from Visa and MasterCard. Actually in my opinion, both companies themselves are the indicators.
There are two aspects of the consumer spending, the number of transactions and the total spending volume. I believe there are no entities capable of tracking these numbers as accurate as V and MA. The reasons? these numbers are their business and they simply occur on the information systems owned by the big two. On the other hand, Visa and MasterCard dominate the electronic payment market, which has been widely adopted across all industries. Listening to their conference call, you will hear them talk about virtually everything, the gas, the grocery stores, the fall of CircuitCity, the restaurants, the overseas travel, etc, somewhat their business represents the overall economic picture.
Then what does this mean for the investors in both companies? In my first article on my blog (read it here), I mentioned in the bear market, we pick companies capable of holding up well during the economic downturn, and benefiting the most from the economic upturn. At that time, I listed both MA and V as my favorites. Economic recovery means more consumer spending transactions and higher spending volume, which translate directly into the improved financial results from both companies. When observers read these numbers and conclude the economy is back to life, both companies have already harvested the fruits. From this perspective, we say both companies proceed the economic upturn, and not in a speculative manner, but in a concrete and logical manner. So if you believe the American economy will come back, these two stocks will be the ones definitely flying earlier and very probably, higher.
2) Visa's Advantage Over MasterCard
In my previous discussion about MA (here), we mentioned that the Visa's dominant market position gives it the competitive edge over MA. Since MA can't produce anything with real or perceived difference from Visa's products, the competition pattern somewhat mimics that between Intel and AMD. Now based on the recent reports, it seems the Visa's dominance in the debit market gives it another layer of advantage over MA.
When we look back, the logic seems to be really simple. We are experiencing the credit crisis. Consumers cut back in credit card usage, and resort more to debit cards. This simply is a big positive for Visa. Visa saw the growth in debit card revenue offset the negative results from credit cards, but MA doesn't have such a luxury. In addition,talking about the future growth in the international market, especially in the developing countries, we all know that the credit system is a lot more complex and sophisticated than the debit system. It requires a series of setups, establishments, regulations, etc, which normally take long time to mature. But the debit card system, basically only requires the card holders have cash in their bank accounts. Therefore, the debit card's growth usually proceed the credit card. On one hand, compared to MA, Visa's dominance in the debit card market will position it better to take advantage of these growth opportunities. On the other hand, not everything is so negative for MA. Visa's advantage is mostly in the developed countries, while in the emerging markets, the opportunities presented to both are equal.
One noteworthy interesting point. In MA's 2008 10K, they quoted the recent bank consolidations as one potential risk, but in Visa's earning conference, they confirm that they expect to be the beneficiary of such consolidations. This certainly reflects Visa's dominant position, but also servers as a sign of Visa's long-term, established, strong relationships with big banks, which is intangible, but might very well be another advantage over MA.
3) International Growth
Both companies posted strong growth in the international market. Their strong performance outside the US helped offset the weak US market, guaranteeing their stock will recover at a faster pace than the US economy. Actually the global diversification is another rule I proposed to apply to pick stocks during the recession.
4) Energy Play
Both companies noted the dropping gas price negatively affected their results.
Actually MA and Visa are all good candidates for energy play.
Many believe the future era will be featured by high energy price, in that case, both companies will be benefited from this trend. After more than 100 years, the human world has been built to be relying on energy. There is no short term solutions to change this fact. High gas price may reduce several trips to Florida, but the enormous basic need will still be there, and grow, when you count in the developing countries from Asia. Both companies benefited from the short time energy bubble we witnessed in 2007 and early 2008, and I won't be surprised to see the similar situation reappear in the near future.
5) The Unabated Trends: Go Plastic and More Transactions
I continue to hold and increased my holdings in MA and Visa during the economic downturn. The underlying theory is based on two beliefs. First, the worldwide worldwide secular shift from cash and checks to electronic forms of payment will be inevitable and fast. And second, when people scale back their spending, it may, on the other hand, boost the total number of transactions. The report from both companies confirmed such views.
6) Final Conclusions
- Both companies delivered very solid performance, and Visa is even more impressive.
- I won't say MA is cheaper than Visa. I am holding onto my old opinion, Visa deserves a higher multiplier owing to its advantage over MA.
- Both stocks are not cheap. But I think the overall market may continue to push them higher.
Showing posts with label V. Show all posts
Showing posts with label V. Show all posts
Wednesday, May 6, 2009
Wednesday, April 15, 2009
MasterCard (MA): Long Term Risks
There are many articles discussing the future of the big two of the credit companies, Visa and MasterCard, and the majority expressed very positive views. In summary, the long case is built upon the following points:
1) The trend to go plastic. There are more and more people making payments by swiping the plastic cards instead of writing checks or using cash. This is a trend across the world, not only limited to the US.
2) The international market. The plastic cards in Asian and Latin American countries just started to gain popularity, which presents great growth opportunities for both companies.
3) They are not directly exposed to consumer credit risks. Both companies operate a payment network that connect the consumer, the merchant, the consumer's bank and the merchant's bank. They earn profits by charging the corresponding transaction fees, not from the interest from the credit issued to the customers. As a result, the credit crisis didn't have direct impact on their business.
4) Economic downturn caused the consumers to cut expenses, which doesn't necessarily indicate the number of payment card transactions will decline. The lost transactions in the luxury stores may be well offset by the increased volume in everyday life spending, such as groceries and gasoline.
I agree with the analysis. I think both companies operate a beautiful business model with extremely high entry barrier and great growth potential. The bear market actually presented us the rare chance to buy in at a sale price. However, there is no companies running without risks. This article is going to discuss some of the potential issues with both companies, focusing on MA. As a long term investor, I believe these are items we need to keep monitoring over time.
Bank consolidation, store cards and rebate: dangerous trend?
In MA's 10K, it describes its payment system as a 'four-party' system that involves the cardholder, the merchant, the issuer (the card holder's bank) and the acquirer (the merchant's bank). Here is a good example how the system works.
'For one example of how interchange functions, imagine a consumer making a $100 purchase with a credit card. For that $100 item, the retailer would get approximately $98. The remaining $2, known as the merchant discount and fees, gets divided up. About $1.75 would go to the card issuing bank (defined as interchange), $0.18 would go to Visa or MasterCard association (defined as assessments), and the remaining $0.07 would go to the retailer's merchant account provider.' (source: http://en.wikipedia.org/wiki/Interchange_fee)
In this model, it seems the acquirer is the role with the least importance, simply sitting behind the merchant to pocket some easy money. The issuer is the one with strongest motives, as it gets the majority of the pie. The merchant is the one with the most resistance. It is forced to raise the price of its merchandise without seeing the profit flowing into its account. The card holder is another key. His decision to use a plastic card instead of cash or check initiates the entire money flow. In addition, his decision to use whose card (which bank), and what type of card (Visa or MasterCard) decides who gets the money. Furthermore, the collective preference for the plastic cards among cardholders put the pressure on the merchants, somewhat forcing the latter to play the card game. Therefore, in MA's business model, the issuer, the merchant and the cardholder are the keys to its success and future growth.
All three groups display certain trend that we need to be aware of.
1) The banks: the collapse of the Wall Street reshuffled the entire financial industry and the banking system has undergone rapid consolidations in recent years. In 2008, 30% of MA's revenue came from the 5 largest customers, and now with fewer banks remaining and each one growing larger in size, we may see the shares of MA's revenue controlled by these banks grow bigger accordingly. As MA can't afford to lose any of these customers, they will gain more leverage over MA, capable of negotiating certain profit away from MA, thus squeeze the margin.
2) The merchant: for a long time, there have been the discussions, the controversies and the lawsuits about the interchange fee. In theory, the advance of technologies should have reduced the cost to process the payment transactions, but in reality, the proportion of the money landed in the banks' pocket went up. To be fair, I don't think the banks can justify such fat profit, and this will eventually be addressed and corrected. However, for MA or VISA, this is not necessarily a negative trend. First, the proportion of the payment distributed to MA and VISA is already minimal. It may go lower, but I doubt would be significant. Second, certainly it will demotivate the banks, but on the other hand, more merchants should become willingly to participate in the 'fairer' system, which actually will translate into more revenue for MA and VISA.
Actually the trend that bears negative indications to MA or VISA is the store card.
Nowadays, it is common to see merchants making efforts to avoid the interchange fees. The bigger players such as WalMart, Amazon, Lowe's, Macy's, etc, offer the store cards. Normally the program combines the issuer bank and acquirer bank into one, and provides incentives to the consumers to use the card by offering sales events exclusively to the card members. There are many variations in the practice, but one thing in common, MasterCard or Visa is left out of the picture.
In my opinion, the store card system is an efficient payment system that can challenge MA or Visa. I am not sure how this system will evolve, but a bold speculation, think about WalMart, Macy's and Lowe's form a coalition and negotiate one deal with one bank, say, JP Morgan, and issue one common card. This one bank will handle the entire transaction cycle between the card holders and the merchants. I see many reasons that MA and V should feel seriously threatened.
3) The consumer: in the past few years, the rebate card gained great popularity. My question is, where does the rebate come from? I know ultimately this drives up the merchandise price, kind of like the consumer pays himself part of the rebate (a hoax, isn't it?). I also understand part of it comes from the merchant, they have to give up a little extra profit if the shoppers simply choose to swipe their rebate cards. Also for the issuer banks, it is a perfect and very rewarding strategy to give up a tiny profit margin to promote the usage of the card, hence bring in larger revenue. But how does this affect MA or VISA? In 2007, MA recorded $332 million rebate as the cost against the $3,335 million fees earned, and in 2008, $357 million against $4,1116 million. I believe, on one side, they are willing to give up some profit to promote their card brand, whereas on the other side, it may be an unwillingly accepted results from negotiations with banks.
We need to monitor how this trend will affect the profit margin of the big two.
Competition with Visa: another AMD vs Intel?
In the electronic payments market, we know that Visa has the controlling market share, around 60%, and MA, around 30%. In addition, MA operates a business model almost identical to Visa, in other words, MA doesn't make any products with real or perceived difference from the Visa. Does this sound disturbing? And familiar? Won't it remind you the competition between AMD and Intel? As AMD can't produce anything significantly different from Intel, it has no resistance if Intel would like to pull it into the price war. With a controlling market share, Intel may still earn profit with a lowered profit margin, but AMD can only post loss. Then how about MA? is it free from this fate or pattern?
My answer is No.
I like MA's 'Priceless' commercials. Time and time again, I was touched or amused. I don't think any marketing campaigns from any other companies can be more successful. But does it make me feel my MasterCard different from my Visa card? adding another fact that I always felt the Visa commercials kind of awkward. The answer is No. In the store, I simply use whatever card that brings back more rebate. In other words, I use the card where the issuer gives up more of their profit and puts it in my pocket. Between Visa and MA, which one can afford giving up more of their profit? The obvious answer is Visa. I believe for any incentive program that MA offers to the banks, Visa can top that, but not the opposite.
Nonetheless, I don't think there is anything really worrisome here - both companies have immense growth space and there is no need for them to engage in any type of price war in the near term. But as an investor, it is a good thing to acknowledge this. Also owing to same reason, I think Visa's stock deserves a multiplier higher than MA.
Competition with American Express and Discover: whose business model is better?
The business model of AXP and DFS differs from the big two in the fact that they issue credit to the cardholders, to a certain extent, they operate as a bank. Then which business model is better? My preference is AXP and DFS.
The stock price of AXP and DFS was punished harsh during this bear market, partly owing to their own management mistakes. However, neither the stock price nor the capability of their management should be used to evaluate their business model. Adding MA itself to the so called four-party payment system, it is actually a five-party system. From the operation perspective, it is far from a lean or efficient process. The numerous interfaces and interchanges are cumbersome, though inevitable, which adds up the cost and inflexibility. On the other hand, the business model of AXP and DFS offers the potential to consolidate the five party system into a three party system, with AXP or DFS operating as a payment system provider, an issuer as well as an acquirer. Each could pocket all the profit that is distributed between three parties under the big two's model. And further, they could extend offers to the merchants or the cardholders with a lot more flexibility and generosity.
In summary, the business model from AXP and DFS actually offers more opportunities, but for the same reason, it demands a more capable management team. In the long term, I believe both companies may have better growth potential than the big two, certainly, the assumption is that they are properly managed.
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1) The trend to go plastic. There are more and more people making payments by swiping the plastic cards instead of writing checks or using cash. This is a trend across the world, not only limited to the US.
2) The international market. The plastic cards in Asian and Latin American countries just started to gain popularity, which presents great growth opportunities for both companies.
3) They are not directly exposed to consumer credit risks. Both companies operate a payment network that connect the consumer, the merchant, the consumer's bank and the merchant's bank. They earn profits by charging the corresponding transaction fees, not from the interest from the credit issued to the customers. As a result, the credit crisis didn't have direct impact on their business.
4) Economic downturn caused the consumers to cut expenses, which doesn't necessarily indicate the number of payment card transactions will decline. The lost transactions in the luxury stores may be well offset by the increased volume in everyday life spending, such as groceries and gasoline.
I agree with the analysis. I think both companies operate a beautiful business model with extremely high entry barrier and great growth potential. The bear market actually presented us the rare chance to buy in at a sale price. However, there is no companies running without risks. This article is going to discuss some of the potential issues with both companies, focusing on MA. As a long term investor, I believe these are items we need to keep monitoring over time.
Bank consolidation, store cards and rebate: dangerous trend?
In MA's 10K, it describes its payment system as a 'four-party' system that involves the cardholder, the merchant, the issuer (the card holder's bank) and the acquirer (the merchant's bank). Here is a good example how the system works.
'For one example of how interchange functions, imagine a consumer making a $100 purchase with a credit card. For that $100 item, the retailer would get approximately $98. The remaining $2, known as the merchant discount and fees, gets divided up. About $1.75 would go to the card issuing bank (defined as interchange), $0.18 would go to Visa or MasterCard association (defined as assessments), and the remaining $0.07 would go to the retailer's merchant account provider.' (source: http://en.wikipedia.org/wiki/Interchange_fee)
In this model, it seems the acquirer is the role with the least importance, simply sitting behind the merchant to pocket some easy money. The issuer is the one with strongest motives, as it gets the majority of the pie. The merchant is the one with the most resistance. It is forced to raise the price of its merchandise without seeing the profit flowing into its account. The card holder is another key. His decision to use a plastic card instead of cash or check initiates the entire money flow. In addition, his decision to use whose card (which bank), and what type of card (Visa or MasterCard) decides who gets the money. Furthermore, the collective preference for the plastic cards among cardholders put the pressure on the merchants, somewhat forcing the latter to play the card game. Therefore, in MA's business model, the issuer, the merchant and the cardholder are the keys to its success and future growth.
All three groups display certain trend that we need to be aware of.
1) The banks: the collapse of the Wall Street reshuffled the entire financial industry and the banking system has undergone rapid consolidations in recent years. In 2008, 30% of MA's revenue came from the 5 largest customers, and now with fewer banks remaining and each one growing larger in size, we may see the shares of MA's revenue controlled by these banks grow bigger accordingly. As MA can't afford to lose any of these customers, they will gain more leverage over MA, capable of negotiating certain profit away from MA, thus squeeze the margin.
2) The merchant: for a long time, there have been the discussions, the controversies and the lawsuits about the interchange fee. In theory, the advance of technologies should have reduced the cost to process the payment transactions, but in reality, the proportion of the money landed in the banks' pocket went up. To be fair, I don't think the banks can justify such fat profit, and this will eventually be addressed and corrected. However, for MA or VISA, this is not necessarily a negative trend. First, the proportion of the payment distributed to MA and VISA is already minimal. It may go lower, but I doubt would be significant. Second, certainly it will demotivate the banks, but on the other hand, more merchants should become willingly to participate in the 'fairer' system, which actually will translate into more revenue for MA and VISA.
Actually the trend that bears negative indications to MA or VISA is the store card.
Nowadays, it is common to see merchants making efforts to avoid the interchange fees. The bigger players such as WalMart, Amazon, Lowe's, Macy's, etc, offer the store cards. Normally the program combines the issuer bank and acquirer bank into one, and provides incentives to the consumers to use the card by offering sales events exclusively to the card members. There are many variations in the practice, but one thing in common, MasterCard or Visa is left out of the picture.
In my opinion, the store card system is an efficient payment system that can challenge MA or Visa. I am not sure how this system will evolve, but a bold speculation, think about WalMart, Macy's and Lowe's form a coalition and negotiate one deal with one bank, say, JP Morgan, and issue one common card. This one bank will handle the entire transaction cycle between the card holders and the merchants. I see many reasons that MA and V should feel seriously threatened.
3) The consumer: in the past few years, the rebate card gained great popularity. My question is, where does the rebate come from? I know ultimately this drives up the merchandise price, kind of like the consumer pays himself part of the rebate (a hoax, isn't it?). I also understand part of it comes from the merchant, they have to give up a little extra profit if the shoppers simply choose to swipe their rebate cards. Also for the issuer banks, it is a perfect and very rewarding strategy to give up a tiny profit margin to promote the usage of the card, hence bring in larger revenue. But how does this affect MA or VISA? In 2007, MA recorded $332 million rebate as the cost against the $3,335 million fees earned, and in 2008, $357 million against $4,1116 million. I believe, on one side, they are willing to give up some profit to promote their card brand, whereas on the other side, it may be an unwillingly accepted results from negotiations with banks.
We need to monitor how this trend will affect the profit margin of the big two.
Competition with Visa: another AMD vs Intel?
In the electronic payments market, we know that Visa has the controlling market share, around 60%, and MA, around 30%. In addition, MA operates a business model almost identical to Visa, in other words, MA doesn't make any products with real or perceived difference from the Visa. Does this sound disturbing? And familiar? Won't it remind you the competition between AMD and Intel? As AMD can't produce anything significantly different from Intel, it has no resistance if Intel would like to pull it into the price war. With a controlling market share, Intel may still earn profit with a lowered profit margin, but AMD can only post loss. Then how about MA? is it free from this fate or pattern?
My answer is No.
I like MA's 'Priceless' commercials. Time and time again, I was touched or amused. I don't think any marketing campaigns from any other companies can be more successful. But does it make me feel my MasterCard different from my Visa card? adding another fact that I always felt the Visa commercials kind of awkward. The answer is No. In the store, I simply use whatever card that brings back more rebate. In other words, I use the card where the issuer gives up more of their profit and puts it in my pocket. Between Visa and MA, which one can afford giving up more of their profit? The obvious answer is Visa. I believe for any incentive program that MA offers to the banks, Visa can top that, but not the opposite.
Nonetheless, I don't think there is anything really worrisome here - both companies have immense growth space and there is no need for them to engage in any type of price war in the near term. But as an investor, it is a good thing to acknowledge this. Also owing to same reason, I think Visa's stock deserves a multiplier higher than MA.
Competition with American Express and Discover: whose business model is better?
The business model of AXP and DFS differs from the big two in the fact that they issue credit to the cardholders, to a certain extent, they operate as a bank. Then which business model is better? My preference is AXP and DFS.
The stock price of AXP and DFS was punished harsh during this bear market, partly owing to their own management mistakes. However, neither the stock price nor the capability of their management should be used to evaluate their business model. Adding MA itself to the so called four-party payment system, it is actually a five-party system. From the operation perspective, it is far from a lean or efficient process. The numerous interfaces and interchanges are cumbersome, though inevitable, which adds up the cost and inflexibility. On the other hand, the business model of AXP and DFS offers the potential to consolidate the five party system into a three party system, with AXP or DFS operating as a payment system provider, an issuer as well as an acquirer. Each could pocket all the profit that is distributed between three parties under the big two's model. And further, they could extend offers to the merchants or the cardholders with a lot more flexibility and generosity.
In summary, the business model from AXP and DFS actually offers more opportunities, but for the same reason, it demands a more capable management team. In the long term, I believe both companies may have better growth potential than the big two, certainly, the assumption is that they are properly managed.
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