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Why Visa Will Thrive

As many of you may have read in my previous article, the card servicers with portfolio exposure are in bad shapes because of rising credit card delinquencies. Names like American Express [AXP: 21.12, +1.17 (+5.86%)] and Discover Financial [DFS: 9.75, 0.00 (0.00%)] will be hurt with these delinquencies as they will be forced to write-down their portfolios. The pure-play card servicers aren’t completely recessionary proof, but history has shown that they perform well during these times and extremely well during recovery periods. Visa Inc. [V: 57.86, +4.04 (+7.51%)] and MasterCard Inc. [MA: 164.20, +10.94 (+7.14%)] will continue to outperform their peers and are safe plays for any portfolio.

The Industry

Card Servicers are generally mis-understood by many investors. They operate as pure network use plays. They hold NO CREDIT EXPOSURE on their book’s which is why they have performed so well in this market. They are paid per swipe and by purchase volume. Secular shifts in purchases also provide these companies with solid revenue streams.

So just how much money do they make on transactions?

As an example, let’s say you go out and purchase a watch for $100 by using your Visa card. Out of that $100 purchase, the merchant would usually pay 2%, or $2, of that fee for the use of the card (fees for merchants vary, as larger corporations like WalMart pay less than the typical Mom & Pop Shop). Out of that $2 fee, only about $0.20 go to Visa the rest would be paid to the issuer of the card (ex: Chase, Citi, etc.) and the bank it corresponded the transaction with. This is a pretty profitable business for all parties, but Visa acts as a pay-as-you-pass-go service because the transaction is made on their network, VisaNet.

The industry is also growing at a rapid pace.

With an increased focus on electronic and mobile payments globally, there has been a greater acceptance of card and electronic payments by merchants and customers. New methods of payments have also emerged, such as pre-paid cards, chip-based cards, and mobile commerce. The use of cards also provides convenience, security, debit/ready funds, and the ever popular rewards system. Visa does not give out the rewards that you receive on your card, those are left up to the issuing bank. Visa is also continuing to heavily invest in card and payment technology that will present exciting opportunities for the industry, such as contact-less and mobile devices. Paying for your purchase with Research in Motion’s [RIMM: 47.029, +3.729 (+8.61%)] BlackBerry or Apple’s [AAPL: 93.99, -0.59 (-0.62%)] Iphone is a thing of the near future, as agreements are already being worked on.

Where is the growth coming from?

Purchase transaction Growth has grown at a CAGR of 14% from 2002-2007. Although this CAGR number is expected to decline to 11% from 2007-2012, there are many growth opportunities in emerging markets. Growth from 2007-2012 is projected to be solid around the world: U.S. 7%, Europe 11%, Asia/Pacific 19%, Latin America 13%, Canada 8% and ME/Africa 17%. Card purchases in 2006 amounted to 43.5% of total purchases worldwide. This number is projected to increase to at least 50% by 2009. Already card payments have over taken paper payments (ex: cash, check, money orders, etc.) in the U.S. In the U.S., card transactions currently represent half of the world’s card transaction. Approximately 43%, or $3 trillion, of PCE in the U.S., this number is expected to grow to 54% of PCE by 2011. This compares to 31% of PCE in 2001.

Market Share

Visa Currently dominates the market across the board in total volume, transactions, cards, merchant outlets, and ATM’s. On a total volume, transaction, and card base, Visa is bigger than MasterCard, American Express, Discover, and JCB COMBINED! Out of the total credit card volume (excluding Europe) Visa operates with over a 60% share. Visa’s dominating market share isn’t a thing of the past, as transaction volume will continue to grow as they have issued the most cards versus their peers.

Visa vs. MasterCard

The similarities between the two companies are striking, as they both operate as card payment networks and don’t hold any credit exposure on their books. The main differences between Visa and MasterCard are: their IPO dates, litigation issues, geographic revenue streams, size of networks, and efficiency.

IPO Dates

You may wonder why these play such an important role to their differences in how they operate. First you need to understand the recent history of these companies and why they went public. Both of these companies were owned by member banks before their IPO. The networks wouldn’t operate for profitability because they were owned by the users of these networks. MasterCard went public in May of 2006 and saw its share price skyrocket over the past 12-18 months. Visa went public in March of 2008. It takes time for these companies to restructure themselves from basically a non-profiting entity to a highly profitable card servicing network. Because of this, Visa will operate with a 12-18 month lag on becoming extremely profitable. This creates an opportunity to investors to get in before performance takes off.

Litigation Issues

One huge difference between Visa and MasterCard is how they are funding their litigation issues. Because MasterCard went public over 2 years ago, they must come up with the funds internally. Visa knew that investors would be wary about the litigation issues that were hovering from Discover and AMEX, so they protected their Class A investors in their IPO. All member banks are at risk for any litigation payments in excess of the $3 billion they set aside. They have an enormous cushion of funds from these Class C shares, and it will not dilute their common share holders.

Geographic Revenues

One misconception between the two companies is that their common shares represent pretty much the entire world. This is not true for Visa. Visa Europe did not IPO with Visa Inc. in March. Visa Europe operates on a framework agreement, in which they must pay Visa a fee for using their name and their systems. They operate as a private company owned by its member banks. In March of 2009, Visa Europe has the option to sell itself back (at a pre-determined price). Visa Inc. also has a call option, which may be executed but only if Visa Europe performs extremely poorly (which will not happen). Therefore, Visa Inc.’s revenues depend more on U.S. consumers. This is good and bad at the same time. Obviously right now, there is a concern that consumers will not continue to swipe. It is a positive though because the U.S. represents the largest earnings stream because they are so large.

Size of Networks

Aside from the market share mentioned above, Visa is substantially larger on a number of other metrics as well. One notable difference is the market share in debit card volume. Since Visa was really the first to enter this business, they have a substantially larger share. They operate with a 76% share, as MasterCard only has 24% of the market.

Efficiency

One thing that many people aren’t aware of is the operating efficiencies of the two companies. Visa is much larger on revenue, earnings, and administration compared to MasterCard. This makes sense since Visa has more than a half a billion more cards in circulation than MasterCard. Their operating efficiencies (ex: revenue/employee, earnings/employee, expense/employee, etc.) are much better. Visa and MasterCard also spend the same amount in advertising which is interesting, since Visa has been able to gain more customers than MasterCard.

I think both are safe plays in this environment, but if you need to choose one it should be Visa. Watch out for Visa’s earnings this Wednesday. You’re not going to see a blowup like American Express, but be cautious. I think that they will report decent quarterly earnings, topping analyst expectations. What could hurt their stock price is the guidance, which is so crucial in this environment.

-Steve Murray

Disclaimer: The mutual fund the author is associated with is long V.

The Following Stocks Were Mentioned In This Article: AAPL, AXP, DFS, MA, rimm, V

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