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MasterCard Incorporated (NYSE:MA)

Q4 2012 Earnings Conference Call

January 31, 2013, 09:00 AM ET

Executives

Ajaypal S. Banga - President and CEO

Martina Hund-Mejean - CFO

Barbara L. Gasper - Director, Investor Relations

Analysts

Craig Maurer - Credit Agricole Securities (NYSE:USA) Inc., Research Division

Jason Kupferberg - Jefferies & Company, Inc., Research Division

Rod Bourgeois - Sanford C. Bernstein & Co.

Sanjay Sakhrani - Keefe Bruyette & Woods

David Togut - Evercore Partners Inc., Research Division

James Friedman - Susquehanna International Group, LLP

Bryan Keane - Deutsche Bank, North America

Glenn Fodor - Autonomous Research

Ken Bruce - Bank of America Merrill Lynch

Julio Quinteros - Goldman Sachs & Co.

Operator

Good morning ladies and gentlemen and welcome to the Fourth Quarter 2012 Earnings Call. My name is John, and I'll be your operator for today's call. (Operator Instructions) Later, we’ll conduct a question-and-answer session. Please note that this conference is being recorded.

I’ll now turn the call over to Barbara Gasper. You may begin, Barbara.

Barbara L. Gasper

Thank you, John. Good morning, everyone, and thank you for joining us today, either by phone or webcast, for a discussion about our fourth quarter and full-year 2012 financial results. With me on the call this morning are Ajay Banga, our President and Chief Executive Officer; and Martina Hund-Mejean, our Chief Financial Officer.

Following comments from Ajay and Martina, the operator will announce your opportunity to get into the queue for the Q&A session. Up until then, no one is actually registered to ask a question. This morning's earnings release and the slide deck that will be referenced on this call can be found in the Investor Relations section of our website, mastercard.com.

Both the earnings release and the slide deck include reconciliations of any non-GAAP measures to their GAAP equivalent. All of these documents have also been attached to an 8-K that we filed with the SEC earlier this morning. A replay of this call will be posted on our website for one week through February 7th.

And finally, as set forth in more detail in today's earnings release, I need to remind everyone that today’s call may include some forward-looking statements about MasterCard's future performance. Actual performance could differ materially from what is suggested by our comments today. Information about the factors that could affect future performance are summarized at the end of our press release, as well as contained in our recent SEC filings.

With that, I'd like to turn the call over to our CEO, Ajay Banga. Ajay?

Ajaypal S. Banga

Thank you, Barbara. Good morning, everybody. As usual, before Martina gets into the details of our financial results, I’d like to give you some of my thoughts from another level of looking at our business. In the fourth quarter, we reported net revenue growth of 10% and that’s really 12% after adjusting for currency. And that drove operating income growth of 18%, which excludes last year’s special item for the litigation charge and a reported EPS growth of 21% or FX adjusted that EPS growth is 24%. So this quarter completed a solid year with performance in line with our expectations.

For the full-year 2012 reported net revenue grew 10% that number FX adjusted is 13%. The primary drivers of this will process transaction growth rates that reached the mid-20s as well as annual GDV and cross-border volumes in the mid-teens. We also delivered a reported EPS growth of 18% for the year or 22% FX adjusted.

So, now let me talk a little bit about the global environment, and I know that’s on everybody’s minds and let’s start with the United States where we continue to see a mixed economic picture. The economy was a bit choppy in the fourth quarter with Hurricane Sandy and the fiscal cliff debate negatively impacting both consumer confidence and retail sales. Consumer confidence levels actually declined 11% over the quarter, and our SpendingPulse data showed that retail sales growth x auto decelerated each moth from October through December.

For the quarter as a whole retail sales growth x auto was up 3.9% over the prior-year from 4.2% in the third quarter, so you can see that trend between the third and fourth quarter and within the fourth quarter the monthly growth rate was decelerating. However, there were also some positive trends. So, in December consumer spending increased in 8 of the 11 retail sectors that we track in SpendingPulse with the strongest growth continuing to come from furniture, hardware associated with what we’ve been saying for a while was the rebound in housing. But this December, lodging and restaurants also showed strong growth in sales.

Unemployment rates have remained steady although this morning’s picture does show an increase, but this is the fourth quarter we’re talking about, and we continue to see improvements in the underlying housing market. So any optimism that we have about the economy however will be tempered until we see what happens to consumer confidence and spending once these fiscal policy issues are addressed over the next few months. All in all Q4 was worst than Q3 in terms of the market in terms of consumer spending and confidence in the United States, and despite that MasterCard's fourth quarter U.S. GDV growth was 7%, which kind of is the same as what we had in the third quarter.

Let's go to Europe and as you know, the region's economic environment is complicated. It's probably going to remain that way over the next few quarters. Looking first to the UK where SpendingPulse data actually showed the year's strongest retail sales growth occurred in the fourth quarter, 3.8% and consumer confidence levels have improved over all these four quarters, the last four.

However, the UK economy as a whole contracted in the fourth quarter and for all we know, it may be headed for another small decline in the first quarter. If that were to happen, it would make it the third time that the UK has had a technical recession since 2008. So we expect UK consumers to remain cautious. It's still not clear to me whether the positive spending and confidence trends will continue into 2013, but the fourth quarter was interesting at a good surprise.

Looking across the Eurozone, consumer confidence declined slightly, business sentiment remained weak in the fourth quarter and as you know, Northern Europe still is in a different position from some of the impacted countries in the peripheral markets. But having said all that, reflecting on how this picture impacted us in Europe, we saw solid GDV growth in the mid-teens similar to the rest of 2012, driven by the relatively stronger economies as I just said of Northern Europe, but also Eastern Europe with Poland and Russia continuing to be key contribute. We also saw, as I said a little earlier, thanks to what happened in the UK, we saw an acceleration in volume growth for the UK in the fourth quarter as well.

In Asia, business and consumer sentiment is mixed across the major markets because after all, economic uncertainty in the two largest consuming markets of the U.S. and Europe will have an impact on the region. But looking ahead, however, there may actually be cause for optimism. China's GDP growth is projected to increase this year over the number of last year and frankly because of its size, that could have a positive effect on sentiment across the rest of the region. For our business in APMEA, in AP, Middle East and Africa, fourth quarter GDV process transactions and cross-border volume growth, all of them increased more than 20%. Countries like Australia, China, India, South Africa, all contributed to that growth number.

So now let's talk GDP in Latin America. Annual 2012 GDP growth estimates in some of the key markets like Brazil and Mexico. As you know, we're revised down in the fourth quarter with Mexico as it is always getting impacted by U.S. economic conditions. 70%-odd of Mexico's GDP comes from in some way a collection of the United States. In spite of that, consumer sentiment across most of the regions increased. All fourth quarter GDV and transaction growth was in the mid-teens, actually a slight decline over what we saw earlier in the year but Brazil, Mexico and Venezuela remained key contributors to our growth.

So given all this, overall, we have still got a cautious outlook going into 2013. There is going to be uncertainty in Europe. The U.S. could well be on a path for a slow recovery, but the fiscal policy discussions and circumstances have not been completely resolved. They could affect consumer confidence further. That would impact spending for at least the first half of the year. In the meantime, we will continue to maintain our focus on the execution of our strategy which as you know, is the displacement of cash around the world supporting financial inclusion and also obviously driving to gain share in the electronic payments space and the 15% of retail payments that are already electronic.

So, some highlights from our recent business activity. We've said a couple of times now that U.S. consumer credit is an area where we probably need to place more focus. As you know, our business is not one that turns on a dime, it's got long lead lag times to sell in, but we've got some new recent wins in this area. So the first one is, we've had a good relationship with the Intercontinental Hotel Group in other regions. We have just announced now a new multiyear agreement for the United States that names MasterCard as the exclusive payment brand for the Intercontinental Hotel Group consumer credit portfolio as well as actually even more interestingly a broad range of marketing, loyalty and innovation initiatives. So that's the first one.

Second one, Bass Pro Shops. As you probably know of them, they're one of America's premier outdoor merchandise retailers. They will be converting their co-brand card portfolio starting in the middle of 2013 to us from a competitor. In the fuel sector, first, we just renewed our agreement with Shell for their consumer Co-Brand Card Program, at Gold, but in addition, we’ve just had another interesting opportunity in this space and we’ve become the exclusive payment partner for the Fuel Rewards Network Loyalty Program. So when consumers linked any MasterCard card to this program, and make everyday purchases at a participating grocery store, restaurant, online merchant, they get extra discounts on gasoline purchases at Shell stations. And this is in addition to the Shell Co-Brand Card, which I just talked about. So that’s kind of two things in the fuel space.

And in November KeyBank agreed to extend the exclusivity we have on that debit and prepaid programs to now include new issuance for both their consumer credit and commercial credit portfolio. So, as you know last year’s announcement with KeyBank was the added Maestro PIN debit capability to their debit and ATM programs. We also signed them up for our IPS solution for their debit and prepaid transaction processing, so this is really on to their credit side now.

And last quarter SunTrust launched a new portfolio platinum in world consumer credit MasterCard’s which are being made available through online, but also through their branches. So that’s some movement in that space.

Moving now to Canada, we announced the launch of the Royal Bank of Canada, RBC Target Co-Brand MasterCard Credit Card Program. The card is going to be available online and of course in Target stores as they open new locations across Canada in the first half of 2013. Its kind of the middle the RED Card Loyalty Program in the U.S., which as you know is co-branded by a competitor. And this then reinforce the leadership position in co-brand programs across Canada, the kind of added target to a list of major merchants there, with whom we’ve got successful partnerships, Walmart, The Hudson's Bay Company, Loblaw’s, the whole lot..

Continuing our momentum in the U.S. commercial space, we extended our existing agreement with the U.S. Bank to include exclusivity for their Fleet and Aviation Card Programs. This agreement also includes our EMS, that’s Expert Monitoring Services, Fraud Monitoring Product, and MasterCard’s payment gateway for segments of their Corporate and Purchasing Card Programs. And in 2012 U.S. Bank actually became one of our top 10 commercial card issuers with all the partnership we’re doing with them.

We are continuing our work with governments and other partners to support financial inclusion for the underserved. So let me highlight a few examples from Africa, I’ve actually I’ve just come back from a trip to Kenya, Nigeria and South Africa. When I was there two weeks ago, we announced an agreement with Equity Bank in Kenya, one of East Africa’s largest financial institutions.

We’re going to be putting $5 million EMV debit and prepaid cards in the market over the next 18 months, that’s probably one of the largest deals of that size in the African continent. The rollout is expected to expand to Uganda, Tanzania, Rwanda and South Sudan, which will make it the largest rollout of EMV payment cards in Sub-Saharan Africa. That by the way 80% of the population is un-banked and that is the target that Equity Bank has. They aim for that segment of the population. That’s their history.

Last quarter we lost collaboration with Comviva Technologies and Tutuka to extend financial inclusion to millions of people across Africa. Operators providing mobile money services will be able to offer prepaid cards or virtual card numbers linked to a stored value account and so then they can make purchases at any merchant that accepts MasterCard. They’re also going to be able to use the service to pay bills, do fund transfers, all the things that they would like to do given the circumstances of that market. Initial focus; African countries like Kenya and Nigeria where Comviva is selling or has sold services with Airtel.

We’ve also been working with the Central Bank of Nigeria and the Federal Government [ph] there I 3rd (3:56) met on this trip to modernize the payments industry and introduced acceptance training workshops highlighting the benefits of accepting electronic payments for merchants. In our adviser’s team joined to the Central Bank of Kenya whom I also met on this trip to develop policies to support the modernization of Kenya’s retail payment system. The Central Banks policies are basically focused on increasing efficiency and encouraging interoperability rather than siloed payment improvements improving safety and increasing financial inclusion through the greater use of electronic payments. So that’s what's going on there.

On the mobile front they’re driving ahead of the IFS developed partnerships with network operators and other companies. And it's interesting just that I was putting this number together. We have 25 initiatives around the world in just the past two years; I’m not counting what you were doing earlier. In just the past two years, 2011 and 2012 we have 25 new initiatives. So, let me give you two examples of what's going on in Brazil in this space. You know we talked in November 2011 of the joint venture with Telefónica. We announced the next phase of the JV with the rollout of a mobile prepaid product in the second quarter, consumers will be able to load money to their mobile prepaid account, make purchases, conduct P2P payments, phone top-ups and other financial transactions with their mobile phones. They're also going to be able to load cash to that account at designated refill locations which are broader than just a Telefónica store. It includes grocery stores and newspaper kiosks.

And now we've partnered with Tim, the second largest mobile network operator in Brazil and Caixa Económica Federal, which is a bank issuing partner of ours to launch a mobile money program in Brazil for Tim's 69 million subscribers. So these two partnerships combined in Brazil will help us to serve almost 150 million mobile phone subscribers which is about 60% of the Brazilian mobile market.

So let's talk prepaid, a couple of wins that we've had from the U.S. and Europe which I can talk about. MasterCard will become Aetna's preferred payment brand for their healthcare flexible spending accounts, health savings accounts and prepaid stored value cards such as their Aetna ValuePass cards. So these plans allow consumers, as you know, to access money in an account usually attached to a health plan to pay for eligible healthcare expenses with pre-tax dollars.

In Italy, we have recently announced a deal with ENI which is one of Europe's largest oil companies to replace their loyalty card with MasterCard branded PayPass enabled prepaid and credit cards. So cardholders will be able to collect loyalty points when shopping at ENI outlets or at any other location around the world where MasterCard is accepted. ENI is planning to install PayPass terminals in their gas stations and coffee shops which is great news for us because that will make them the largest PayPass merchant in Europe when they complete this.

By the way, we're now up to about 700,000 PayPass outlets around the world, up from the 400,000-odd that we had at this time last year. So this is all part of what we are trying to do with that whole space. So now let's talk China and the Middle East for affluent travelers which I think will also help us enhance our cross-border business. Let me give you a few examples. The Bank of China launched a six-month program to drive cross-border transactions using our MasterCard reward services platform. Bank of China MasterCard cardholders are earning credits for up to 10% of their purchases when they shop at luxury stores which, as you know, is a good way for the Chinese to spend money such as Louis Vuitton, Cartier, Prada, Hermès in the UK, in the U.S. and Canada.

In Bahrain, Al Baraka Bank and Nonoo Exchange launched the first platinum prepaid card in the country. The card offers access to events and destinations as there is merchant funded discounts, shopping privileges and all other kinds of premium experiences that make sense in the Bahrain market. In the UAE, we recently launched GoCash with UAE Exchange, a leading regional remittance and exchange house. So GoCash is the Middle East's first six-currency prepaid travel card. So a consumer can load up six currencies, lock down the value of their foreign currency in advance of their travels. So that's kind of what's going on around the world.

Let me turn the call over to Martina for the detailed update on our financial results and all our metrics. Martina.

Martina Hund-Mejean

Thanks, Ajay, and good morning everyone. Let me begin on page 3 of our slide deck where you will see as reported growth numbers as well as the FX adjusted growth rates. And all of my comments on this slide will pertain to the FX adjusted figures.

We are very pleased with our performance this quarter, especially given the tough comps that we were up against the fourth quarter of last year. Net revenue grew 12%, driven by volume and transaction growth which also reflects the impact of the deals that we have signed over the last year.

Operating expenses grew 4% and together with net revenue growth resulted in net income growth of 21% and EPS growth of 24% also benefited from our share repurchase programs.

Now cash flow from operations was 866 million and we ended the quarter with cash and cash equivalent and other liquid investments of about 5 billion. During the fourth quarter, we purchased about 1.3 million shares at an approximate cost of $613 million.

Through January 25, we repurchased an additional 322,000 shares at a cost of about $165 million. And we now have $440 million remaining under the current authorization. We will continue to look to repurchase shares on an opportunistic basis.

So let's first talk about the operational metrics for the fourth quarter and here we'll start on page 4. Our worldwide gross dollar volume or GDV was up 14% on a local currency basis. In the U.S., GDV grew 7%. Debit growth in the U.S. remains solid at 11%. And credit volumes in the U.S. grew about 2% with commercial credit growth up from last quarter in the high-teens. U.S. consumer credit improved slightly versus the last quarter, but as Ajay said, it is not where we wanted to be and we work – keep working at.

Outside of the U.S., volume growth was 18% on a local currency basis, and this includes to be driven – this continues to be driven by more than 20% growth in APMEA and mid-teens growth in Europe as well as in LAC. Cross-border volume grew 17% on a local currency basis, including high-teens growth in LAC and more than 20% growth in both Europe and APMEA.

Let me turn to page 5, and here you see our processed transactions were up just over 20%. And that’s our sixth consecutive quarter of 20 plus percent growth. As expected, we continue to see a deceleration, which was mainly driven by the full lapping of our processing win in the Netherlands, as well as some lapping of U.S. debit wins. So, let me drill further down into the numbers and a little less than half of the 20% growth comes from new PIN debit transactions in the U.S., leaving about 12% as the underlying growth rate, very similar to the last couple of quarters. Globally, the number of cards grew 8% to 1.9 billion MasterCard and Maestro branded cards.

Let’s now turn with this background to page 6, where you can see both the fourth quarter as reported and FX adjusted growth rates for each of our revenue line items. So, let me just comment on a couple of these categories. Domestic assessments grew 9% while worldwide GDV grew 14%. The gap between these two growth rates is 5 percentage points of which 2 percentage points is foreign exchange and the remainder is driven by relatively higher growth of ATM volume in emerging markets.

On cross-border volume fees, they grew actually 14%, while cross-border volumes grew 17%. The primary reason for this difference is a higher proportion of intra Europe activity, so that really means Europeans stayed closer to home and the resulting spend came with a lower revenue yield than when they travel outside of Europe.

Transaction processing fees grew 15%, driven mainly by the 20% growth in process transactions. Narrowing considerably from recent quarters, the gap between these two growth rates can be attributed to U.S. PIN debit transactions that come with a lower than average revenue yield. Only a small portion of the gap is explained by foreign exchange. And finally the distribution of rebates and incentives followed relatively the same pattern as last year with fourth quarter representing slightly less than 30% of full-year 2012 total rebates and incentive amount.

Let me move to page 7, where we've detailed the as reported in FX adjusted growth rates for our expense line items. So within total operating expenses you see the increase in G&A expense was primarily driven by the impact of increased salary costs as a result of hiring more people to support our growth initiatives. We ended 2012 with approximately 7500 full-time employees. The net impact of foreign exchange activity was also a factor in the G&A increase primarily due to balance sheet re-measurement. The decline in advertising and marketing expense was primarily due to the non-recurrence of certain promotions.

So, let me turn now to slide 8, and let’s discuss 2013 starting with an update of what we have seen for the first quarter through January 28. Globally our cross-border volumes grew about 18% and that’s just slightly higher than what we saw in the fourth quarter. This was primarily driven by higher growth in our APMEA and LAC regions. In the U.S. our process volume proxy for GDV grew 6% that's just a bit lower than our fourth quarter growth, primarily due to the lapping of some debit wins. We did, however, see a slight increase in our consumer credit growth.

Process volume growth outside the U.S. grew 15%, which was a bit lower than what we saw in the fourth quarter. And since all of you have a keen interest in Europe given the economic environment there, our processed volume growth there was mid-teens similar to what we saw in the fourth quarter.

Globally, process transaction growth was 17%, down from the 20% we saw in the fourth quarter, mainly driven by the full lapping of our Netherlands processing wins as well as some lapping of U.S. debit wins.

As a reminder, with the April 1st anniversary of the U.S. regulatory change relating to debit card non-exclusivity, we expect a deceleration in our process transaction growth rate for the rest of 2013.

So looking forward, let me just start first with our long-term performance objectives. We remain confident that our business can deliver in a 11% to 14% net revenue CAGR and at least 20% EPS CAGR over the 2013 to 2015 period. These growth rates are on a constant currency basis and exclude any new acquisitions.

We also remain committed to our annual operating margin target of at least 50%. And as we've first told you at our Investor Day last September, based on our current expectations of the economic environment, we expect that net revenue and EPS growth in the early part of this three-year period might be slightly below the 11% minimum threshold for net revenue growth and 20% for EPS growth.

In later years, assuming the world would turn to a more stable environment, we believe net revenue growth could be at the higher end of the range and that could also benefit EPS growth in that particular period.

Just one other comment that I would like to make about our EPS CAGR objective, which we said was based on a normalized tax rate that excludes the impact of several one-time benefits that we were able to achieve in 2012.

Our 2012 normalized tax rate is 31.8% and that will result in a pro forma EPS of $21.44 which becomes the base on which you should be modeling EPS growth beyond 2012.

Now, I would like to share with you a few specific thoughts about 2013. Given the current economic backdrop that Ajay just discussed, we expect net revenue growth in the first half of 2013 to be below the 10.7% currency adjusted rate that we saw in the second half of 2012.

Additionally, the tough comparison to the very strong growth that we had in the first half of last year is a factor in our outlook. Given our investments and initiatives such as mobile, ecommerce and information services, our total operating expenses will continue to grow likely just a bit below the 8% currency adjusted gross rate we saw in 2012 with more money being put to use in all of the expense line items.

Therefore, we may be able to deliver some operating margin expansion in 2013. The amount of any improvement will depend on both top line growth and investment opportunities that may surface during the year. For modeling purposes, you should assume a full year tax rate similar to our 2012 normalized tax rate of 31.8%.

With respect to foreign exchange, assuming the euro continues to trade at the $1.35 level and the Brazilian real at the $2 level for the rest of the year, we would expect about a 1 to 2 percentage point tailwind to as reported net revenue, net income and EPS growth for full year 2013.

Now let me turn the call back to Barbara to begin the Q&A session. Barbara?

Barbara L. Gasper

Thank you, Martina. We're now ready to begin the question-and-answer period. And in order to get to as many people as possible, we ask that you limit yourself to a single question and then queue back in for additional questions. John? Operator, are you there?

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) And we have a question from Craig Maurer from CLSA. Please go ahead.

Craig Maurer - Credit Agricole Securities (USA) Inc., Research Division

Yeah, good morning. Regarding your comments on European cross-border, you’re seeing increasing activity in intra-EU, is this a trend you expect to continue through ’13 and should we see the applicable yield also decline with that? Thanks.

Ajaypal S. Banga

Craig, its tough to say. This has happened over the last two years, a couple of times when if you go back through our earnings calls, you will find there were quarters when Europeans tended to travel within Europe. I think a lot depends on their feeling of confidence. My sense is, if you look at January, most of the cross-border growth that we’ve talked about, Martina was very careful to say it’s come from Asia-Pacific, Middle East, Africa and Latin America, because this European issue hasn’t really completely changed in January. So, I don’t know yet, but I’d say that its going to go through its ups and downs. Its probably a fair question, which I don’t have a good answer for it.

Craig Maurer - Credit Agricole Securities (USA) Inc., Research Division

Thank you.

Operator

The next question is from Jason Kupferberg from Jefferies. Please go ahead.

Jason Kupferberg - Jefferies & Company, Inc., Research Division

Hey, thanks guys. Just wanted to ask a question here in the U.S. with the EMV, the first EMV milestone coming up quickly in April for the acquirers, and then of course the liability shift plan for October 15, there seem to be some outstanding questions regarding how EMV will be made compatible with the multiple debit network provisions of Durbin? So, curious if you think the April deadline will hold and then could that have any impact target timelines as well? Obviously, the banks and merchants still have a lot of work to do to become EMV compliant and we’ve seen in other countries planned timelines, obviously, shift to the right. And then can you just also in conjunction with that comment on whether or not there will be any material difference in your network economics in the U.S., once EMV and chip-and-PIN, if it goes chip-and-PIN actually becomes reality?

Ajaypal S. Banga

So the second one first, and just I’ll repeat that from past time. We do not expect a material impact to our economics just because that hasn’t happened elsewhere the EMV exists and that’s kind of what we have been saying through times and my thinking of that hasn’t changed.

Jason Kupferberg - Jefferies & Company, Inc., Research Division

Okay.

Ajaypal S. Banga

The first one, when we started this whole EMV journey we have said many times over that it's possible that they won't meet their deadlines, but we put these deadlines together -- together meaning through a consultative process that involve acquirers, issuers, merchants and us. And that’s how we did it differently from some of the other forces out there. And I think we therefore feel that we’re in it together, we’re working with them. We have recently announced that we’re willing to do an OpenAPI on our EMV so that the regional debit networks can also be allowed to be enabled to participate without having to build all their own technologies which may take a long time, so we’re trying our very best to be flexible and thoughtful and take all the ecosystem players along. But, that’s how we’re planning for it. I have no way of saying will October become December or will some of the trend move but, I got to tell you our discussions are pretty productive, and the announcement that OpenAPI was greeted with enthusiasm by a number of the players, because it gives them the chance to meet deadlines and schedules and be a player in the game.

Barbara L. Gasper

Next question.

Operator

The next question is from Rod Bourgeois from Bernstein. Please go ahead.

Rod Bourgeois - Sanford C. Bernstein & Co.

Yeah, so just a couple of questions about what's happening in Europe and from a regulatory standpoint I just wanted to start with the comment about your revenue yield on cross-border transactions in Europe being held back by more travel, actually occurring within Europe. So does the lower yield on inter European transactions have anything to do with the temporary interchange rate caps that you have in Europe which could be holding back your pricing or your revenue yield in Europe and then if that is a factor, looking forward do you agree that Europe is prone to pass regulation that might include permanent interchange rate caps for cross-border transactions over there. So we’d love the comments on the European dynamics.

Martina Hund-Mejean

Rod, this is Martina. I'm going to take your first question. First of all, as we had said a number of times, there is absolutely no impact from what is happening from an interchange environment on what's happening on our fees. As we have seen a number of times over the last few years many, many times, from time-to-time depending on how the European economy unfolds, Europeans are staying closer to home. And just by the effect in terms of how our cross-border fees are set up in Europe versus when Europeans are actually traveling overseas, that's where you see a change on our yields. But it has absolutely nothing to do with the regulatory environment.

Ajaypal S. Banga

At the end of the day, they are also spending in the same currency. So we have that issue as well. You don't make the money that you would make, either the issuing banks or us on the FX. There's a lot of reasons. It's not the reason that you may otherwise think. It's actually logical that you will get a lower yield because of the way those fees are set as well as the FX.

As far as Europeans being prone to passing regulations, that's a politically great statement but you know better than I do that they love passing regulations. It's just the reality. So, I don't know what to do about that as an answer, other than to tell you that they will, no doubt, at some point of time, do something because they have said that in the second quarter of this year, they will likely publish some legislation on interchange.

What we have been doing with them is to take a thoughtful approach on legislating interchange and to make sure that they're still serious about continuing vigorous competition in the EU's payments market which, by the way, I think is a very competitive market. Any interchange in regulations got to be carefully weighed against the now known consequences of reduced trades. We've seen it in Australia. We haven't seen the benefit of lower pricing in the U.S. going to anybody, certainly not at a gas station.

So in addition, a level playing field between open four-party schemes and closed third-party schemes has got to be ensured if they want to be fair in the legislation. So, there's many aspects to this. Will they pass legislation? Yes. Will that dramatically change the industry? I don't know, but we've been through these steps earlier and we're working with them in a constructive way to help inform them while they keep in touch with us.

So, we're all in it together. Ask the banks and the merchants in Europe. I still think there's an enormous amount of opportunity in Europe, just given the quantum of cash in those economies. Germany is still 80% cash; just one number, Germany itself. You can forget before you get to the Italy's and Greece's of the world. So, yes they still happen. It's one of the things we've got to deal with, but we're dealing with it.

Rod Bourgeois - Sanford C. Bernstein & Co.

Ajay, could you have some more domestic processing wins in Europe in the hopper just to complete the European picture?

Ajaypal S. Banga

If it was in the hopper, I wouldn't tell you, Rod, you know that. But yes, that is definitely part of the strategy. Absolutely, 100% part of the strategy. SEPA and the payment systems directive allowed us to play that game, as you know, so we're in it. It's just that you get portions. In fact, today, we see domestic processing transactions in most of the European countries which we did not see just three, four years ago.

So, we're at different stages of opportunity in different countries. It takes a little time and we're kind of growing along as we go and it's not about a bad way. We're a 50-something percentage points up over the previous period on our European domestic processing number. That's a good thing, but it's off a smaller base than what we have in the U.S. and in Brazil.

Barbara L. Gasper

Operator, could we get on the next caller please?

Operator

Next question is from Sanjay Sakhranim from KBW.

Sanjay Sakhrani - Keefe Bruyette & Woods

Thank you. Good morning. I've got a question on the U.S. credit card market for Ajay. You've talked about some of the impacts related to the mix of your customers which may have led to underperformance over the past couple of years. But do you feel like when the tide turns, you might see the opposite and kind of how close are we to that? Thanks.

Ajaypal S. Banga

Great question, Sanjay. I don't know how to answer that other than -- let me put it this way. I don't know how close we are to the tide turning because that's why I'm uncertain about the U.S. economic situation. I genuinely believe that over a period of a couple of years, the United States has the opportunity to surprise people on the upside, just given how much restructuring in the economy has happened over the last two or three years, compared to some of the economies overseas. But the whole picture hasn't come together. Yes, some restructuring has happened but the regulations are still complicated. We've got moving parts from the fiscal policies, we've got consumer confidence down 11% in one quarter did surprised me.

So, those are the kind of things that I don’t know where the U.S. would go, until all those forces align you can’t see the North Star being the revival of consumer credit, if you know what I mean. But there is stuff going on, housing’s picking up, sectors related to housing are picking up.

The other part of your question, the part about our mix of customers; it’s kind of the business we’re in, right. So we get a lot of business from some customers who got more impacted in the downturn. They’re still to come out of it, you can look at their own results and you can make your conclusions on that. But from what I feel what they’re doing, they’re doing some very intelligent things as institutions to help revive their businesses. So, when they do revive, yes, absolutely I’ll also get an opportunity to ride their revival. But I don’t know when that will be, because I’m not party and privy to what they’re up to inside. I just see what I see. So, you see as much as I do, more or less on that one. That’s the part I don’t know how to answer.

In the meantime, what I’m trying to do, is to diversify my customer base in the U.S. and that’s what takes time, but I have over the last year or two won a number of deals in the independent bank and credit union and regional bank spaces and those are helping. They’re very, very helpful, we’re building new partnerships and new friendships along the way and we’re looking at the right co-brand portfolios whether it would be Bass Pro or the Shell and the Fuel Rewards Network, there are others that goes in the hopper.

Sanjay Sakhrani - Keefe Bruyette & Woods

Thank you.

Barbara L. Gasper

Next question.

Operator

Next question is from David Togut from Evercore Partners.

David Togut - Evercore Partners Inc., Research Division

Thank you and good morning. U.S. commercial credit continues to drive most of your GDV growth.

Barbara L. Gasper

David could you speak up just a little bit, we’re having a hard time hearing you.

David Togut - Evercore Partners Inc., Research Division

Okay. Can you hear me now?

Barbara L. Gasper

It’s little …

Ajaypal S. Banga

Go ahead. You were saying something like U.S. commercial credit?

David Togut - Evercore Partners Inc., Research Division

Yes, so U.S. commercial credit continues to drive most of your U.S. credit GDV growth, Visa has made a lot of investments in their U.S. commercial credit platform even though they were really years behind MasterCard. Do you see the competitive battle with Visa changing a lot in U.S. commercial credit over the next couple of years and what do you see as your main competitive advantages in this area versus Visa?

Ajaypal S. Banga

I always think of all the competitors in that space as being relatively good at what they do. It’s a well served market, both by AmEx and Visa, quite frankly, we all do a decent job. In many ways, I think our assets hadn’t completely been owned at the front end of our business to give us the results that we’re now beginning to get by realigning those assets.

In the meantime, we put money into improving a number of our assets over and beyond what we had, let’s say, a couple of years back. So, we’ve got a new version of Smart Data out there, which is one of the reasons we win these deals and that new version is actually even superior to what we had earlier. So, we feel relatively good in that space. And vis-à-vis, with the other competitors in the space, if you travel outside of the U.S. and you do not only go to certain countries where you can go to the five star hotels and the bigger restaurants, I continue to make this point, that it just takes a few people in that company to have an unfortunate experience where their card is not accepted or doesn’t work for that company to feel the need to empower their employees with the cards that work everywhere and that helps us win our deal. We believe that the power of our acceptance is superior to that of others.

And so between different competitors have different advantages and disadvantages vis-à-vis us. My sense is between Smart Data, between the aspects of the acceptance and then all that we do with our small business rewards and all the activity in the commercial card space, I continue to feel that we’ve got some runway for growth here for a little while. Now, I don’t know whether the numbers will be as high as they’ve been in the past year or two. Who the heck knows that, but I’m pretty confident of our advantages and our product portfolio.

David Togut - Evercore Partners Inc., Research Division

Thank you very much.

Barbara L. Gasper

Next question.

Operator

Next question is from James Friedman from SIG.

James Friedman - Susquehanna International Group, LLP

Hi. Thank you for taking my question. Since, it’s topical this week, in this month, I just wanted to ask about the introduction of fees related to the merchant litigation settlement specifically some of the surcharging that you might be seeing if any at this point? Thank you.

Ajaypal S. Banga

Hi, James. Not seeing anything new, just happened in the 27th and so, it’s been three days and I don’t know that anybody has done much in that space. But remember, first of all, a number of states in the United States, do not allow this even if the settlement provides for it. So, that’s kind of one thing that you’ve got to factor in and there are 10 states that don’t allow it, but they also represent a larger percentage of the transactions just because of the nature of those states. But beyond that, all I know is what I've seen elsewhere. And I'm kind of using that to inform my thinking. Now, every market's different and the United States is different but if you think about the U.K. or Australia or other locations where surcharging has been going on for some years, I've seen it start in some ways, fizzle out in others, continue in merchants where their competitive position allows them to do so online, ticket sellers for airlines, for example, and so on. It could well happen, but it doesn't really go to a very large extent because of the obvious consumer dissatisfaction. I mean that's the reason the rule was enacted in the first place.

So, it's that idea. But in the settlement, it is allowed. On the 27th, they could go ahead. I'm sure there are a number of them considering it and doing it. Even before it started, there were discounts being offered for cash vis-à-vis cards, in a number of merchants in the U.S. So I think the picture isn't as clear as some spreadsheet would give it out to be. It is a little murky, but that's how I think about it. I think over six, seven, eight, nine months, depending where this whole litigation goes with the court and the opt outs and the like, that's when you'll be able to see where really this is going. I doubt you'll see a great deal in the early part of these days.

James Friedman - Susquehanna International Group, LLP

Thank you, Ajay.

Operator

Our next question is from Bryan Keane from Deutsche Bank.

Bryan Keane - Deutsche Bank, North America

Hi, guys. Just wanted to ask about the move to EMV chip and PIN. I assume that's going to impact your debit yields since the likely move to PIN will drive lower U.S. debit revenue. So, I guess just thinking about the strategy, how do you plan to offset that debit yield revenue loss? And then second question for Martina, the pick-up you expect in net revenue growth in the range after 2013, I think you said to even potentially the high end of the range. Is that purely economic driven? I'm just trying to gauge your visibility there. Thanks.

Martina Hund-Mejean

Yeah, Bryan, let me take both of them because we just had the question in terms of whether the move to chip and PIN is actually impacting our economics. And Ajay had said no. When we look really at other markets where we had introduced EMV over a number of years, it really does not impact our economics. Every market is obviously different, but we really don't expect anything differently in the United States.

In terms of the net revenues, moving potentially higher in the higher end of the range beyond 2013; yes, it's exactly how we laid it out at the Investor Day conference back in September. The one variation that we always have to deal with is really what's going on in the economy. And as you know, we are really relating that to our growth in Personal Consumption Expenditure and we do believe that in the early part of the range of the 2013 to '15 period, that really the Personal Consumption Expenditure is a little lower than what we've seen in the last few years. And hopefully as the world normalizes, that will move up.

So it's only that one particular impact. It's not the other drivers that drive our revenues, which is basically the secular trend in terms of conversion from cash and check to electronic forms in payments, nor what we are thinking in terms of participating more in that 15% share that is already converted to electronic forms of payments.

Ajaypal S. Banga

So, Bryan, think of it this way. When we make targets for these years out, we kind of look at all the factors, obviously, that change our revenue; one being the PC, which Martina just explained. We think the early part of these years may be tough, but just given what the economic environment is, I should think the first half of 2013 will actually be tougher than the second half let alone out into 2014 just given what's going on in the U.S. and Europe. But once we get past that, we are doing a bunch of things strategically to grow more share in the 15%, we're doing things to participate in the 85, all that's factored into the numbers we gave you.

The only variable that we see changing, which is driving the guidance we are giving you, is what we think about economic growth. The others we are still plugging along. We are putting our money into the strategy, we're doing things to grow our business, we're doing things in mobile, we're doing things in prepaid, in commercial, in credit, in debit, in biometrics, in financial inclusion. That's not changed. It's the response from the PCE that really Martina is referring to.

Second, a little clarification you might think about is let me give you one of the many reasons why EMV technology implementation doesn't equal diminution of economics. We can do many transactions that don't work on a single message format. For example, where the final amount of the transaction is not fixable at the time that the transaction is authorized which by the way are some of the most interesting transactions. You leave a tip at a restaurant. You got a $300 bill. You're going to put 35 bucks hopefully or 50 bucks or 20 bucks depending on where you are in the world on the tip. That entire transaction doesn’t go through in a single message. That's a little different. If you stay at a hotel. You use a rental car. Those are all different transactions to just the ones that go through very easily on single message.

So, EMV what it really does, it's a card authentication methodology. It tells you when that card goes in there is a dynamic encryption on the chip, it says that's a real card. It's not one that's been counterfeited or compromised. And so that's what it's about; and that's why I would encourage you to think about this a little differently from; oh my God, that just means everything is going to hell in a handbasket due to chip-and-PIN. We’ve had 20 years of experience of doing this in Europe and Asia and so we've got some history behind us when we're telling you this. I hope that helps, Bryan?

Bryan Keane - Deutsche Bank AG, Research Division

Now that helps. I mean, the confusion always is that the debit market has two different yields for signature and for PIN, so that will be …

Ajaypal S. Banga

That’s got a lot to do with the nature of debit as a business where you’re really in fact if you think about outside of the U.S. it doesn't have such a widespread between signature and PIN. The U.S. had a developmental pattern where signature debit went all the way to signature credit, and that's what led to the Durbin Legislation. So, this is a self-fulfilling issue. I actually think that debit per se being the money of the consumer has a different profile and being direct access from the bank has a different profile in terms of the risk profile for the merchant, the risk profile for the issuer and therefore the interchange is today going to a lower level than it did in the past.

Bryan Keane - Deutsche Bank AG, Research Division

Okay. Helpful, thanks.

Operator

The next question is from Glenn Fodor a private investor. Please go ahead.

Glenn Fodor - Autonomous Research

Hi, good morning, it’s Glenn Fodor from Autonomous Research. Thanks for taking my question. Ajay, reports said debit issuance is beginning to gain momentum in some parts of your APMEA segment. What's the story here for getting more volumes? Is it just winning new issuing business or do these countries have local government bank backed debit schemes that you'll have to compete with similar to Europe and that could impact your growth rate?

Ajaypal S. Banga

Glenn, I didn't hear the first part when you started out. I heard the second part. You said something's growing in Europe and you went in and out on me.

Glenn Fodor - Autonomous Research

I'm sorry, I switched to the handset. There's just been some reports out there about debit issuance is gaining momentum in some parts of Asia Pacific, Mid-East and Africa segment. So, what's the story for gaining volumes? Is it just winning new issuers or are there debit schemes like there are in Europe owned by the banks that you could win and things like that?

Ajaypal S. Banga

Got it, got it. That’s a great question Glenn. It's doing in different ways. There are a number of countries around the world, where there are local debit schemes, but unlike the way Europe originally developed when those debit schemes were mandated to be the only ones and nobody else could compete. In most of these countries, there is actually competition between a local debit scheme either run by the government or run by the local banks and us and most of them, not true for all, but in most of them. So, what we are trying to do is to try and be sensible about all those opportunities and play there and so, you know that we only see something like 50% of our process transactions around the world through all these reasons of the kind of schemes we're talking about. But that number's been growing, thanks to SEPA, thanks to the work we've done in Brazil, thanks to the work we're doing in a number of countries around the world, but this is a continuously moving issue. And most of the emerging market countries as they see the value of payments in electronifying their environment and country, they're more and more headed down the path of saying let's make sure that we have some control of the payment environment.

So, you've got to deal with them and play with them. And a number of them, they’re even trying to white label what we do, to help them setup their payments network so that they’re embedded in where they are, and it's not just us doing it, it's others doing it too. So, all of that actually is great, because what it's doing is it's driving the move from cash to electronic. And I’d tell you, the opportunity in places like Africa, I mean, this trip this week in Africa, just reinforced everything. And in December I was out in Myanmar and of course in the developed economies of Asia. But you go to Myanmar and you see the opportunity, it's not today, maybe my successor will get a great deal of benefit over Myanmar, but I’d tell you for the next 20 years, you can see the opportunity if we do this systematically with technology, with care for local governments and being sensible about the role we play and that's what we're trying to do.

Glenn Fodor - Autonomous Research

Thanks, Ajay. I appreciate it.

Ajaypal S. Banga

Somebody ask a question, Barbara.

Barbara L. Gasper

Next question.

Operator

And we have a question from Ken Bruce from Bank of America

Ken Bruce - Bank of America Merrill Lynch

Thanks. Good morning. My question really develops on a couple of the other questions and answers that you provided specifically around the secular growth potential. I'm wondering if you're seeing any changes to that aspect of the growth potential. Maybe if you just look at the past couple of quarters, obviously the economic backdrop is being quite low and has been creating headwinds, yet you continue to grow through that and I'm wondering is it that you're seeing the secular potential accelerate here to the upside or if it's more of the market share wins that is essentially driving that growth? And how do you see that playing out? And I have a follow-up after that.

Ajaypal S. Banga

Yeah, I don't think the secular growth potential has yet all the work we're doing. Think of the mass we're dealing again. So, we launched 5 million cards in Kenya, that's interesting, but there's like hundreds of millions of people in Africa. When you do 10 million South African social security benefit cards, that's interesting, but there are 60 million people in South Africa alone. So what happens is that you make dents in the system, but as you make the dents over a period of time, it accumulates.

It's also interesting that the emerging world and the developed world are kind of moving around in terms of their PCE growth. So what's happening is with the emerging world growing faster and with their PCE growing faster, but their level of electronification being lower, when you weight the whole thing together, the damn thing still looks like 85% cash and 15% electronic, even though it isn't that way if you go by country. There's a change happening in the emerging world that's pretty quick, but the total number doesn't change.

So I don't know yet. I think that's what we've got factored in, in the guidance we've given you is what we see today in that secular growth. It isn't dramatically different from the last two or three years. What drives that is urbanization, globalization, travel, middle class growth, all the stuff that we all know about. I haven't factored in huge increases from that in my revenue growth expectations. If that changes, we will talk to you again. But right now that's where we are.

Barbara L. Gasper

Operator, we have time for one last question.

Operator

Our last question is from Julio Quinteros from Goldman Sachs.

Ajaypal S. Banga

Julio?

Julio Quinteros - Goldman Sachs & Co.

That's my Indian name.

Ajaypal S. Banga

How are you doing?

Julio Quinteros - Goldman Sachs & Co.

I'm good. So just real quickly on the cadence of spending, Martina, can you just go through that real quickly in terms of rebates and then also add marketing through the first half and the second half of 2013?

Martina Hund-Mejean

Well, as you know, the rebates and incentives are all baked in what we said already about revenues, right? And I really don't expect any different cadence in what you already had seen in the last year, which was up by the way not too different from 2011. From an A&M spend point of view, so I just want to draw you back. We said total operating expenses of 2013 is expected to be just a bit below the 8% currency adjusted growth rate that we saw in 2012 and really what you should be taking this -- in all line items. So G&A, A&M as well as D&A will be impacted from that point of view. So all of those line items you should be expecting to grow in order to get to this just below 8% on a total basis.

Julio Quinteros - Goldman Sachs & Co.

Okay, that's great. And Ajay, of the 25 new initiatives that you mentioned in mobile on a global basis, what is the base technology for that? Is it NFC? Is it Tap & Pay? What are you guys looking at?

Ajaypal S. Banga

Good question. It's mixed. The NFC Tap & Pay kind of stuff is in a number of the markets, but actually what's also doing really well is the joint venture we had with Smart which uses a basic wallet that allows SMS-based money movement. That's what Telefónica has, that's what we're doing with a number of people; Tim. We're doing it with Turkey, with Toxel which actually is probably out there the longest and the most effective. So, it's a mixed bag there. Julio, there's both types going on.

And as I said, I'm trying to put my best into multiple places in mobile because I think that this thing will develop in different ways whether it go NFC and Tap & Go, whether it go with the SMS, what rolled the wallets out there. That's why we're so keen to put our wallet as an open wallet rather than one where we own the consumer. We want to be seen as the brand, if you will, at the bottom right-hand side of the card for a mobile payment. So we're not trying to be the brand in any other part of the card. And that's kind of what our whole perspective is in this mobile space. So, it's a mixed bag of those. But maybe the next time we meet, we can talk a little bit more about it.

Julio Quinteros - Goldman Sachs & Co.

That's great. Thank you, guys.

Barbara L. Gasper

Before we sign off, I think, Ajay, you've got some closing comments.

Ajaypal S. Banga

Yeah, just thank you all for your questions and Julio, I hope you don't mind my pulling your leg about your name, but I couldn't forget that when you came on. So, let me leave you with a few closing thoughts. We just ended a great 2012. We built off the momentum we had in 2011. 2011 was an even stronger year in terms of financial performance as you know.

Now 2012, good performance is good, despite the somewhat unpredictable economic circumstances and these choppy waters globally that we’ve just talked about, and as you all know, consumer spending and confidence were slower in the second half of 2012 in many parts of the world. That environment continues as we enter 2013. We are all very conscious of that, we’re very watchful. But we’re going to keep investing in the initiative that we see having the maximum potential for our future, some of the things we just talked about between the call and the questions. These are not things that Martina and I believe, can be turned on and off like a tap. So, all in all, we haven't changed our thinking from what we said to you at Investor Day last September.

We are confident about our 2013 to 2015 objectives. We do expect performance in the early part of that period to be below the range. We think growth will pick up as we go along. As I said a little while back in answer to a question, I continue to believe that the U.S. economy has the potential to outperform over the three-year period and that will have a salutary effect on global economic conditions.

Meanwhile, our task is simple, relatively simple, guide our ship through these waters, stay focused on both growing share in the current electronic payments business as well as just keep investing in driving the conversion of cash through technology, but also through public private partnerships around the world and that's what we’re trying to do. So, thank you for your participation. Thank you for your support and thank you for being on the call.

Operator: Thank you ladies and gentlemen. This concludes today’s conference call. Thank you for participating. You may all disconnect at this time.

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