Long Visa: Not All Credit Card Companies Are Created Equal

The next shoe to drop, a hidden time-bomb. This is the herd’s mentality on the credit card companies. I am telling you not to follow the herd and label all card companies together. It would be a big mistake to do so, and they are not created equally.

You should know by now of the two different business models of the card companies. Visa (V) and MasterCard (MA) do not take on the credit risk of their customers. This is passed on to the issuing banks. It’s the main reason why Visa and MasterCard are head and shoulders above American Express (AXP), Capital One (COF), and Discover (DFS). While American Express, Capital One, and Discover have piled up losses and write-offs, Visa and MasterCard have beaten their earnings estimates consistently and easily each quarter. They are really just toll collectors on each transaction when a card is used.

So how is Visa different and better than MasterCard? Let us count the ways.

1. Market Share. Visa is the market leader in credit cards having about one-third of that segment, the market leader in debit cards having about two-thirds of that segment, has the largest payment network, VisaNet, which accounts for roughly 59% of all transaction volume, and has about 55% of all total cards issued. The main trend is a shift from cash to plastic across the world. You would think this trend is in trouble given the recent stigma of being in debt, but it is not. In fact there is a trend within a trend. The shift from credit cards to debit cards so the customer has no chance of getting themselves in debt as the debit card automatically deducts the cost from a linked account. While luxury spending may subside for a while given the recession and layoffs, card usage has been increasing for all items that include gasoline, food shopping, going to the movies, shopping at the drugstore, and even at McDonald’s. Just use a card and Visa gets paid and usage is not slowing down at all.

2. Litigation Insulation. Both Visa and MasterCard have settled lawsuits with American Express and Discover. Visa, however, settled with American Express in 2007 before their IPO. Visa then used $3.2 billion of their record IPO to fund an escrow account for future litigation costs. They then used that recently for the Discover suit. These actions by Visa management significantly insulated the shareholder from these costs. MasterCard had no such provisions in place exposing their shareholders to those costs.

3. Visa Europe Will Be Counted Soon. Currently Visa Europe is a separate entity from Visa and none of its revenues, cash flows, and earnings are counted in analyst projections. Visa has a put/call option that can be enacted to buy Visa Europe from the member banks beginning on May 9, 2009. count on Visa Europe being brought into the fold sometime this year giving an earnings growth boost to Visa.

4. Governments vs. Interest-Rates and Interchange Fees. Governments around the world want to alter what they deem high interest-rates and unfair fee practices. What some investors do not understand is that the interest-rate and the interchange fee affect the issuing banks of Visa and MasterCard more than the card companies themselves. Quietly Visa has shown more of a willingness than MasterCard to work with government and renegotiate some fees with merchants which will protect their margins better than having government name the price.

5. Cleaner Balance Sheet and Other Ratios. Visa has the best cash ratio (1.75), debt-to-equity ratio (0.47), degree of operating leverage (0.95), and degree of financial leverage (0.068) in the industry. Compared to MasterCard’s cash ratio (1.44), debt-to-equity ratio (2.36), degree of operating leverage (1.21), and degree of financial leverage (2.15). In a de-leveraging economy Visa has nothing to de-lever and its earnings are not reliant on leverage to the extent MasterCard’s earnings are.

6. ZillionTV. This is Visa’s joint venture in television and content with the heavy-hitters of media. An application of ZillionTV is a Wii-like interactive shopping program run, and transactions processed, by Visa. This could be a major headache in the future for the cable and satellite companies. Bad for them, good for Visa. Granted any growth benefit is years away, but it shows Visa management is thinking of innovative ways of growing their core business while at the same time branching out into a different area.

Positions: Long V; Short Jan. 2010 V Calls

Comments

[daveddawg:]

Go Visa. Kick AIG & C out of the DOW, and put in V, a company that will grow. This will stabilize all markets.

Apr 02 09:15 AM

[Harry Tuttle:]

While it is true that they do not take credit risk, I would expect the number and value of transactions to be positively correlated with consumption. The stock already trades above 20 times earnings. Not exactly cheap in this economy.

Apr 02 10:05 AM

[who:]

Strong resistance around $58, should it stay above $58 then I will put a bull call spread.

Stock is down form its high of $90. Great stock to trade and buy for the long term investment.

Apr 02 12:23 PM

[gkr87:]

The total debt-to-equity ratio of Mastercard is 8.76 not 2.36

Apr 02 02:48 PM

[Joshua Morg...:]

yeah, i think that most of the downturn in consumer spending is in V since its drop from high 80's...Barclays had a great piece of research on V in mid-feb after meeting with management as well

I bet Visa or Travelers get added to the Dow when they replace Citi this summer

good article

The Reformed Broker

Apr 02 08:36 PM

[Marcap:]

You are absolutely correct, Harry. While Visa and MasterCard may not be directly exposed to the same risk of consumer credit card default as the banks are, they will certainly feel its impact. After all, with less credit cards in circulation, it only stands to reason that there will be less credit card transactions. Less transactions equate to less fees for Visa and MC. And of course that does not even take into consideration the growing impact places such as PayPal have on their overall revenue streams.

On Apr 02 10:05 AM Harry Tuttle wrote:

> While it is true that they do not take credit risk, I would expect
> the number and value of transactions to be positively correlated
> with consumption. The stock already trades above 20 times earnings.
> Not exactly cheap in this economy.

Apr 03 12:58 AM

[H.J. Huneycutt:]

Interesting article. I'll have to look into V.

Fwiw, I don't think DFS is a bad buy right now, either. Even if they do take on greater risks, the stock would appear to have an astronomically high default rate (15%+) already factored into the price. They have the cash and equity to absorb very substantial losses.

Apr 03 08:09 AM

[H.J. Huneycutt:]

Just took a quick glance at Visa's balance sheet and I'm not sure I'd share your somewhat rosy assessment of it. For one, once you discount Goodwill and Intangible Assets, Visa basically has 0 equity. That should debunk some of the stuff about its lower leverage.

Of course, V could still prove to be a good investment, but it's certainly not because of a strong balance sheet. Discover's B/S looks vastly better to me.

Apr 03 08:15 AM

[Ishortyou:]

I think Discover Financial looks pretty good DFS.

Apr 03 09:18 AM

[Marcap:]

I agree completely. DFS has a very strong B/S whereas Visa's B/S leaves quite a lot to be desired. At $6.50 DFS is trading at just over 50% of its net book value, while Visa on the other hand at $56.00 is trading at over 87 times its net book value which is virtually nil after factoring out all the fluff. IMO, Discover beats VISA hands down with regards to both potential gain and downward risk.

On Apr 03 08:15 AM H.J. Huneycutt wrote:

> Just took a quick glance at Visa's balance sheet and I'm not sure
> I'd share your somewhat rosy assessment of it. For one, once you
> discount Goodwill and Intangible Assets, Visa basically has 0 equity.
> That should debunk some of the stuff about its lower leverage.<br/>
>
> Of course, V could still prove to be a good investment, but it's
> certainly not because of a strong balance sheet. Discover's B/S
> looks vastly better to me.

Apr 03 09:57 AM

[Deumlaokeng:]

Most credit card companies are created quite equal, especially Visa and Mastercard as they are simply different sides of the same coin, the same monopoly or maybe now a veneer of a duopoly, formerly a single-sided monopoly, the banker's consortium known amongst us merchants as "Merchant Services". One can not go wrong investing in any monopoly that has the power to raise rates at will, not to mention the power to force merchants to buy airline tickets for the consumer. The only downside is a slide in consumer spending which can easily be offset by raising the discount rates they charge the merchants, even though the cost of processing goes down. And that is exactly what they are currently doing, raising rates to offset the spending slowdown. Resistance is futile.

Discover and Amex are not monopolies but mere secondary players. Many merchants are able to survive without accepting those cards. As the VISA/MC duopoly begins to increase rates to offset decreases in consumer spending, as well as to offset financial losses elsewhere, expect to see more merchants stop accepting AMEX as the cost averaging of the transaction fees no longer allows for the far higher AMEX costs. As for Discover, I have never lost a sale over the past 20 years for not accepting that card, they are not really in the game.

Apr 04 09:02 PM