Since my last article "MasterCard And Visa Are Winning The War On Cash" in early March 2013, shares of MasterCard (MA) and Visa (V), as well as those of the two other major credit card companies, American Express (AXP) and Discover Financial Services (DFS), have healthily outperformed the rise in the S&P 500 index (see graph). MasterCard and Visa should continue to benefit from:
a secular shift to paperless payments,
higher consumer confidence and employment rate,
lower bankruptcy rates, and
higher utilization of credit cards by businesses.
There are threats to the top two credit card companies from their smaller competitors Discover and American Express as well as from technological innovation, regulations and new entrants. However, there is little evidence so far that anyone is threatening significantly MasterCard's and Visa's global dominance in payment networks. The growth that Discover and American Express are seeing is mostly from offering additional services and products, not from gaining market share from MasterCard and Visa.
Quarterly performance and valuation
In a word, MasterCard's and Visa's first-quarter performance was fantastic. During the quarter ended March 31, 2013, MasterCard and Visa reported revenue increases of 8% and 15%, while their earnings per share rose by 16% and 20%, respectively, compared with the same quarter of 2012. Net income per share growth was better than the growth in revenues due to lower rate of increase in expenses as compared to revenues and share buybacks. MasterCard and Visa repurchased shares worth $766 million and $1.8 billion during the latest quarter, respectively. Similarly, Discover's and American Express' revenues rose by 10% and 4%, respectively, while their earnings per share increased by 10% and 7%, respectively. MasterCard, Visa, Discover and American Express have approximately $1.7 billion, $1 billion, $2.4 billion, and $4.2 billion, respectively, available for share buybacks in the next few quarters.
As of this writing, MasterCard and Visa traded at similar valuation levels based on price-to-earnings (22.5 for MasterCard and 23.8 for Visa) and on price-to-earnings-to-growth (1.2 for MasterCard and 1.5 for Visa). In addition to aggressively buying back their own shares, both companies return capital to shareholders by paying dividends. MasterCard and Visa have annualized dividend yields of 0.4% and 0.7%. Finally, both MasterCard and Visa are less volatile than the market as they have betas of 0.8 and 0.7, respectively. It is interesting to note that shares of MasterCard and Visa are valued as growth companies, while Discover and American Express have the valuation characteristics of banks with higher volatility, lower price-to-earnings ratios, and higher dividend yields.
Recent developments and regulatory hurdles
From operational and competitive standpoints, MasterCard and Visa continue to win new customers and offer innovative services and products. During Q1 '13, MasterCard's MasterPass Wallet made a deal with Alibaba Group, the large Chinese based e-commerce company, which gave MasterCard access to 6,000,000 merchants and 800 million users. Visa's most notable development in the past quarter was its partnership with JP Morgan Chase (JPM), which gave JP Morgan Chase bank more flexibility in setting interchange terms with merchants. This allows greater cooperation between issuers and acquirers without Visa standing in between with its rules. In essence, this is similar to American Express' own closed loop network. Overall, Visa will likely gain market share and some incremental revenue due to its relaxing of rules until MasterCard follows suit.
Also, MasterCard is able to gain more corporate customers, likely at the expense of American Express, with its products offering automated business expense management. Most recently MasterCard introduced mobile applications that are able to reduce expense accounting overhead and improve the overall expense tracking process for businesses. The most recent large win in this area was the government of Canada, which is converting its travel expense program to MasterCard.
On the negative side, MasterCard did have a setback recently as an organized group of criminals was able to drain over $40 million from two Middle Eastern banks, National Bank of Ras Al-Khaimah and Bank of Muscat, with fake ATM cards. Experts agree that if MasterCard had implemented the security chip and pin it already uses in Europe (EMV for Europay, MasterCard, and Visa) this large theft could have been prevented. Making ATMs and merchants accept EMV technology is going to require significant resources and is expected to be implemented in the U.S. by 2016. Companies that can benefit from ATM retrofitting include NCR (NCR) and Diebold (DBD), which is the subject of another article.
Discover is threatening MasterCard and Visa's dominance by partnering with eBay's (EBAY) Paypal. Paypal hopes to be accepted everywhere where Discover is, while also giving Discover access to the millions of its online customers. This partnership is potentially dangerous for MasterCard and Visa as it combines two major payment companies with complimentary expertise. Paypal brings technology experience while Discover is an expert at point of sales and offline networks. The partnership is being rolled out this year and it is still early to measure its success.
Also, American Express is rolling out its partnership with Wal-Mart (WMT), called Bluebird, offering its network to be used similar to a bank and allowing the two companies to offer such services as FDIC insured free checking, pre-paid debit cards, and direct deposit from employers and governments. While these two developments are in their early stages and are currently taking place only in the U.S., they are something investors in MasterCard and Visa need to be aware of.
Finally, on the regulatory front, MasterCard and Visa are having challenges that both companies have been able to manage well so far. In the U.S., MasterCard and Visa are close to settling the antitrust lawsuit filed by merchants and the expenses are already accounted for. The suit should not have a major impact on MasterCard and Visa as it simply slaps a fine on the companies without effectively increasing merchants' fee negotiation leverage. A major reason is that 11 states have already banned merchants from surcharging customers that pay by credit card. On the negative side a number of states, in addition to major retailers such as Wal-Mart and Home Depot (HD) have recently voiced their opposition to the settlement deal as it will prevent retailers from suing MasterCard and Visa in the future.
And in Europe, the European Commission is investigating MasterCard and Visa in regards to inter-regional interchange fees and cross-border acceptance rules. The effect of this investigation is too early to estimate but it is likely to have larger impact on MasterCard as VisaEurope is a separate entity from Visa.
Credit card companies such as MasterCard and Visa are no longer just about making paperless transactions more convenient and secure. They want to develop a deeper relationship with customers as evidenced in their evolving marketing campaigns. For example, MasterCard is sponsoring the BRITs music awards and recently signed-up Justin Timberlake to promote MasterCard at his concerts and in ads. Also, MasterCard is developing a concept called Priceless Cities that allows major cities' residents and visitors to find out about everyday events and deals.
Similarly, Visa is offering a high-end Infinite Dining Series to its customers and American Express has its own Delights program and has partnered with Twitter to allow consumers to buy directly on Twitter. Finally, Discover card is offering new credit cards (Discover it) with lower fees and better customer service and is also expanding into traditional bank areas such as direct mortgages and student loans areas. Such innovative rewards and/or offerings increase customers loyalty. Importantly, new services and partnerships allow credit card companies to leverage their payment networks with minimal investments.
Without a doubt, credit card companies are here to stay. Even more, it seems like they are taking full advantage of the secular move to a cashless society. Also, the credit card companies are partnering with issuers, merchants and even competing companies to offer a better and more competitive products and services. While anti-competitive regulations are likely to have a negative impact it is likely to be minimal due to MasterCard's and Visa's experience in the legal area. The current dynamics are likely to contribute to MasterCard's and Visa's continued strong performance for the foreseeable future.
My past articles on MasterCard and Visa: