Visa's Management Presents at Morgan Stanley Technology, Media & Telecom Conference (Transcript)

|
 |  About: Visa Inc. (V)
by: SA Transcripts

Visa, Inc. (NYSE:V)

Morgan Stanley Technology, Media & Telecom Conference Call

March 05, 2014 12:30 PM ET

Executives

Byron Pollitt - Chief Financial Officer

Analysts

Smitti Srethapramote - Morgan Stanley

Smitti Srethapramote - Morgan Stanley

So good morning everyone. My name is Smitti Srethapramote, I am the payments and processing analyst in Morgan Stanley. Before I begin I just wanted to note that all important disclosures including personal holding disclosures and Morgan Stanley disclosures appear on the Morgan Stanley public website at morganstanley.com/researchdisclosures. This morning we are very pleased to have Byron Pollitt, the CFO of Visa with us.

Byron you guys released an 8-K this morning that has some updated information regarding transaction data for February, maybe you can start off with you giving just an overview…

Byron Pollitt

Yes so I would be happy to. So as Smitti said we released an 8-K this morning. So as our practice we would like to give some progress through the quarter on certain of our transaction metrics. So let me start with U.S. payment volume and let me anchor it first in what delivered or reported for the first fiscal quarter which ended in December. U.S. payment volume growh in the December quarter was 8% and that’s exactly what it was for January and for the month of February, 8%.

There was no real difference when you look at the spread between credit and debit; for the first fiscal quarter, for January, for February credit grew at 10%, debt at 7% for the first quarter then 6% in January, then 7% in February. So I would say steady as she goes in the U.S. And if we then move to cross-border, here we saw a bit of a down shift. In the first fiscal quarter, we delivered 12% cross-border growth measured on a constant dollar basis, drop to 9% in January and 8% in February. And then if you look at the split between U.S. and international, the first quarter we had 11% cross-border growth, in the U.S. 8% in January, 6% in February, international went from 13% in the first quarter down to 10% in January, 9% in February.

Just a little bit of color here. First of all as contact cross-border rates tend to be a bit volatile. So it’s way too early to call this -- it’s certainly a downshift relative to the first quarter, but it’s way too early to call it a trend. With regards to where it’s occurring geographically, I would say that it is both in the developed and in the emerging markets. So it’s a broad based down shift. And if I had to pick one area where it was probably a bit more pronounced, it would be Latin America, where it got two assists, one of which from a couple of governments who are attempting to restrict, travel and then it certainly was hurt by several weakening currencies. With regards to process transaction growth, it remained very healthy. We delivered 13% in the first quarter, the December quarter and then 11% in January; February, 11% as well, so very, very healthy.

I would say overall when I talk to you all on the first quarter call we characterized the U.S. recovery as tepid. I think what we're seeing in January and February is a continued trend in support of that judgment. The numbers I just talked to you about are consistent with how we thought about the guidance. So from that standpoint, none of these numbers would change our guidance and we look for, hope for some acceleration as the year progresses particularly in the U.S. but we're not counting on it.

Let me close with just a word on Russia, since the activities of the Russian military have come to grab the headlines over the last week or so. First of all, Russia in our orbit is, without question that's an important long-term growth market for us. We have four regions, the smallest of which is Central Europe, Middle East and Africa; Russia is one of the largest countries in our smallest region. So, we pay a lot of attention to it. It is a rapidly growing market. It would certainly be disappointing if the activities that are currently underway in the Ukraine ended up creating a broader dislocation.

So, let me just say it is an important market for us, where we keep a close eye on it. But it is one that is that we our portfolio is broad enough that we can handle disruptions of this type as long as they remained relatively contained.

Question-and-Answer Session

Smitti Srethapramote - Morgan Stanley

Maybe just following up on a couple of the regions and particularly the U.S. a lot of the data that we've seen from the retailers have been relatively week in the first two months of the year because of weather related issues. Just wondering based on seasonality patterns, are you seeing any abnormal decrease [as entails] that could potentially attributed to the adverse weather that we have seeing?

Byron Pollitt

It's -- we don’t like to use weather as a driver of our performance, but I mean if you look back over the weather particularly in the U.S. over the past couple of months it’s clearly been more severe in a way that would discourage retail at the physical point of sale. The balance is when you shop online you’re opened 7 days a week, 24 hours a day. And so we’ve seen a pick up in the online business that’s remained very healthy in fact. As I said on the earnings call this was the online that really delivered the holiday spend for the first fiscal quarter.

I am sure it has something to do with it but we look more broadly at the underlying economic drivers. And in the end if credit and debit are going to start getting back to some really healthy growth rates then it’s going to have to be economic driven which means more than a tepid recovery.

Smitti Srethapramote - Morgan Stanley

On the issue of debit, can you give us a flavor what you’re seeing in terms of growth intend versus signature? Recent data from one of the largest merchant acquirers show that growth has signature debit may have turned negative in January.

Byron Pollitt

That’s not what we’re seeing. We’re, both are growing at healthy single-digit rates. There is not a lot of difference between the two in terms of growth rate. So, both of those product types are performing well within our orbit.

Smitti Srethapramote - Morgan Stanley

And just sticking with the U.S. It’s been a little bit over a year since your deal with Chase was announced. Can you give us an update on the status of the partnership and what kind of impact on volumes you may be seeing? Recently one of your (inaudible) called out the potential loss of revenue streams in 2014 (inaudible).

Byron Pollitt

So, with regards to the Chase net part of this relationship, we have been up and operational now for some time. Chase has, according to their Investor Day it was last week, has a number of merchants in pilot, those are expected, from their words, expected to come out of pilot in their second fiscal quarter and we’ll see where we go from there. We don’t have a line of sight to what happens when they come out of pilot.

With regards to a part of that deal, requires a portion of the portfolio that's non-Visa to be converted to Visa that activity is underway. We said at the earnings call that this would be much more back end weighted for us. So no material impact, I would say certainly in the first three fiscal quarters of our year, we start to see it more in the fourth fiscal quarter.

But this is something with a -- the bigger impact for us is more likely to be in fiscal year ‘15, where the conversion completes and annualizes.

Smitti Srethapramote - Morgan Stanley

Have you had conversations with other issuers and merchant acquirers about structuring the same type of deals that you struck with Chase?

Byron Pollitt

Everything we have done for Chase, we stand ready to fully duplicate or do a suitable version with any of our other partners. We have discussions underway but I think honestly this is more of, some of our institutions have just chosen to do pursue a different strategy, others I think are wait and see.

Smitti Srethapramote - Morgan Stanley

Yes. You guys have talked about China as being a 5 to -- sort of more a 5 year plus opportunity; I know Charlie was in China over the past couple of weeks, can you give us any updated thoughts in terms of the China opportunity for Visa?

Byron Pollitt

So China, note that I think it remains one of those very attract -- potentially attractive long-term growth opportunities for us. In order to realize it, it’s going to mean persistent focus and patience and relationship building which will be the near-term deliverables that deliver long-term fruit. So, our growth over the next year or two or three in China is primarily -- is exclusively anchored in the healthy kind of cross-border portfolio we have with a number of very large Chinese banks that have issued our cards. And Charlie’s visit in China was productive on the relationship building side and reinforcing our interest and commitment to China long-term where we have offices in Beijing and Shanghai and Guangzhou and I don’t know a 100 more people deployed there. So, we are there for the long-term and I think the opportunity for us is long-term.

Smitti Srethapramote - Morgan Stanley

Shifting gears a little bit on the legal and regulatory front, can you give us an update of how you see things in the development world currently?

Byron Pollitt

So elevating, in the developed world I would say there are two themes that we’re witnessing broadly and fully engaged on and I think the first is debit. Debit is a growing; it’s the fastest growing part of our portfolio outside the United States, it’s one where governments are taking a very active interest. When you think about financial inclusion, you should think about in the context of debit. So there is a very clear supportive government agenda with regards to debit and the notion that it should be regulated.

We have deployed Visa government relations people all over the planet to help establish relationships early with governments in order to educate, because economically how you structure or potentially regulate debit can have a dramatic impact on the speed at which it penetrates a market. And there is a tendency for governments to think starting out low cost, put pressure on interchange. These types of pressures taken too far can significantly limit the rate of growth for debit.

And so, I would say this is one theme that is becoming increasingly one of the top two or three things we talk about on the agenda, the recent agreements made in Europe with the European Commission on debit are good example of that. The other topic that has just catapulted to the top of the agenda, and I would say top of the agenda today, the catalyst was the Target breach. And so cyber security is undoubtedly topic number one. And this is one that very quickly gets you to chip on cards.

Smitti Srethapramote - Morgan Stanley

And just on the issue of chip on cards which has been probably the most, sort of the hottest topic in the payment space right now. The technology is 30 years old, was invented I believe in 1984. What’s your view in terms of security, once we go to EMV, is that enough? And what else is Visa doing to enhance security?

Byron Pollitt

So, on this security front, I would say that near-term, companies are going to be looking and we will be pushing more in the encryption activity. Encryption that goes beyond the minimum required to be PCI compliant that’s something that is relatively actionable now in the near-term and it works. The bigger idea is chips on card and let me just give you a little bit of perspective here. In the U.S. at the physical point of sale roughly 70% of fraud is due to counterfeit, counterfeiting the mag-stripe.

When you have a high penetration of chip cards and merchants with chip readers and you have replaced mag-stripe, you have replaced the primary driver of counterfeit. Because it’s just -- it’s in a way that chips are structured, it’s not -- I’m not going to say it’s counterfeit proof, but it is really difficult to counterfeit.

So, once we get to a chip environment, we have taken down the driver of 70% of the fraud, as a byproduct lost and stolen will also start to move down. And so this topic often comes up in the context of should be to going to chip and pin. Our view is it’s chip and choice and that pin could well be a red herring here because two-thirds of the retailers in the United States do not have a pin pad with their POS terminal, two-thirds. And so, if pin were to be included as a fix at the same time, it would -- in our view, it would dramatically slow the roll out of EMV which is chip. And chip is what gets you to 70% of the fraud, the lost and stolen is addressed by pin. And there are a lot of other issues with pin. But given the catalyst of the Target breach, the urgency that the industry feels now to take action to get fraud levels down, chip is the horse that will win the race if we let it run as fast as it can and that means keep focused on chip, get the chip readers in place, get the cards replaced to a chip and get that foundation in. And at that point, we should have substantially dealt with the primary cause of fraud at the physical point of sale.

Smitti Srethapramote - Morgan Stanley

And maybe just sticking on security on the mobile realm, in the past 2 weeks, both yourself and MasterCard came out with standards or host card emulation. Is this the break though that’s necessary now to get NFC jump started and any thoughts at all on just NFC versus sort of cloud-based laws like PayPal?

Byron Pollitt

So, the notion of NFC, it’s kind of interesting, looking at the markets in which it’s kind of taken hold which is if you think of Visa payWave or contactless is a proxy for NFC of the 6 markets, of our 6 top markets for Visa payWave, 5 of them were all prior members of the British Commonwealth; I mean Australia, it’s Hong Kong, it’s Singapore, it’s Canada, it’s New Zealand, the outlier there was Taiwan. So, some of this, some the NFC is simply consumer behavior, willingness to adopt. So, the technology is there. And without the willingness of consumer to adopt, you don’t have the roll out. So that’s a wildcard. Having said that, to the extent that the mobile phone has been a battle ground with telcos wanting -- using the SIM card as a control point, the device manufacturers using the secure element as a control point with host card emulation and Android, in effect, they bypass that. And there is a lot to like about the host card emulation approach that’s being pursued with Android. And that could -- that holds the potential for being a catalyst for NFC starting with this country.

Smitti Srethapramote - Morgan Stanley

May be just sticking with NFC, and the U.S. at least, Apple has been quite vocal about not supporting NFC, none of their iPhones are NFC enabled so far. Recently Tim Cooks talked about Apple’s efforts in the payment space; obviously we’ve seen efforts from Google, from PayPal, Starbucks, various companies. Can you talk about where Visa fits in the payment ecosystem as we see more and more entrants come into the payment industry?

Byron Pollitt

Yes, we’re pretty agnostic about technology, we’re agnostic about form factors, we strongly believe that the future for everybody in this room will more -- will increasingly have you using your phone over time whether it’s NFC or otherwise, whether it’s host card emulation or otherwise. Mobile will become a much more important form factor in the years to come.

There will be a variety of approaches. It’s way too early to pick a winner and it may not be a single winner; there maybe multiple technologies that take route. Our strategy is to basically have an open architecture that can accommodate the different technology approaches that might be applied. Our business is to make it easy to get transactions routed across our network.

So, what we are focused on around the perimeter of our network is developing ATIs developing standards so that it’s easy for new entrants to attach themselves to our network. I often think, I’m a former retailer, so I think in terms of open to buy. When I think about the appeal of our network, if you were to take all the credit lines that sit behind Visa credit cards globally and you take all demand deposit balances to sit behind our debit cards and you put them together, we must represent one of the, if not the largest private open to buy on the planet. Folks are going to want to access that open to buy and our job is to make it easy and safe and secure.

Smitti Srethapramote - Morgan Stanley

Given that you bought retailers out, maybe we can talk about your relationship with the retailers, I think Charlie has made one of his prime initiatives to try and repair the relationships that you guys have with the retailers and the retailers are also looking on their own mobile wallet, MCX, which is eligibly going to use the ACH rails to transact. Can you talk about these two trends?

Byron Pollitt

So I can’t really say much about MCX because they haven’t been that forthcoming about what the strategy is, what the end game really is. It’s more rumor than I think fact at this point. Today we have an entire organization dedicated to serving retailers. And I would say if you were to go back five or six years ago, the intensity of focus that we had issuer versus retail without a balance.

Over the past two years we have made enormous strides to bring that into much better balance. And I think in the months and years to come, you will start to see the fruit of that investment that out of balance situation was in place for a long time. So it’s -- this is not a relationship that will be turned overnight, but we are earnest, we’re investing against it and we are committed and Charlie is the person out in front making sure that it happens.

Smitti Srethapramote - Morgan Stanley

Okay. And on EMV, the question gets raised a lot whether or not EMV will have any impact on network economics what we have seen in other markets where EMV has been introduced as [broadways] for offline transaction to accommodate. Can you talk about how you think the EMV will potentially impact in the U.S.?

Byron Pollitt

Yes. So let me speak broadly about the economics at EMV and if we relate it to the U.S., there is going to be quite a bit of an investment required to get to a state of EMV, high degree of EMV penetration. It’s one of the reasons that it hasn’t occurred to-date, its high investment. And in the absence of a target catalyst, I doubt that we would be on the track we are on today.

But remember, two-thirds of the terminals in the retailers in the United States, well actually it’s probably more than that, two-thirds don’t have PIN [pads], we do not have a high share of chip reading terminals. So these terminals are going to have to be replaced which means investment.

And then if you were to look in your wallet, I strongly suspect you might have one card with the chip on it, some of you will have none. So all of these cards are going to have to be reissued with chips and so that’s an issue of cards. The retailers and/or the acquirers are going to be investing in the chip terminals, lot of software work to make sure that all this happens. That needs to be compensated and a higher value will be created in a chip environment because there will be less fraud.

Normally when you invest and you create a higher and better value proposition, you are often able to charge more. So we view the implementation of EMV more as an investment with no immediate impact on network economics. And if anything a higher value proposition given to the merchant and the issuers, these both sides will benefit.

Smitti Srethapramote - Morgan Stanley

Right. On the online front for security, you and a couple of your peers have announced standards in tokenization. Can you talk about the impact that it potentially have on card not present economics once it's fully rolled out?

Byron Pollitt

So let me elevate a bit on tokenization. The value of tokenization ultimately is the removal of sensitive payment data that would otherwise be held by a retailer that could be [fraudulently] intercepted and reused. And so this is a situation that will apply for NFC transactions, probably most immediately. Overtime it can apply to PC or tablet transactions. But I think the near-term opportunity here is really more NFC rather than the PC and the tablet. It's possible to adapt, but I think in terms of the sequence, it's a bit more complicated and will take longer.

And in that regard, I think what happens is that they were mean to be investment again. And when it comes to the impact on economics, I think it’s too early to call. If you have to invest to get fraud down, you expect to return because value has been created. And I think that part of the equation we have to keep focused on.

Smitti Srethapramote - Morgan Stanley

Sure. You can talk a little bit about margins; you guys have been telling investors to not expect any significant expansion in your operating margins despite the sort of the operating leverage that’s inherent in your model. Can you talk about where your investment dollars are expected to go in the next couple of years?

Byron Pollitt

Okay. So if I could correct you on the first part, we don’t guide to margins long-term, we give the margin expectations year-by-year. And I think the equation to keep in mind that we’re hitting, we’re getting -- we’ve either hit or we’re getting close to a transition point.

In the first few years after our IPO, we were focused on taking out cost, we were after having merged six companies together ,we largely generated revenue in the way that we had historically, which gives you optimal marginal economics.

Today, what we’re doing is investing much more aggressively in extending our network whether it is online with the cyber stores, whether it is mobile whether it is [Green Dot] and the further that we vertically integrate or invest in ways that aren’t simply extending our data center, the more offices we open, the more people we’re putting on the ground, we’re doing that at a much greater rate today than we were before as we continue to invest to sustain attractive revenue growth.

And so that rapid run-up in margins you saw in the last few years, in the first few years first IPO that's not what you should expect going forward. And the pace of our investment as we extend the reach of our network that will be the governor on margins. And those extensions come at attractive margins, but not at the margins that you are current seeing for the company as a whole.

Smitti Srethapramote - Morgan Stanley

Got it. And maybe with that I’ll open up the floor to the audience. If you have questions, please raise your hand and wait for mic.

Unidentified Analyst

Good morning.

Byron Pollitt

Good morning.

Unidentified Analyst

So just a question comes around chip and PIN and fraud you were discussing, so what has Chip and PIN done in terms of European fraud rates? Just give us some context, how that improved? And then how that overtime, how has that changed, interchange or discount rates that you offer to the retailers?

Byron Pollitt

So is the first part of the question related to Europe?

Unidentified Analyst

Yes.

Byron Pollitt

Okay. So as many of you may know, Chip and PIN is basically the standard in Europe. And that was a direct consequence of what was a very uneven infrastructure that Europe started with. They had huge issues in counterfeit. They had huge issue -- and you should think Chip. They had huge issues on lost and stolen, think PIN. And in the early days that was very little real time particularly as you moved out of the major cities and they often relied on more batch processing which meant that there could be fraud in the morning and you may not pick it up till the next day after a batch is processed.

So the fraud rates were unsustainably high and the infrastructure complicated uneven spread across numerous countries. And so they made a decision it was a decision early on to just tackle both with chip and PIN and that brought the fraud rates, there is no question that brought the fraud rates down to a much, much more acceptable level.

In this country as example we too have counter fit and we have PIN, but we also have an incredibly fast for the most part real time infrastructure where we were able to implement fraud algorithms that kept fraud under control on a signature basis. And it never -- signature is a bit of a misnomer, we call it signature, it had nothing to do with the signature, it had to do that when you did a transaction and you sign for it what was really happening behind the scenes were incredibly sophisticated real time risk scoring algorithms that we are determining whether or not this was a counter fit card or whether it was actually you at the [DOS] making the transaction.

PIN, in this country really began with ATM. So the precursor to a debit card was an ATM card. Multiple networks were built up to service the PIN environment and it morphed into what is today PIN debit. In PIN debit, the lost and stolen, fraud rate is lower. And because the PIN gives as long as the PIN’s not stolen, presumably you are the only one that knows the PIN. So that experience was better. And historically in the pre-Durban world, a PIN transaction would have been less expensive than a signature type debit transaction.

Yes. Follow on.

Unidentified Analyst

Thank you. My whole point, I was trying to understand the value proposition. So if frauds coming down with EMV or if with the chip program. And you say you want to address fraud with chip in the U.S. what is that really going to, I mean what exactly are we going to do or why don’t you use the Europe as an example, how much fraud we can tackle in the U.S. that 70% of fraud that you could tackle with chip, how much did you really address?

And at the same time what is the outcome, what is the outcome for bringing discount rates down for bringing interchange rates down, if you lower that fraud?

Byron Pollitt

Well, we should not automatically make a correlation that the two will naturally come down because of that. Fraud our experience has been, fraud moves to the weakest link. So you strengthen it, you invest, you strengthen and then fraud moves. It moves geographically. Fraud will move the PIN. In the target breach the PINs were stolen, they were hijacked. So this is an investment cycle that never ends. It is never a job that’s done contained move onto the next.

The resourcefulness that intellect the level of the innovativeness in the fraud sector is absolutely amazing. I don't know where their Silicon Valley is, I think it moves. But it's a just a proposition that will never end. And so I would not make a correlation that with chip that will allow or force rates down.

Unidentified Analyst

I love my Visa card, seriously. And the thing I like about it is, wherever I am, I mean Europe or here. I don't care where the money came from, I just want to make sure it’s a Visa card. But when you go to the online world, the transaction facilitator is not the Visa card, I may have funded with the Visa card, but the transaction facilitator is my iTunes account, my Amazon password, my PayPal account.

So, my question is what's your strategy for the online world, particularly this mobile world that you're talking about down the road, where if you can't be the transaction facilitator you're the number one guy that the transaction facilitator wants to work with in that new mobile world.

Byron Pollitt

So, it's a really good question because that's where a lot of the innovation around the network is occurring right now. Historically when you opened a Visa account, you've got a plastic card and that's how, for the most part that's how the world ran for a long time. With the advent of the digital -- well, first of all, with the advent of online transactions and now the digital world represented by mobile, we have reconceived what it means to open a Visa account today. And this is the trust now of V.me.

When you open a Visa account, yes you get a plastic card or maybe metal and that would be your form factor for the most part for the physical point of sale. The way we think about it today, you will also get a digital version of the card. The software tools we’re developing behind it are aimed at making the digital use of a Visa card as seamless and as easy as the swipe of a card at the POS, and that our approach is to introduce that kind of ease of convenience, safe, sound, secure through our issuers and have that as an alternative for the issuer and for all those other opportunities to be in front of us whether were a load or otherwise to make sure it is very easy to connect to our network. And whether it’s a direct transaction or via a load, it does end up a transaction routed across our network.

Smitti Srethapramote - Morgan Stanley

I think with that we have to go.

Byron Pollitt

All right.

Smitti Srethapramote - Morgan Stanley

Thank you.

Byron Pollitt

Thank you.

Smitti Srethapramote - Morgan Stanley

Okay, thank you.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!