The Short Case on MasterCard

When looking for opportunity in this market, I have been concentrating on stocks with a significant amount of optimism surrounding the story, and names that could be damaged by a weakening global economy. While many companies in the financial industry stand to suffer from a lack of liquidity and tightening lending standards, most of these names have already experienced multiple contraction and the stock price may already reflect the detrimental conditions.

MasterCard (MA) is a company who’s investors do not appear to have surrendered their optimistic outlook. The stock is still trading over 30 times 2007 earnings and over 20 times expected 2008 earnings. The premium stems from excitement over the fact that the company has been able to continually beat expectations and has delivered stunning growth over the past three years. While the stock has only been public for a little over a year, the company has been active and growing for quite some time and has become a giant in the transaction processing business. Analysts appear to be in relative agreement when looking at the company’s future, expecting growth of roughly 15% over the next 3 to 5 years.

One of the primary differences between MA and many other financial companies is that the firm does not have any credit risk (similar to First Marblehead (FMD)). Banks issue the credit or debit cards to the consumers and those banks take the risk as to whether the consumers will be able to pay off the balance for their purchases. MA simply clears each transaction and receives a payment per transaction to offer its processing services. There is some speculation that a slowdown in consumer spending may not be such a big deal for the company as consumers will likely maintain a similar rate of transactions with each transaction simply representing small dollar amounts. While it is true the company does not have risk of consumers not paying, tighter lending standards will make it much more difficult for consumers to receive new cards and that will likely slow transaction growth. This dynamic is significantly different than during the last recession when the Fed made interest rates and liquidity extremely favorable towards the American consumer.

MasterCard receives roughly half of its revenue from domestic transactions and is likely to see most of its growth through international expansion. China will likely provide a significant amount of additional incremental revenue during the next 18 months as the Olympic rush drives growth in this high profile area of the world. However, this phenomenon is likely priced into the shares and any disappointment in this area will likely severely dampen the excitement surrounding the stock. After 2008, it is unclear what catalyst will drive further growth and the global economy is not likely to continue the rapid pace of growth seen in recent years.

In summary, I believe the risks in this name far outweigh the potential return. Even though the stock has pulled back 20% from their high, I believe a significant multiple contraction will drive prices lower. In accordance with this view, I have a short position in the stock and anticipate holding it unless significant evidence convinces me that the overall economy is in better state than originally believed.

Disclosure: Author has short position in MA

Comments

[Winston Kotzan:]

Interesting idea, but I don't think the economy will slow enough to shut down the consumer to some terrible degree.

2007 Sep 11 01:40 AM

[leonard fr ...:]

this is more BS fr one that missed the boat on this stock last yr . Goldman Sachs put 80 price cap on this last fall, maybe Goldman should may more attention to their hedge funds. A happy and rich MASTERCARD holder from the begining. Happy days to the non investers. Con't to be short on America and globe shot the world or better yet get into a hedge fund.

2007 Sep 11 04:40 PM

[Big Daddy:]

MA, along with Visa when it IPO's, are the Microsoft/Google/GM/IB... of this era.

2007 Sep 28 11:30 AM

[E:]

Man when you screw up you do it in a big way.

2007 Nov 01 04:24 PM

[Jermy:]

Its a pretty risky move selling Master Card short buddy.

2008 Mar 15 05:09 PM