A Reason To Be Cautious on Visa, Mastercard 30 comments
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A collection of articles that I read recently on the major credit card companies – Visa (V), MasterCard (MA), and American Express (AXP) – is perfect evidence of the strength of American Express’ moat, and gives reason to be cautious after the extremely successful IPOs of both Mastercard and Visa.
This recent article from Bill West attempts to paint the pure credit card processors (Visa and MasterCard) in the best light possible on all angles. I’m not surprised that Bill is long both stocks, and while I’m not short either of them, I do feel that he glossed over several potential negatives to allow for an overly bullish argument.
The most glaring dismissal is over the current legislation that could potentially result in the renegotiation of fees that merchants pay issuing banks, known as the interchange fee. While I’d be far out of line to assess the odds that the bill passes, it’s a worthwhile example to illustrate why American Express is the much better company and – as we’ll see later when looking at valuation – investment.
West likens the Congressional review of interchange fees to the on-and-off threats against the integrated oil majors for their “excess profits” – typically attributed in Congress to the oil companies having a monopoly over the commodity. Trouble is, the oil companies don’t have any real, actual control over the price of oil - in fact, even the largest publicly traded oil companies pale in comparison to the size of state-run oil companies. Deep down, I believe most everyone in Congress would acknowledge this, as long as it never came back to some of their constituents angry after a $4/gallon fill-up at the pump. Visa and MasterCard, however, are very much a duopoly in the credit card market, with roughly 80% of the cards in force being one of those two brands. While there are lawsuits by merchants alleging antitrust violations, none have gone to trial as of yet, although a successful verdict against Visa wouldn’t be the first time that company has been hit for anti-competitive practices – Visa was forced to settle a multibillion dollar lawsuit brought by American Express alleging Visa had a long history of preventing banks from issuing rival cards.
The big question, though, is whether the leverage Visa and MasterCard have over merchants is enough to entail government arbitration to the point of setting fee schedules lower. Again, whether or not that happens, or to what extent it does happen, is beyond my knowledge. But there are two adverse possibilities, one being that interchange fees are lowered, and the other being that the fees Visa or MasterCard can charge are lowered. While the latter’s impact is quite obvious, the former’s isn’t so much – Visa and MasterCard, after all, don’t collect the interchange fee; it goes to the bank issuing the card. But a decrease in the interchange fees would make these cards a much lower-profit enterprise for the issuing financial institutions, and that would incentivize them toward making money on the interest rate side. Raising credit card interest rates would make using credit cards a much less-appealing option for consumers, and this could put a clamp down on the revenues Visa and MasterCard receive. In a way, the celebration of Visa and MasterCard for being non-credit exposed financials is highly ironic, because they are dependent on the highly credit-exposed financial institutions to put the cards in force that drive their earnings growth.
Some rudimentary calculations show that the processing fees Visa itself collects are quite low as a percentage of transactions. For the two quarters ending March 31, 2008, Visa processed 17.9 billion transactions, from which it earned data processing revenues of $986 million, or roughly 5.5 cents per transaction. Those transactions amounted to roughly $1.3 trillion in payment volume, from which Visa earned $1.52 billion in service fees – or slightly under 0.12% of transaction dollar volumes. When adding in interchange fees (again, which do not go to Visa or MasterCard), the net remittance from the merchant is around 1.8%. This is the amount that the credit card payment processors are being dragged before Congress over. The real kicker in that equation? As noted at the end of the AP article, “Visa executives have also complained that the bill, which applies only to companies with ‘substantial market power,’ wouldn’t affect American Express Co or Discover Financial Services (DFS).”
Like I noted in my recent American Express stock report (see my PDF valuation), that company’s highly affluent cardmember base allows for them to charge a premium discount rate, and their closed loop payment network means they retain the fees charged to merchants. Last year, American Express’ realized discount rate averaged more than 2.5% - even though they obviously occupy a relative niche in the market share scheme of things. This is the benefit of having one of the best customer bases of any large-cap company on the planet, which creates a moat that Warren Buffett noted consistently expands year after year.
But wait, you might be saying – doesn’t American Express have scary credit exposure, whereas (to go back to Bill West) “MA and V are simply toll-takers in the credit economy?” Yes. But part of taking on that credit exposure means American Express is much better compensated from merchants, and looking at profitability over time shows that credit exposure has hardly been detrimental to American Express’ bottom line.
None of this is to say that Visa or MasterCard are bad companies – far from it; their model has very positive operating leverage, they should benefit greatly from marginal shifts from cash to plastic, and the lack of huge capital commitments puts most other industries to shame. But are these companies worth fairly high multiples given their existing size and scale? I think it’s going to be a real contest for earnings growth to outpace multiple compression over the intermediate-term, and given how hot Visa and MasterCard have been of late, the prudent thing to do is be cautious… or even look at the unloved stock with the best underlying economics in the space – American Express.
An additional note: Oppenheimer’s Meredith Whitney has said that she expects roughly $2 trillion in credit card lines to be removed between now and 2010, effectively halving outstanding credit to consumers.
Disclosure: none
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If merchants find fees excessive let them offer 5 percent or more discounts for using cash and if advertised properly and offered for an extended time, that should bring both major cards to the table to negotiate fees.
This intrusion into credit card fees is merely face-time for a club of elites who should spend more time getting the country out of debt, better educated, and more respected in the world vision.
visa and master card may settle for a minor reduction of fees.but long term future is bright for both V & MA.
The article is well written but wrong. Take a look at V three years down the road. Compare AXP stock price in the same upcoming time frame ..No contest - V will double or triple, AXP won't .
Simply because this writer is long AXP does not justify the negative bias towards MA and V.
there is a reason why the banks did the VISA IPO. And i suspect that reason is NOT to let the retail investor participate ina money making machine. Rather, the very business model of visa will face some severe challenges. It is no coinicident that VISA is struggling in Europe. Our electronic cash system over here allows for immediate processing of plastic transactions involving basically ZERO fees for customers and merchants alike. I have come across a number of shops where you could not or not anymore(!) pay with Visa or mastercard.The reaosn given by the merchants was always "it's too expensive for us." Now, credit culture is different in most Eusropean countries than in the US, granted. we simply are not used so much to live on borrrowed money or bridge gaps and delay payments utilizing credit cards.we rather prefer being clean and even and buy things we can afford rather to pile on debt (well mortgages are a different matter, obviously)
now, i would not be surprised to see banks switching to a similar electronic cash payment system in the u.s. as well over the coming 3-4 years (when they are free to sell their visa-stakes). that way, they will avoid a lot of trouble recovering credit card debt and save substantial money.
bottom line: while plastic grows and v /m will take a large part of that growth, revenues and earnings might not grow as much, if at all. as i see it most positiv scenarios are baked into the stocks' prices leaving a lot of space for negative and nasty surprises.
regharding amex: hm, i would be very careful calling them out of credit-related problems too soon. the economic slump and ecline is just about to start and that will affect even amex's customers. that being said, it is a great business and a great company, but i simply do not see enough potential for appreciation and earnings growth to warrant an investment for me
The Author suggests that V and MA are overvalued because of some bill that MAY pass somewhere down the line, capping their interest charges. I find it a stretch at best to suggest that this will be nothing more than a blip on the radar screen for V and MA if the bill passes. Futhermore, the companies know that they can only go so high on their interest charges before consumers start cutting their cards up anyway. This is a non-event for the companies and their bottom lines in the longrun.
But, if you were a writer and were expected to write a "negative" article about V and Ma to support your bullish stance on AXP...this is about the only negative thing you could point too. I don't blame the Author for writing it, as it is his job...But, IMO its a lame bearish argument.
The key metric is percentages of income, not the overall number. As we haven't seen Meredith's worksheet, we can not comment directly. For instance, what figure is used for inflation and wage growth for 2009 and 2010? We don't know and neither does anyone else until the analysts disclose their papers for scrutiny by peers.
CrossProfit
everything is good point for you, that why your option off 50% dude
I bought visa and I am very glad I did. Visa is going to be one of the better ones I have. NO WAY BUT UP - DON'T WAIT AN SEE AND SAY I WISH I HAD
TKTK53
There you will find research, support, and opinions all related to Visa. Please only come on board if you are currently a shareholder of Visa. We look forward to seeing you on the other side.
I hesitated when V was in the $50s, and $60s, and $70s because of bearish arguments just like this one. I'm not gonna get phased this time even though I bought shares at $82.
And reframing those reasons as upsides for Amex isn't going to change that fact.
Additionally, I don't want to come across as bashing Visa or Mastercard - far from it. I just think investors need to be more realistic, and dig deeper so you don't get statements like "I don't see any way this stock doesn't double/triple from here."
How does cutting $2 trillion in credit lines 'practically' relevant to this article?
Fact: Average american has 4 credit cards.
Even if couple of those cards are canceled by the issuer or the credit limits cut, the consumer would use one of the other cards to pay for gas, groceries, etc.
Cutting credit lines would in fact impact Amex & DFS adversely, as they cannot collect additional interest on those who would have used that extra credit.
The math is still in favour of V.