Long Visa: Not All Credit Card Companies Are Created Equal

Includes: AXP, COF, DFS, MA, V
by: Ryan Pollack

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 (NYSE:V) and MasterCard (NYSE: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 (NYSE:AXP), Capital One (NYSE:COF), and Discover (NYSE: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.
  1. 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.
  1. 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.
  1. 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.
  1. 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.
  1. 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

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