The Great Visa Debate: Refuting H.J. Huneycutt

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

I feel I need a chance to explain my thinking and reasoning further on the subject of Visa (NYSE:V), the credit card industry, and to SeekingAlpha contributor H.J. Huneycutt’s article. Not that Mr. Huneycutt attacked me in any way, shape, or form. That’s far from the truth. I found his article to be gracious and very well done in research and deconstructing balance sheets.

I actually agree with Mr. Huneycutt in that goodwill and intangible assets should be taken with a grain of salt in most cases. Visa, however, is not one of those cases. There are two huge reasons why I decided to include goodwill and intangible assets in my assessment of Visa and the rest of the card companies. Those reasons are brand value and the network.

I believe there is a distinct gap between the brands of Visa, MasterCard (NYSE:MA), and American Express (NYSE:AXP) compared to Discover (NYSE:DFS) and Capital One (NYSE:COF). Visa, MasterCard, and American Express are the top three card companies in the world and have been so for about 40+ years. That explains the goodwill number of Visa. The network is where Visa distances itself from the other four companies. For this article’s purpose I will just compare Visa to Discover. I will also include Diner’s Club’s numbers to Discover’s numbers since it is owned by Discover. These numbers are from Visa’s latest 10-K and were from 2006. I expect the numbers to be updated in Visa’s next 10-K, but not to be drastically different from the 2006 numbers.

Total Payments Volume. Visa had $2.127 trillion of payments volume compared to $118 billion for Discover. Discover’s payment volume is only 5.55% of Visa’s total payment volume.

Transactions. Visa had 44 billion transactions compared to 1.5 billion transactions for Discover. Discover’s transactions were only 3.41% of Visa’s total transactions.

Cards Issued. Visa had 1.254 billion cards issued compared to 64 million cards issued under Discover. Discover’s total cards issued are only 5.1% of Visa’s total cards issued.

In a high barrier-to-entry business, that has established players, I do not see how Discover could ever catch up to Visa’s network. That is the reason for the premium for Visa’s intangible assets and the network is a tremendous asset in this industry.

Mr. Huneycutt acknowledges Visa’s growth potential. We know it will come from bringing Visa Europe under the Visa umbrella and Asia. Visa did a great service to itself by sponsoring the Beijing Summer Olympics, in effect starting a relationship with the Chinese government. Overlooked is Latin America. Visa has a strong presence in Brazil as well. It is also a country with a rising middle-class and fifth most populous in the world. How is Discover going to grow? In March 2008 it sold its U.K. card business, Goldfish, to Barclays Bank. “This business represented substantially all of our International Card segment.” That statement is from Discover’s 10-K. Perhaps Discover had to sell that part of their business to raise cash, but doing so left it with no international presence. And international is where card growth will come from. The U.S. is the most mature card market in the world by far; it is the one area that does not present a good growth opportunity for the card services industry.

I would be foolish to be oblivious to the consumer spending crunch. I realize spending is decreasing. Visa, however, relies on usage not the amount of the purchase. While payments volume might decrease overall in the short-term because of a slowdown in luxury item spending, transactions are still increasing thanks to more usage at the grocery store, drugstore, gas station, movies, and fast-food chains. Basically everyday recession-proof items are making their way on to plastic.

I believe Mr. Huneycutt and I are looking at the same coin--just different sides of it. But that is what makes a market. I hope our analysis and discussion can help the readers of SeekingAlpha make an informed decision on this industry.

Positions: Long V; Short Jan. 2010 V calls