Visa (NYSE:V) hit a minor bump in the road as far revenue growth last quarter goes, when it reported that revenue growth for 2014 would slow to 10%-11%, the lowest level for 4 years.
While this may superficially appear to be a concern, Visa is riding several growth waves that will mean it should, in due course, resume an upward growth trajectory.
Increasing spend - We are moving more and more to a cashless society. While penetration of credit cards is fairly high in western economies, the amount of spend that's being put on credit cards is increasing. Checks and cash are decreasing in use, with check usage globally declining from 22% in 2005 to 16% in 2009.
Increasing acceptance - Credit cards are being accepted by merchants who previously hadn't accepted them. This is thanks to the lower costs of Point of Sale terminals, such as those distributed by Square. The result is that accepting credit card payments is now cheaper for many smaller merchants, all of which will contribute additional purchase volume for Visa.
International - Credit card penetration amongst BRIC countries has been rapidly increasing. Russia's credit card penetration has increased from the low-single digits in the early 2000s to close to 25% today. Visa has over 100M credit cards issued in Russia. As disposable income increases, the average spend per user will also increase, contributing to additional credit card purchase volume. Russian sanctions may have temporary impact, but sanity is likely to prevail in the long term.
In my opinion, the biggest uplift in revenue to Visa is from a product that Visa is still in the early stages of deploying through its platform, Visa Digital Solutions. Within the scope of the press release for Visa Digital Solutions was an announcement from Visa that it will be rolling out its own tokenization service in September. It's not just Visa that has jumped on the tokenization bandwagon. MasterCard (NYSE:MA) is also launching its own tokenization enablement platform, with the aim to be commercial in late 2014.
So why does tokenization represent such a big opportunity, and why is this something that investors in Visa and MasterCard should care about?
There has been a spate of hacks into merchant systems in recent times, with the commission of large amounts of credit card data theft. The list of victims is a who's who of retail. Target, J.C. Penny and Neiman Marcus have all been victims in recent times. The impact of the data breaches are not only major cost and inconvenience to card holders and merchants, but also loss of consumer confidence in merchants, which can account for untold lost sales.
The reason these massive breaches are possible? Largely because merchants are storing sensitive credit card data on their systems, which in turn, is proving an easy target for hackers to access and then use to commit online fraud.
The inherent weakness that enables such fraud to occur is that credit card data today is static data which was never intended to be stored on remote servers.
To combat these deficiencies, Visa and MasterCard have pioneered a concept of tokenization. The essence of tokenization would be to transform static credit card data into dynamic data. Each credit card transaction would be given its own unique identifier that would be for one-time use. Thus, any tokenized data that is stolen essentially becomes useless, as it would be only be applicable to a specific transaction, with tokens not capable of being reused.
Why does this represent such a significant market opportunity for Visa and MasterCard? To get a scale of the opportunity, one only needs to consider the cost of credit card fraud in the US today, which runs close to $200B annually. Much of this occurs because credit card data is stolen and then used to generate fraudulent sales with online merchants.
Banks also bear a hefty cost of $10B annually from credit fraud through the need to reissue cards to consumers. The cost of call centre support and card issuance for fraudulent cards runs at close to $10 per card. Given the scale and cost of the problem, Visa and MasterCard will likely find a willing market amongst banks and merchants for tokenization solutions that reduce the scale of the credit card fraud problem.
From a reputation risk perspective, merchants do not want to take the chance that credit card data they store on their systems could be hacked and compromised. The recent situation with Target bears this out. Target received extensive negative media coverage, which ultimately led to a CEO resignation and ongoing remediation costs exceeding $100M. Merchants are very interested in solutions that do not require them to store such sensitive data.
Visa and MasterCard have both moved quickly to capitalize on the opportunity that tokenization represents to their businesses. Both were instrumental in working to define an industry-wide tokenization standard that has wide acceptance. Both have also positioned themselves to start offering tokenization services later in 2014.
While interchange rates are coming under increase pressure from merchant groups, tokenization represents a strong growth area for both Visa and MasterCard in the coming years. In fact, tokenization as a service has strong interest amongst merchants, with Gartner reporting that 27% of merchants surveyed expressed interest in leveraging a tokenized service solution.
Implications on Visa and MasterCard stock
While tokenization as a service is a market that is still very much in its infancy, I expect that it represents a potentially significant market, with a long-term market potential of $10B+ in annual revenues. With Visa and MasterCard taking first-mover positions, both are well-positioned to grab a significant piece of this market.
Although it is still too early to credibly estimate what such revenues may mean for stock prices, investors should start looking for signs of successful penetration of Visa and MasterCard tokenization platforms within the merchant and issuer markets.
If Visa and MasterCard's tokenization efforts prove successful, it could pave the way for the payment networks to become payment security companies, in addition to successful "toll takers" in their own right. Such a move should provide a nice hedge to any downward pressure on interchange rates.
Disclosure: The author is long V, MA. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.