Update: Visa Faces New Litigation From Discover

| About: Visa Inc. (V)
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Summary

Discover has filed a suit against Visa on the grounds that Visa's policies are anti-competitive.

Discover is suing for lost profits, while claiming that the strategy Visa used damaged merchants with higher fees.

It appears that the cost to merchants has gone down while Visa had the policy in place, which undermines Discover's argument.

This news indicates potentially increasing rivalry within the industry, which would make it less attractive under Porter's Five Forces.

I expected the industry to remain less competitive, but Visa is up over 20% since I recommended the stock in early October.

Discover (NYSE:DFS) suing Visa (NYSE:V) may be precisely the desired outcome from the Durbin Amendment. The amendment was part of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. In simple terms, the amendment was designed with the goal of lowering acceptance costs for merchants by enhancing competition among networks for processing transactions. The amendment introduced a cap on debit card interchange fees, and required issuers to provide at least two independent payment options. You can read more the amendment here.

Visa responded to the challenge by creating a pricing system that encouraged companies to run as many of their transactions through Visa's network as possible, to gain volume discounts. This strategy provides an incentive to merchants to choose Visa instead of the Pulse Network, which is owned by Discover. While the incentive for Discover to attack Visa is clear, the results are problematic. If Discover actually won, which I do not expect, the industry would become much more competitive and potentially more litigious. (Disclaimer: I am not a lawyer.) Under Porter's Five Forces, this is known as rivalry within the industry. Increasing rivalry levels make the industry less attractive for all participants.

According to work done by Thomas McCrohan and Leonard DeProspo, the industry became more competitive after the Durbin amendment. The prices paid by merchants went down, which contradicts the claims made by Discover. What Visa is doing could be considered bundled pricing, as the company is encouraging customers to buy more of their service at better rates and making up part of the difference on volume. I believe that the bundled pricing makes it more difficult for customers to change their behavior. High switching costs are another favorable aspect under Porter's Five Forces. In my original article, I believed Visa was priced attractively off fundamentals, and that the risk of pending litigation with Wal-Mart was already priced into the stock. Since then, Visa is up over 20%, while DFS is up just over 1%. I still like Visa's position in the industry and consider it attractive, but I'd be concerned about the industry if Discover won. On the back of Visa's share prices rising over 20%, I believe a substantial portion of the excess returns may already have been captured. Based on the new higher prices and potential for industry damaging litigation, I'm downgrading my stance to neutral in the short term. I still like them in the long term (10+ years).

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