Manole Capital Management
No CASH Accepted
Maybe you are macro investor and closely watch Fed verbage changes in its policy decision this week. After all, this will be the 4th time since December of 2015 where short-term interest rates were raised. Will The Fed deviate from its plans to increase interest rates another two times this year? Our favorite location to gauge market perception remains the CME Fed Watch tool. There seems to be a battle between our Fed and the overall markets.
The disconnect is apparent to us in the tightening of the 2 and 10-year Treasury. We expect additional volatility once The Fed decides how it will begin the mechanism of unloading some of its Treasury and mortgage securities. This will be interesting to watch and will absolutely impact global markets. As of today, the tightening has yet to truly impact financial markets and stocks continuously hitting all-time records.
Maybe you are more fascinated with geopolitical issues, like the recent elections in France and England. Maybe you focus your attention on energy and watch the rising and falling of oil prices with comments from OPEC or tensions from the Middle East. Closer to home, maybe the investigations into Trump interest you.
How did the Russians tamper with our elections and did it impact results? What will happen if our debt ceiling isn't lifted? Uncertainty persists with the fate of healthcare reform. What will happen to that growth-boosting tax overhaul? Just maybe you are wondering how Puerto Rico's decision to pursue statehood will get settled. Wouldn't adding a 51st star to all of our flags be a "huge" boost to US flag manufacturers?
Less than 1 in 4 voters participated in Puerto Rico's nonbinding referendum, but statehood drew 97% of support. Unlike prior votes (in 1967, 1993, 1998 and 2012), statehood had never actually won an outright majority. While Puerto Rico has been a US territory for over 100 years, its debt crisis, bankruptcy proceedings and outstanding debt of $125 billion highlight another point.
The Top 5 shadow economies, as a percentage of 2017 Gross Domestic Product are Greece at 21.5%, Italy at 19.8%, France at 12.8%, Sweden at 12.1% and Germany at 10.4%. Economists estimate the shadow economy in Puerto Rico is an astounding 30% of its GDP! This equates to $21 billion of goods and services produced "off the books." Simply stated, underground activity and tax avoidance deprive a government of significant income.
Besides the demographics of high unemployment (~11%) and 45% of its population living below the poverty level, Puerto Rico erred in setting its sales tax at 11.5%. This wasn't always the case, as sales taxes were increased to these levels from only 7% a couple of years ago. Increasing the sales tax had an unintended consequence of lowering governmental income as merchants and consumers now actively look to bypass card or check transactions. With such a high sales tax, Puerto Ricans routinely look to evade taxes with "cash only" transactions.
Countering this is the "Cashless Society":
In several developed economies, we see the exact opposite of this trend. Consumers frequently use credit cards to generate airline points or cash back rewards. The simplicity of using cards, not only quickens transaction speeds, but has numerous other benefits for merchants. Over the last few years, most airlines have stopped accepting cash for in-flight purchases of food and beverages. One local merchant has the following sign posted outside its establishment.
When we questioned the owner about why they moved to 100% electronic transactions, she said it simply was for "safety reasons." The main reason some restaurants switch is because of cleanliness. We apologize in advance for the following fact. Paper currency can carry more germs than a household toilet. Viruses, bacteria and the flu can live on money for 17 days. Think about that the next time you pay for your food and don't wash your hands before eating.
Cash has a cost:
Maybe the "safety reason" is not having cash available to be stolen. Theft from employees can occur, but the risk also exists for robbery. Any merchant that has significant cash is taking a risk, so moving away from cash reduces the potential for theft. Lastly, cash eventually needs to be transported from the store to a safe environment, like a bank. The cost of moving, storing and transporting money can be costly, with armored car pick-ups running $2,000/day.
In addition, a Harvard Business Review study indicated that the US spends $200 billion annually just to keep cash in circulation. The US Mint reported that its production cost to make a penny and nickel were $0.015 and $0.08 respectively. With the government putting nearly 5 billion pennies into circulation each year, one should question the use of these costly coins.
We have identified 5 key drivers for electronic payment growth. It is the combination of these 5 factors, that provide us with so much confidence in the future of electronic payment growth.
1) Displace cash & check
3) Underserved by banks
4) Merchant acceptance
#1) Displacement of cash:
Many are surprised that some developed economies are still widely dependent upon cash transactions. As our example above with Puerto Rico, Greece and Italy, there are still numerous reasons for societies avoiding card transactions. Until electricity and technology are widely available in rural and some emerging markets, cash will continue to dominate.
As the MasterCard chart above shows, 84% of global transactions are still conducted in cash. While this is declining, the pace is somewhat slow. A decade ago, this percentage was 85.9% and was still only 83.7% in 2014. There are drastic differences between developed markets (at 58% cash) versus emerging markets (at 91.5%).
What's the goal?
In developed markets, there is still a great deal more that can be accomplished. Sweden is a wonderful example of a country striving to become a cashless society. According to a recent Visa study, Swedes are 3x more likely to use a card for payment than the average European. On average, each Swedish card carrying individual makes 207 payments per card annually. Public transportation (like buses, rail and metro) no longer accept cash. Not only do merchants prefer card and phone payments, but even churches can accept electronic payments.
According to its central bank, the Riksbank, cash transactions made up ~2% of the value of all payments made in Sweden last year. While it estimates that this should drop to 0.5% by 2020, we would expect a slightly more conservative estimate. 900 of Sweden's 1,600 bank branches no longer keep cash on hand nor do they accept cash deposits. ATMs are becoming a scarce citing.
The easiest and simplistic catalyst for electronic payments, is the trend towards online shopping versus traditional retail purchases. Even with a trend of more physical locations taking credit and debit cards, cash usage is simply declining. If anybody looks to shop online, transactions only can be conducted with cards or through electronic intermediaries like PayPal (NASDAQ:PYPL).
eCommerce is estimated to be ~8% of the $4.9 T of US retail sales. This trend should continue to creep higher and all of these purchase transactions will boost the secular growth of electronic payments. Cash and check are declining in developed markets, but they are non-existent online.
#3) Underserved by Banks:
It is estimated that there are 2.5 billion people that are underserved by banks. Even in our modern society, it is believed that 1 out of 13 US households are unbanked. There are numerous reasons for not using a bank or financial institution and a US Federal Reserve study highlighted a few key reasons. 25% did not have enough money to open an account, 10% had a bad credit history and 2% couldn't afford the banking fees.
#4) Merchant Acceptance:
One of the many merchant arguments we hear on card acceptance is its high costs. This obviously ignores the theft, transportation and hygiene issues listed above. However, more and more merchants are looking to adopt card and mobile payments to boost sales. iZettle is a cheap and easy payment application that allows micro and small businesses to accept card payments.
Using their phone as a card reader, some merchants have seen sales increase by 30% once they made the change. Remember that comment above concerning Swedish churches? Well, some are now displaying their phone numbers at the end of a service. Instead of passing a plate, members can virtually make donations for a traditional Sunday collection.
We love the diversity of food trucks in our city and they all accept card payments. If you plan on enjoying an art or street fair this summer, most sellers will be more than happy to swipe your cards. Not only have most vending machines migrated to card acceptance, but so has our daily commute. Most toll roads have replaced collectors with automatic (card-based) readers. Going back a few years, all taxi cabs only accepted cash. Nowadays, not only are Uber (UBER) and Lyft (LYFT) cashless, but all taxis have converted their payments to card-based systems. Passengers and commuters love the security and simplicity of card payments.
Quite possible the most surprising, but wildly successful example of embracing a new channel for electronic payments is Kenya's M-Pesa platform. The M stands for "mobile," while pesa is Swahili for "money." M-Pesa is a mobile, phone-based money transfer platform which was launched by Vodafone (NASDAQ:VOD) in 2007. It allows mobile phone users to deposit, withdraw, transfer money and pay for goods and services quite easily. The service bypasses traditional banks and allows users to put money into an account stored on their cell phones.
If a user wishes to transact, he/she simply texts a secure PIN (personal identification number). Users are charged a small fee for sending and withdrawing money, but it is 100% bank-free. When an individual needs to load funds or withdraw money from their account, there is a wide network of agents and retail outlets available. These are modern day bank branches with airtime resellers acting as bank tellers. Not only has this system been credited with bringing financial services to millions of people in the developing world, but it is credited with reducing crime in otherwise largely cash-based societies.
Another example - India:
Nearly 4 years ago, India began an innovative process. Instead of providing governmental benefits direction to people in cash, it began to transfer funds into recipients' bank account. This program, called Direct Benefit Transfer or DBT, was the start of a digital revolution in India's government. Once personal, unique identification numbers were widely employed, India could attempt to replace its traditional cash transfer scheme.
One of the biggest problems with this system was India's lack of a strong banking infrastructure. It has only 10.5 bank branches for every 100,000 adults and many struggle to travel miles to reach a bank to withdraw funds or make payments. This is where the cell phone can help.
It was recently reported that India has surpassed the US, in terms of number of smartphones. There are issues with power, electricity and poor network connectivity, but mobile phone usage is clearly on the rise. With more of these devices available, it was only a matter of time before mobile payments exploded in India.
Then India's Prime Minister - Narendra Modi - made an aggressive monetary decision in November of last year. He declared that existing 500 and 1,000 paper money notes were to become invalid. This was clearly an attempt to shine light on the shadow economy and get Indians to finally pay sales taxes. The ensuing chaos forced everyday citizens to re-consider how they transact for goods and services.
Enter Paytm or the acronym for "pay through mobile." This full-page ad, in The Hindustan Times, was paid for by Paytm and thanked Prime Minister for "taking the boldest decision in the financial history of independent India." Paytm is the leading Indian mobile wallet and it immediately saw a huge surge in growth following the government's crackdown on paper money and corruption. Paytm allows users to make transactions at ~1 million locations across India's 1,200 cities. The growth in digital payments across India is truly unprecedented. It will take decades to fully occur, but India is quickly migrating from a physical to a digital economy.
We continuously look to keep it simple. Our belief is that electronic payments are a wonderful, long-term growth opportunity. Cash will likely be in existence for decades, but it is seeing a slow and steady decline. Some older generations fear advances in technology or simply worry about electronic fraud.
Mobile phones and cards will continue to steal market share from cash for decades to come. As cellular and smartphones become more prevalent, more and more purchase transactions will go electronic. With the advent of easy to use person-to-person apps, cash usage should continue to decline. We continue to be attracted to secular growth stories, that benefit regardless of which way volatile cyclical markets turn.
For a detailed note on the mobile payments industry as well as PayPal's opportunity (Sept '16), please click here.
If you want details into how payments work, click here.
If you want to better understand how Active can compete with Passive, click here.
Firm: Manole Capital Management LLC is a registered investment adviser. The firm is defined to include all accounts managed by Manole Capital Management LLC. In general: This disclaimer applies to this document and the verbal or written comments of any person representing it. The information presented is available for client or potential client use only. This summary, which has been furnished on a confidential basis to the recipient, does not constitute an offer of any securities or investment advisory services, which may be made only by means of a private placement memorandum or similar materials which contain a description of material terms and risks. This summary is intended exclusively for the use of the person it has been delivered to by Warren Fisher and it is not to be reproduced or redistributed to any other person without the prior consent of Warren Fisher. Past Performance: Past performance generally is not, and should not be construed as, an indication of future results. The information provided should not be relied upon as the basis for making any investment decisions or for selecting The Firm. Past portfolio characteristics are not necessarily indicative of future portfolio characteristics and can be changed. Past strategy allocations are not necessarily indicative of future allocations. Strategy allocations are based on the capital used for the strategy mentioned. This document may contain forward-looking statements and projections that are based on current beliefs and assumptions and on information currently available. Risk of Loss: An investment involves a high degree of risk, including the possibility of a total loss thereof. Any investment or strategy managed by The Firm is speculative in nature and there can be no assurance that the investment objective(s) will be achieved. Investors must be prepared to bear the risk of a total loss of their investment. Distribution: Manole Capital expressly prohibits any reproduction, in hard copy, electronic or any other form, or any re-distribution of this presentation to any third party without the prior written consent of Manole. This presentation is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use is contrary to local law or regulation. Additional information: Prospective investors are urged to carefully read the applicable memorandums in its entirety. All information is believed to be reasonable, but involve risks, uncertainties and assumptions and prospective investors may not put undue reliance on any of these statements. Information provided herein is presented as of December 2016 (unless otherwise noted) and is derived from sources Warren Fisher considers reliable, but it cannot guarantee its complete accuracy. Any information may be changed or updated without notice to the recipient. Tax, legal or accounting advice: This presentation is not intended to provide, and should not be relied upon for, accounting, legal or tax advice or investment recommendations. Any statements of the US federal tax consequences contained in this presentation were not intended to be used and cannot be used to avoid penalties under the US Internal Revenue Code or to promote, market or recommend to another party any tax related matters addressed herein.
Disclosure: I am/we are long MANY OF THE PAYMENT NAMES LISTED. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.