Hedge Fund Investment Thesis
Payment Networks and MasterCard
What I Learnt on Wall Street
June 2016
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• MasterCard is a payment technology and network company, operating the
world’s second largest payment network connecting banks, consumers, and merchants in over 210 countries.
• MasterCard was collectively owned by the banks until it became public in 2006 (Visa went public in 2008).
• MasterCard operates a duopoly in the electronic payments market. 85% of
all retail transactions globally are still in cash. MasterCard will benefit from :
a) the transition to electronic payments
b) increase in personal consumption spending (PCE) c) rising middle class in Emerging Markets.
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•
At the highest level, the electronic payment ecosystem is funded
indirectly through the Merchant Discount Rate (MDR), a fee
embedded in the sales price of products purchased at a retailer.
•
The MDR encompasses all the transaction related fees associated
with processing, settling, and clearing a transaction through all
participants in the network – and is subtracted from the total amount
paid by the consumer when payment is remitted to the merchant.
•
The MDR is negotiated between a merchant acquirer and a
merchant, and caries significantly based on the merchant’s purchase
volume: the higher the merchant’s purchase volume, the lower the
MDR.
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Payment
system
network
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• The MDR is composed of the following fees:
• Interchange – Interchange typically comprises the largest portion of the MDR in a
transaction, and is intended to cover the cost of cardholder charge offs and most credit card fraud. At the low end, interchange ranges between a flat fee of $0.23 (for a debit transaction), and 2.95% at the high end (when a premium high-end credit card is used). • Interchange rates for various transaction and card types are set by the card networks,
although issuing banks receive the entire interchange fee, Visa and MasterCard do not receive any portion of the interchange fee.
• Interchange received the greatest scrutiny of any aspect of the electronic payment ecosystem over the past five years. As part of the Dodd-Frank financial reform legislation in the United States, Congress sought to regulate the fees charged by banks for consumer credit card transactions (see our
discussion of regulation elsewhere in this report).
What is the MDR
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• Network and data processing fee – The network fee is charged by the
card network for routing the transaction, and is typically in the range of 4 – 25 bps of the purchase price.
• Merchant acquiring/processing fees – The processing fee is charged by the merchant’s credit card processor for transaction handling and clearing on the merchant side, and is typically assessed as a fixed fee (for example $0.003 - $0.10 per transaction, depending on volume). The acquiring fee is changed by the merchant’s acquiring bank for handling and settling the transaction, and is intended to cover costs related to settling transaction balances with merchants, as well as the cost of merchant fraud.
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•
MasterCard is a technology company in the global payments
industry that connects consumers, financial institutions,
merchants, governments and businesses worldwide, enabling
them to use electronic forms of payment instead of cash and
checks.
•
A typical transaction on their network involves four
participants, in addition to MasterCard: card holder, merchant,
issuer (card holder’s financial institution) and the acquirer (the
merchant’s financial institution).
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Business Overview (Contd.)
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•
Consumption growth
•
Card Penetration into Cash economy
•
Growth in online / electronic payment
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• Payment volumes rise and fall with personal consumption expenditure – PCE
• Certain countries have higher growth in PCE, while others lag. In addition you have to understand what types of PCE spending could a card be used.
• Simplistically one can assume that 60% of global GDP is PCE and a then a smaller 80% of PCE is Purchase PCE.
• PCE that isn’t ‘purchased’: Housing expenses, healthcare (ex-out of pocket), Financial Services, Social Security
• If GDP grows 3% globally, then consumption grows ~5-6%per annum.
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• In terms of growth attribution, Visa
and MasterCard estimate that :
• 50% comes from cash/check penetration
• 25% from PCE growth globally & • 25% from pricing.
• Management guided to for 2013-2015:
• 11-14% CAGR revenue growth, minimum of 50% operating margins and at least 20% CAGR of EPS.
• Card penetration is estimated to be about ~40% currently, and is expected to grow 2-4% per annum.
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• Both Visa & MasterCard are focused on the singular growth opportunity surrounding cash transaction volume.
• According to Visa’s estimate, of the ~$13 trillion PCE in Developed Markets, 41% is still in Cash / Check. This represent a ~$5 trillion opportunity, growing at 4% per annum. This implies that PCE is growing at ~$500 billion per annum.
• While in Emerging Markets, the PCE is ~$10 trillion, with 62% in Cash / Check. This represents a ~$6 trillion opportunity growing at 10% per annum. This means that only is there a ~$6 trillion opportunity there today, but that PCE as a whole is growing at ~$1 trillion per annum.
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Penetration levels of at least
60-70% are attainable, as some
countries are there already –
while many lag far behind.
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• Domestic assessments: fees charged to issuers and acquirers based primarily on the
dollar volume of activity on cards and other devices.
• The revenue here is a function of: a) assessment fee b) GDV and c) rebates as a % of revenues. • These fees have historically been 9-10 bps. GDV is expected to grow as a function of a) number of
cards issued and b) growth in mobile payments. Broadly about a transition from cash to electronic payments.
• Cross-border volume fees: cross border volume fees are charged to issuers and acquirers
based on the GDV of activity where the merchant country and issue country are different.
• MA charges a cross-border fee equal to 0.8% of the transaction amount on all international purchases. In some circumstances when the transaction is in a foreign currency, a currency
conversion fee is also charged. Cross-border volumes are a function of the travel market, as more people go abroad, higher likelihood of cross border fees.
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•
Transaction processing fees: fees charged for both domestic
and cross-border transactions, based on the number of
transactions.
• The revenues here are a function of: a) MA connectivity fee b) total
transactions processed c) authorization / settlement and switch fee per transaction and d) rebates as a % of revenues.
• Authorization fees have historically been 7 cents per transaction.
• Connectivity fee of 0.5 cents per transaction.
•
Service fees: fees charged for consulting, research, compliance
and penalties.
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• Of the 1-4% fee charged at purchase, MasterCard gets about 20 bps. About
150 bps goes to the buyers / customers bank. Another 30-50 bps to the
hardware partner, the MSP (merchant service provider), merchant’s bank. Effectively by using the MasterCard network, the merchant and buyer is signing up to pay them an incremental 20 bps. Not a high number, and not one likely to change / impact purchase decisions.
• MasterCard has significant operating leverage in the business, between
2009 and 2013, revenues grew by 60-65%, but net income grew by over 100%, and earnings per share grew by over 130% (due to buy backs).
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1. Increase their core businesses globally, both for products such as credit, debit, prepaid and commercial – and increasing the number of payment transactions
2. Seek new areas of growth in
• New markets
• Encourage current consumers / businesses to use MasterCard for new payment areas • Bring in SMEs which have not historically used MasterCard products
• Financial inclusion for the unbanked and under banked
• Building new areas of business by:
• Taking advantage of the opportunities from the convergence of physical and digital worlds;
• Using data analytics, loyalty solutions and fraud protection services to add value
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Potential
for
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• Both Visa and
MasterCard make about 24-27 bps in net yield per transaction. This amount is relatively stable, and slightly higher for Visa. • Net Yield = Net revenue
(revenue after the impact of client incentives) per $100 purchase volumes.
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•
Yields are a dynamic equilibrium and are driven by the
following forces:
•
Negative for yields:
• Increased client incentives • Increasing debit mix
• Lower mix of cross border volumes
•
Positive for yields:
•
Growth in online retail
•
Online has higher credit vs debit usage
•
Increase in international processing
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•
The biggest risk to the industry is a loss of duopoly pricing
power
•
This can come from a loss of price discipline or new technology
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•
These are high tech payment networks, so there should be a lot
of room for margin growth with growing volume and scale.
•
But what is the evidence?
•
Visa which is 2x the size of MA, has a higher margins than MA
•
MA: ~50%
•
JPM: ~60%
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Why the difference in margin
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•
Volume Growth:
8-10%
•
Revenue Growth:
8-10%
•
Net Income Growth: 13-16% (from operating leverage / margin
expansion)
•
EPS Growth:
16-20% (from buy backs)
•
While PCE only grows at 5-6%, with growing penetration you
can get 3-4% of additional volume growth, especially a lot of the
growth comes from EM countries where both PCE and
penetration are growing faster.
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Simple Model (Contd.)
Income Statement
Year 2012 2013 2014 2015 2016 2017 Domestic Assessments 3,387 3,688 3,967 4,108 4,590 5,090 Cross Border Volume Fees 2,268 2,715 3,054 3,213 3,590 3,990 Transaction Processing Fees 3,199 3,554 4,035 4,358 4,800 5,300 Other Revenues 1,154 1,331 1,688 2,014 2,180 2,300 Rebates and Incentives -2,617 -2,976 -3,303 -3,936 -4,300 -4,800 Total Revenue 7,391 8,312 9,441 9,757 10,860 11,880 Revenue Growth 12% 14% 3% 11% 9% General & Administrative (COGS) 2,429 2,615 3,152 3,185 3,365 3,500 Gross Margin 67% 69% 67% 67% 69% 71% Advertising & Development 775 841 862 859 889 930 EBITDA 4,187 4,856 5,427 5,713 6,606 7,450 EBITDA Margins 57% 58% 57% 59% 61% 63% Depreciation 230 258 321 343 347 360 Operating Income / EBIT 3,957 4,598 5,106 5,370 6,259 7,090 EBIT Margin 54% 55% 54% 55% 58% 60% Interest / Investment Income -5 -3 -27 -40 -32 -30 Pre-tax Income 3,952 4,595 5,079 5,330 6,227 7,060 Tax 1,181 1,414 1,462 1,467 1,744 1,977 Tax Rate % 29.9% 30.8% 28.8% 27.5% 28.0% 28.0% Net Income 2,771 3,181 3,617 3,863 4,483 5,083 Shares Outstanding 1,255 1,216 1,168 1,136 1,098 1060 EPS 2.21 2.62 3.10 3.40 4.08 4.80 EPS Growth 18.5% 18.4% 9.8% 20.1% 17.4% Cash flow Model
Cashflow from Operations 3,001 3,439 3,938 4,206 4,830 5,443 Capex -218 -300 -334 -280 -330 -300 Free Cash flow 2,783 3,139 3,604 3,926 4,500 5,143
FCF Yield 3.65% 4.18% 4.78%
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Global Payment Processors Comp Sheet
MasterCard Visa American Express
Market Cap ($, bn) 102 168 74 Revenues ($, bn) 9.8 13.9 33.2 Operating Margin % 55% 64% 26% Free Cashflow Yield % 3.5% 3.6%
P/E Multiple (2015) 27 27 13.5 ROE 50% 20% 29% Operating Exp /Transaction 8.5 5.7
Personnel Costs/Transaction (cents) 4 2.3 Advertising as % of Opex 20% 20% Personnel as % of Opex 47% 41% Global Credit Card Market Share 30% 41% US Credit Card Market Share 22% 47% Europe Credit Card Market Share 30% 1% 2015-2018 Payment Volume Growth 13% 10% 2015-2018 Revenue Growth % 13% 11% 2015-2018 Net Income Growth % 16% 13% Europe % of Volume 28% 1% US % of Volume 35% 52% EM % of Volume 33% 42%
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• Both are driven by the same big themes:
• Card penetration
• PCE growth
• Stable yields
• Buy backs
• MasterCard also gives you potential for margin improvement / cost
cutting and ex-US (EM) share gain
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• About 30% of
MasterCard’s revenue is non-USD, primarily earned in Europe.
• This adds an Additional layer of volatility and noise when EURUSD have large moves.
• In 2015, when EURUSD depreciated significantly, top line & income growth was impacted.
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MasterCard isn’t
cheap – if you can
assume that
valuation multiples
can stay around
23-25x, then you can
buy this with a 2-3
year view as a
multi-year compounder.
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On weakness !
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•
In late 2014, the market was unsure about their business, and the
stock had gone nowhere for over a year. This seemed out of place to
us given their growing top line. We began buying in the high 70’s.
•
In late 2015, around $95-100, we sold 25-30% of the position, since
the multiple has re-rated without a growth in earnings.
•
Even the best businesses and stocks have 10-20% moves in a year.
•
Do your work and then be ready.
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History of MasterCard:
• 1966: Founded as the Interbank Card Association (ICA)
• 1969: "Master Charge” purchased by the California Bank Association
• 1979: Renamed MasterCard to reflect a commitment to international growth • 1985: Acquired an interest in EuroCard (predecessor to Europay International)
• 1988: Acquired the Cirrus® ATM Network
• 1991: Launched Maestro®, the world’s first online point-of-sale debit network
• 1997: Launched “Priceless” advertising campaign
• 2001: Launched MasterCard Advisors, the largest global consultancy focused on the payments
industry
• 2002: Merged with Europay International
Appendix
33 • 2002: Converted from a membership association to a private share corporation
• 2006: Transitioned to a public company with a new corporate governance and ownership structure
MasterCard begins trading on the New York Stock Exchange under ticker symbol MA. The MasterCard Foundation was formed
• 2010: Ajay Banga named CEO
• 2010: Launched MasterCard Labs to promote greater innovation in electronic payments • 2010: Acquired DataCash Group plc, to expand e-commerce payment solutions
• 2011: Completes acquisition of the prepaid card program management operations of Travelex (now
referred to as Access Prepaid Worldwide) and announced a joint venture with Telefónica to offer mobile financial solutions in Latin America
• 2012: Acquired Truaxis, Inc., a California-based provider of credit and debit card-linked offers made to consumers through merchants and financial institutions
• 2013-14: Introduced MasterPass, established HomeSend joint venture with eServGlobal and Bics, and acquired Provus and C-SA
