Aug 27, 2020
How did we get here?
1. Visa can be traced back to the issuance of the first Bank of America cards in the late 1950s. As demand for credit cards grew, the demand for interbank partnerships became necessary, and Visa was formed in 1976. In 2006, Visa was a private membership association jointly owned by over 20,000 financial institutions worldwide.
2. Through a series of corporate restructurings, the company formally became Visa Inc. on 10/3/2007 and became public on 3/20/2008.
3. Visa Europe became a separate entity from Visa Inc. when the latter became a public company. Visa Inc acquired Visa Europe on 6/21/2016, reuniting as one global company.
4. Today, Visa connects consumers, businesses, banks, and governments in more than 200 countries worldwide, with a total nominal transaction volume of over $11 trillion.
What is driving the company?
1. The company is driven by payment processing growth in the Visa network, which includes usage of Visa products by consumers and infrastructure to process payments by merchants and financial institutions, and other value-added services.
2. Visa is attempting to further engrain itself into the global payment processing ecosystem despite its seemingly impenetrable operations and expand into new markets and services.
- On 5/8/2019, Visa acquired a majority interest in Earthport, a company that provides cross-border payment services to banks, money transfer service providers and businesses via the world’s largest independent ACH network.
- In January of 2020, Visa agreed to acquire Plaid, a company that connects payment apps such as Venmo and Cash App to uses’ bank accounts to transfer funds (commentary attached).
3. Due to the strength of the core business, Visa has continued to repurchase shares and issue dividends extensively
Why are the shares a good investment?
1. Visa has an impenetrable moat defending its business. With access to 99% of bank accounts in top 80 countries via Earthport, 3.4 Billion cards currently in use, and access to more than 61 million merchant locations, it is hard to imagine a world where Visa becomes obsolete.
2. Visa is a platform company, and thus the company will be able to accelerate free cash flow overtime with little additional investments. Additionally, the global electronic payments industry is growing at 6% per year with a long runway ahead.
3. Over time, Visa can extend its service offerings to new payment flows and leverage its existing data and technology to increasingly provide consulting, analytics, and security related services.
Industry Structure Overview
-Payment networks like Visa connects issuers (banks that issue cards), acquirers (the merchant’s banks), merchants, and customers.
-When you purchase something with a Visa card, the average merchant receives 97% of the total payment, with 2% going to the card issuing bank and 1% going to the merchant’s bank. Then, the two financial institutions will pay Visa, on average, a combined rate of 0. 17% of the initial transaction.
-As you can see one the right, Visa’s share of the total amount transacted over the Visa system has been incredibly stable over time, from 0.16% in 2015 to 0.175% in 2019. Networks also charge additional fees for any cross-border transactions. Historically, Visa has charged around 0.15% (2015) to 0.18% (2019) in additional fees for cross-border transactions.
2015 Visa System Value Chain
New Payment Flows:
-Square, Venmo and Zelle are all popular ways to transfer money between individuals. Traditional ways of sending money via checks, ACH transfers and cash are slow, lack ubiquity and create security concerns. Payment networks (V/MA) now offer real time payment systems that allow businesses to send funds to debit cards within 30 minutes while only requiring the debit card number.
-Digital wallets (Samsung Pay, Apple Pay, etc.) allow consumers to link various debit/credit cards to one’s phone, and thereby enabling contactless payment. It is important to note that these companies still rely on the infrastructure of payment networks, and thus various fees would still apply.
Porter’s 5 Forces Analysis – Strong/Moderate
1. Supplier Power – Low
Visa generates revenue through taking a small percentage of electronic transactions processed through the Visa network, in addition to providing various value-added services to merchants, financial institutions, and card holders. Visa’s supplier is none of the three, because all three could be analyzed elsewhere with more relevance. I will analyze Visa’s supply of talent in this section. Visa is having a hard time attracting and retaining talent. According to statistics from Glassdoor, Visa is very unattractive when compared to other card networks and FinTechs. To provide better value-added services and integrate further with new payment flows, Visa needs to attract top-tier data science and engineering talent. Insofar, the company has not demonstrated the ability to do so on a consistent basis.
2. Buyer Power – Low
Visa needs to convince the following players in the payments ecosystem to join their network in order to sustain and grow its business: card issuers to choose to include Visa cards in their card offerings; consumers to have confidence in their Visa card working everywhere, and merchants to accept Visa cards in exchange for around 3% on each transaction.
This seems to be an impossible task, and yet Visa has managed to do just that. By enabling this three-sided network from the beginning, Visa has allowed banks to gain more transaction fees and extend more loans, consumers to access credit at any time and spend money conveniently, and merchants to accept payments from anyone on credit and receiving the money instantly.
Currently, each side of this three-sided network can be viewed as a buyer of Visa. Visa has solved a fundamental problem in purchasing process while charging very low fees, such that each side would be much worse without Visa. On top of this network of payment processing, Visa offers value-added services to all the players in the three-sided network ranging from security and identity protection, data analytics, and account risk controls. The company also leverages the amount of data the company processes and offer outside consulting and analytics services.
These value-added services are not directly engrained into Visa’s network, and therefore could be more vulnerable to attacks. That being said, the basis of providing services mentioned above are vast amounts of payments processing data. The predictive power of models rises as the amount of data increases. Visa, being the largest payments processing network, should have a natural scale advantage over its competitors.
Visa relative scale
It should be noted that Visa is not the only game in town. Mastercard operates a very similar network with almost identical service offerings. This, paired with almost no switching cost between the two networks, should signify more bargaining power for the buyer. Merchants are eager to accept all credible methods of payment; banks want more cards out, and consumers want better deals on their credit cards. This should pressure the profit potential of the card networks as well as push card networks to improve service quality. Indeed, both Visa and Mastercard capture very little value of the transaction, and both companies are constantly improving the quality of their services. However, the oligopolistic nature of the industry has allowed both Visa and Mastercard to enjoy outstanding margins and returns on capital, and such will remain going forward.
3. Threat of New Entrants – Low
The three-sided network I describe above is very unlikely to be replicated by pure new entrants. The sheer breadth of Visa’s established network should be able to deter new entrants from attacking the company directly. It is improbable that a new payment processor could ever be started today.
That being said, local card networks with an existing two-sided network (financial institutions and consumers) may elect to venture into Visa’s dominant markets and pursue merchants to accept their payment methods and attack specific channels within Visa’s network.
Take the Chinese consumer and business international travel market, for example. UnionPay, China’s only payment processor, has existing relationships with Chinese financial institutions and consumers. To attack Visa’s network in their established markets, UnionPay only needs to convince merchants to accept their credentials. Merchants should never want to limit their customer base, and the transaction fee any card company charges is unlikely to exceed the variable profit each merchant receives for completing an additional transaction. Conforming to this theory, UnionPay, a card that basically had no acceptance outside of China 15 years ago, is now accepted in 174 counties, with 90%+ acceptance rates in large, popular shopping centers in major cities across the world. Any Chinese consumer who wants to travel globally today would not need to apply for Visa and Mastercard cards, a practice that was the norm not long ago.
It is important to note that Visa’s core business, transactions from existing card holders, is not heavily affected by new entrants entering into the market this way. These new entrants do, however, limit Visa’s growth potential in select countries (China, Russia, Canada, Japan). In addition, the loss of potential international travelers as cardholders means that Visa’s international transactions revenue segment, a particularly lucrative business for the company, will also be limited in growth.
Overall, I assess the threat of new entrants to be low, with a caveat that existing players in other markets are capable of attacking Visa’s network on a small scale.
4. Threat of Substitutes – Low
Are Fintechs a way to bypass Visa’s network? No, but maybe in the future. There are two types of Fintechs that are relevant to Visa’s core business model: digital wallets and P2P payment apps that allow a store of money (Venmo, Cash App, etc.).
Digital Wallets: Most smartphones (IOS, Android) are equipped with NFC digital wallet capabilities, allowing users to store card information in their wallet apps. The card information can then be accessed by swiping the phone over a standard wireless card reader that is equipped in most stores around the world, allowing for a quicker and easier electronic payment method. This is a tailwind for payment networks like Visa. Digital wallets solve one of the major pain points that remained in the payment process: the need to carry a card and take it out on one’s wallet to pay for things. Now, people only need to carry around their phones, which should be located in their hands at all times. Overall, the adoption of digital wallets should only increase Visa’s revenue growth potential.
Payment Apps: AliPay and TencentPay are the two most popular transaction methods in China. Consumers typically receive paychecks, deposit everything into AliPay or TencentPay, and proceed to spend the money as one would do in the U.S., with one key difference: banks and card networks do not take a cut of the spending. If that were to be replicated in the U.S. and other countries, Visa would be rendered into a niche player in the payments at best. This seems not to be happening, for now. With much of the current physical infrastructures of payment processors not supporting the usage of P2P apps, these companies are relying on co-branded cards with Visa and Mastercard to allow users to spend money in a physical setting. Venmo could be used online where PayPal is accepted, while the cash app from Square still relies on card networks for that connection. Overall, I assess the threat of substitutes for Visa to be low; however, it is prudent to cautiously observe the changing Fintech landscape for new threats.
5. Competitive Rivalry – Moderate
The card network/payment processing industry is highly concentrated with two main players, Visa and Mastercard, controlling over 75% of the market. The rest of the industry is controlled by American Express, JCB, Diners Club, and other niche companies. A point of differentiation between Visa and Mastercard with the rest of the industry is that the two dominant companies are only card networks, and they outsource the issuance and potential credit originations to banks. Therefore, it is in the interest of the two companies to rapidly expand the total addressable market of the industry, while the smaller companies have an interest in limiting the number of their users to avoid potential credit losses.
The market size and demand for card networks are expanding rapidly as cashless payments are rapidly adopted across the world; this theme is more thoroughly discussed in the macro section. With the market size continuously expanding, Visa and Mastercard have focused on capturing new users as opposed to competing for existing ones.
Cards currently have essentially no switching costs. This means that as the market becomes more saturated and % of payments in cash continues to fall, competition is bound to ignite between Visa and Mastercard. As you can see on the right, while Visa is growing process volumes absolutely, the company is failing to capture new payment volumes as effectively compared to Mastercard. Card volume growth figures suggest that Mastercard is not only growing the number of cards but also increasing payment volumes on existing cards.
Overall, competitive rivalry in the card network business is moderate, with the potential to heal up significantly during the upcoming years as % of purchases in cash fall.
Operating Margins – Strong
The only comparable card network relative to Visa in terms of cost structure is Mastercard. On the right are the relative operating costs of Visa and Mastercard.
As one can easily observe, Mastercard has a significantly lower operating margin, but almost all of the difference can be attributed to a higher incentive cost. One should also note that while incentive growth is a great predictor of Visa’s revenue growth, it is not for Mastercard, suggesting that Mastercard is also using incentives to catchup with Visa’s network in terms of partnerships and acceptability (regression model shown on the right, (1) being Visa and (2) is Mastercard). This explains why Mastercard’s volume growth and card count growth are both higher than that of Visa’s. Other operating costs are insignificantly different between the two companies.
In absolute terms, however, Visa’s operating margins are outstanding, with a historical average of over 50%. We should not be surprised: the nature of a platform business allows for essentially zero marginal costs, and Visa, being the largest card network in the world, is certainly in a position to take advantage of that. In addition, due to platform size differences, Visa’s operating costs ex-incentives should be lower compared to that of Mastercard’s. While this is true historically, the difference is not meaningful, suggesting that Mastercard is investing more money into its platform compared to Visa.
Note: Is Visa’s decision to not compete on incentives with Mastercard correct?
No. While consumers have essentially no switching cost between card networks; the other network has to be better in a marginally significant manner for the consumer to want to switch cards. As organic growth in the industry slows, Visa will eventually need to compete with and beat Mastercard’s price to win over customers, an action that the company is currently not willing to support. While detailed calculations cannot be performed due to a lack of data, I am confident that both Visa and Mastercard’s current consumer acquisition costs are far below their Costumer Lifetime Value.
Overall, I assess the operating margins for Visa to be strong.
Return on Invested Capital – Strong
As I mentioned before, card networks are companies. The two-card networks are currently is enjoying very high returns on capital, as shown on the right. Visa’s ROIC has been compressed due to many historical acquisitions expanding the invested capital base, while Mastercard, having a relatively clean balance sheet, has sky high invested capital figures.
Mastercard’s invested capital figures showcase the capital light nature of the card network business. Due to the established network, incremental markets and sources of revenue can be established at very little investment. Returns on incremental invested capital for both companies are also very high. Overall, ROIC for Visa seems very strong.
Balance Sheet Management – Strong
Due to the capital light nature of Visa’s business, the company in recent years has returned, on average, 70% of its operating income to shareholders in the form of dividends and share repurchases. Mastercard returned, on average, 80% of its operating income to shareholders.
CAPEX as a percentage of operating income for Visa is higher compared to that of Mastercard, where Visa should have the scale advantage. This suggests that Visa is investing more to maintain and expand its platform capabilities.
There is not much more here that warrants commentary. Overall, I assess the balance sheet management of Visa to be strong.
Acquisitions and Divestitures – Strong
“Our approach has always been capabilities you can either build or buy. If it’s faster or cheaper to buy rather than build, then we would buy. Or if you can acquire talent in a way that is attractive by buying, then we might do that.” – Vasant M. Prabhu, CFO
“We analyze three things: what’s the time to market of the various alternatives; what’s the cost of them; and what are the talent implications.” – Alfred F. Kelly, CEO
Recent acquisitions for Visa include:
1. Earthport for $223.4 mm in 2019; cross-border payment services via ACH.
2. Verifi in 2019; risk management for credit card merchants and resolve transaction disputes faster.
3. Payworks in 2019; SaaS gateway solution to payment providers.
4. Fradeom for $195 mm in 2018; expense management for financial institutions and business clients.
5. TrialPay in 2018; a platform for merchants to reach consumers through targeted promotions
These acquisitions have mainly allowed Visa to offer additional value-added services to their existing clients. The acquisition of Earthport strikes me as very interesting: it is apparent that Visa wants to become the one-stop-shop clients with any potential payment needs. Most current ACH (automatic clearing house) and RTP (real-time-payment) systems are owned by governments and regulators and are not attractive businesses. Taking ownership in the distribution process of funds, however, allows Visa to potentially bound clients to the Visa ecosystem and provide the higher margin, value added services along the way.
I should note that Mastercard has completed very similar strategic acquisitions in the past. Overall, I believe the acquisition philosophy outlined in the two quotes above is sound, and the execution of synergies post acquisitions are strong as well.
Business Robustness – Strong
Visa’s core business is all about consumers making purchases using Visa branded cards and transferring money within the Visa network. All value-added services are derivatives of the original business. The company’s current strategy is to expand Visa’s network by forming partnerships with companies that have a strong position in markets where Visa lacks scale (Paytm in India, Ali and WeChat in China, MFS in Africa, and LinePay in Japan). In addition, Visa is also expanding their value-added services offerings. Lastly, Visa is attempting to use their strong position in their card network to attack other payment flows.
Three strategic initiatives are being executed to expand the Visa payments network: the first kind is where Visa pursues their partner’s existing clients who are traveling to a location where Visa has a strong network while the local issuer does not. For example, Visa recently announced a deal with Tencent, where Chinese citizens are traveling outside of China can use Visa credentials in WeChat to purchase on the Visa network. The second kind of strategic initiative is acceptance oriented, where current users of Visa can make purchases on the local issuers’ network. For example, partnerships with Tencent and Alibaba allows Visa credentials to be put in Alipay or WeChat pay to allow non-Chinese cardholders to shop in China. The third type of strategic partnerships are partnerships with Fintech companies that allows Visa to access historically underbanked consumers. Visa’s card deal with Square adds value to both sides: Square customers now have access to Visa’s network, while Visa collects fees on each additional transaction.
One of the value-added services side, Visa now offers a suite of services to financial institutions and merchants that currently exist in Visa’s ecosystem. I believe these services are easy sells due to the integrated nature of these solutions with Visa’s current transactions business if Visa delivers quality services. Revenue growth of this segment has been accelerating for the past 2 years, with a 39.1% growth rate in 2019. I believe such will continue into the future, compounding at 20%+. Note: as Visa’s customers grow, the potential for more value-added-services grow as well.
On the capturing other payment flows side, Visa believes that current ways of transferring money in a commercial and governmental setting is outdated, and the company is posed to capture this market opportunity. Currently, the company believes it has captured less than 1% of their market.
These flows (less P2P) are currently being processed primarily by government regulated ACHs, as well as by sending checks. Much of it is highly inefficient. I do believe Visa will be able to add significant value to adopters of their rails of transferring money. We can currently observe some of these new flows in action already: Uber drivers can choose to receive payments to their Visa cards or bank accounts within 30 minutes, instead of waiting for 2-3 days for an ACH transfer, a transfer powered by Visa Direct, a proprietary RTP system. Stripe, Square, and other payment operating systems are also providing merchants with this option. I thoroughly believe these new flows will accelerate Visa’s processing volume for the next decade.
Earnings Quality – Strong
As shown below, Visa’s earnings quality is very high. We can rely on the company reported financials to value this company.
Guidance Reliability – Moderate
Visa gives good guidance, with occasional misses.
Below is the one-day price reactions to earnings announcements. The stock has an average 1-day return of 0.4% with a 2.86% standard deviation. Visa has historically traded at a daily volatility of 1.7%. This relatively small gap shows that the market is very good at predicting Visa’s earnings.
Note: I believe Visa’s quarterly earnings can be modeled very precisely using the abundance of alternative data on card transaction data. We do not want to trade this stock in the short term.
Tenure and Track Record of Management – Moderate
Leadership at the top for Visa seems to be relatively stable. Previous CEOs include:
Joseph W. Saunders – 5/2007 to 11/2012: payment services background, president and CEO of Providian from November 2001, and chairman of the board from May 2002 until 2005.
Charlie Scharf – 11/2012 to 12/2016: corporate finance guy; JPM early career, Salomon CFO, Citi IBanking CFO, Bank One CEO, and CFO, JPM PE Buyout MD, and CEO of Retail Banking.
The current CEO of Visa is Al Kelly, who joined the firm in 2016. He was president of AMEX, CEO of Intersection, and has 20+ years of experience in the payments industry. Relevant management members include:
Jack Frestell, Chief Product Officer, since 2014. Previously, Jack worked at Capital One, and led online and mobile banking, emerging payments, and digital product design and development.
Vasant Prabhu, CFO since 2015. Previously, Vasant served as CFO at many notable institutions, including NBCUniversal Media, Starwood Hotels and Resorts, and Safeway.
Rajat Taneja, president of technology since 2013. Previously, Rajat was the CTO of Electronic Arts, and have experience at Microsoft as V.P. of commerce and online services.
Overall, I believe the management team of Visa is capable of defending its core business of consumer payments and expanding to more value-added-services (not shown, but many consultants in the management team). I am less confident in management’s ability to execute on their vision of capturing new payment flows. Fortunately, most of the new payment flows to Visa will be delivered via partnerships. Additionally, most startups acquired by Visa have their founders stay on. I believe this injects the company with the innovative spirit it needs.
Corporate Governance – Moderate
Visa has a very strong Board, consisting of members from very well-respected companies in tech, consumer, finance, industrials, and law. The pedigree of this board is to be expected due to Visa’s status as the world’s largest card network.
Echoing the sentiment voiced in the last section, I am very confident that the board has expertise in defending Visa’s existing business. I believe adding a board member with Fintech expertise would be highly valuable.
Compensation – Weak
While over 90% of executive management’s income is tied to various hurdles, the metrics are simply very weak, with only net income and revenue growth. Obviously, without a return on capital metrics, management is incentivized to pursue M&A liberally. Insofar, that has not been the case, with management pursuing solely strategic acquisitions.
Cyclical or Secular – Strong secular tailwind, with deacceleration within N.A.
Visa has been the beneficiary of the shift from cash/check to electronic payments. The industry has enjoyed a growth rate in the double digits for the past 15+ years and is expected to continue into the near future. However, % of payments in cash suggests that deacceleration is ahead for the North American segment of Visa’s business. Still, there is a long runway ahead for Visa’s core business of card transactions.
Additionally, Visa has ample amounts of growth opportunities ahead of it in multiple regions, as shown above.
One additional tailwind for Visa is the penetration for Ecommerce, shown on the left. Digital retail currently comprises 14% of total retail spent, with a historical CAGR of 23%. This is good for Visa because digital transactions are 3x more profitable for Visa.
Lastly, payments should fluctuate with the state of the general economy. However, less economically sensitive debit spending (44% of Visa volume) has grown to 30% of payments today vs. 19% in 2009. With all cards topping 60%, from 42% in 2009, their use has extended beyond discretionary purchases to day-to-day essentials, supporting spending during downturns.
To summarize, Visa’s core business should fluctuate with the general economy more or less. However, the company has huge potential for growth in capturing new payment flows.
Legal and Regulatory Backdrop – Moderate (High Historically)
Visa has historically been pressured by regulators to decrease swipe fees.
It started in 2010 after the passage of the Durbin amendment, capping U.S. debit fees at 0.05% plus 21c, from 44c, followed by the E.U. in 2015 with debit- and credit-fee caps. U.S. interchange fees on credit cards are higher, but merchants are seeking caps. Mastercard and Visa set the fees, which are paid by merchants to card issuers, who use that revenue to fund rewards and pay the networks. Currently, I believe U.S. regulatory sentiment towards Visa is favorable due to a governmental interest in advancing U.S. payments technology.
Another threat comes from countries favoring local card processors for domestic transactions. Visa can’t handle these in Russia or China. India and Africa began supporting local companies to help them compete with Visa, while some Middle Eastern and Southeast Asian countries may restrict Visa’s participation.
– Visa targets not the emerging-market local transactions market, which is truly dominated by local networks with regulatory capture, but rather the payments generated by locals traveling globally and internationals traveling locally. This should still give Visa a long runway ahead in E.M.
Valuation Relative to Peers – Low
I consider Mastercard to be the only peer to Visa. Visa is trading at a discounted multiple relative to Mastercard. While Mastercard has a higher revenue growth rate compared to Visa, much of it is fueled by Mastercard’s higher incentive costs. Indeed, Visa’s operating margins are 14% above that of Mastercard in 2019.
Bear Case – Weak
The only sell on Visa is by Brett Horn of Morningstar. Interestingly, he is also the only analyst with a sell rating on Mastercard.
Overall, the bear case is as follows:
1. Visa’s leading market share creates more opportunities for loss than gain.
-Scale is what drives returns in the payments industry.
2. The oligopolistic nature of the industry makes Visa and Mastercard targets for regulators, and the companies have paid some large fines.
-Historically regulators have cracked down on the fees charged in the payment process; Visa’s processing margins are a small part of the value generated in that process
-Is this likely to happen in the future, given what has occurred in the past? I argue that large fines in the past actually decrease the probability of fines in the future because now the company is aware of the probability of receiving regulatory backlash.
3. UnionPay provides an example of how governments could favor local networks, and this could shut Visa out of some emerging-market opportunities.
-Visa targets not the emerging-market local transactions market, which is truly dominated by local networks with regulatory capture, but rather the payments generated by locals traveling globally and internationals traveling locally. This should still give Visa a long runway ahead in E.M.
In addition to these points, I believe Brett does not believe Visa can capitalize on new revenue sources, and that growth will decelerate fast.
Please see our General Disclosure.
Junior Equity Analyst
Vincent joined Narwhal in the summer of 2020 after graduating from Emory University with a B.B.A in finance. With previous internship experiences in institutional investing and crude oil trading, Vincent currently focuses on analyzing equity securities, with a focus on consumer and technology related companies. Outside of work, Vincent enjoys a game of classic chess.
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