If you think of growth at Visa (V) and MasterCard (MA) in terms of business as usual, then even in a slow growth global economy where a company with a clear long-term growth trajectory should command a premium, these two stocks seem pricey. Using the current Wall Street earnings consensus for 2015, Visa at a commonly cited Wall Street target price of $260 offers only 7% upside and assumes a multiple of 24 times projected 2015 earnings per share. A similar target price of $94 for MasterCard offers a 12% upside potential but assumes a multiple of 26 times projected 2015 earnings per share.
The question, though, for Visa and MasterCard—and the investors who are thinking of buying them—is whether Wall Street’s business as usual growth scenario is accurate. There is a good argument to be made—and I’ll try to make it here—that this is a transformative moment for these two companies that may, thanks to Apple Pay, have found a way to jump into the big global move toward financial transactions on mobile devices. If that’s the case, and I think it is, then you do want to own one of these “expensive” growth stocks because they’re a “cheap” way to buy a piece of that global growth story. I’ll be adding Visa to my Jubak’s Picks portfolio tomorrow, November 5.
As the battle among Apple Pay, PayPal, and the CurrentC payments app forthcoming from the Merchant Customer Exchange group, demonstrates the valuable product here isn’t that square of plastic that sits in your wallet but the network that processes payments and collects information on all those transactions. The Merchant Customer Exchange’s CurrentC payments app is designed to cut Visa and MasterCard out of those transactions by substituting the automated clearinghouse system now used for direct deposits and Social Security payments for the credit card companies’ processing networks. The CurrentC system uses customers’ checking accounts–payments would come out of customers’ checking accounts and not out linked credit cards. The merchants in the CurrentC group—a group that famously includes Rite Aid and CVS (famous after disabling the Near Field Communications technology that lets customers use Apple Pay (and Google Wallet) to pay with a flourish of a mobile phone) and Target and Wal-Mart—would avoid the fees they now pay to Visa and MasterCard. (Fees paid by merchants would drop since the automated clearinghouse processes payments for a lower fee. Whether those lower fees would get passed on to consumers is, of course, an unanswered question–although I suspect we know the answer.) And stores themselves using the CurrentC system would have access to all the data about who buys what where that credit card companies now keep to themselves and that Apple Pay doesn’t even record. (Apple Pay generates an anonymous payment token for a transaction so that merchants never get a credit card number/identity that they can use to track purchases for later marketing. This approach also makes Apple Pay more secure than the traditional credit card number system that has been hacked at Home Depot and Target, to take two examples.)
The deal that Apple Pay offered to Visa and MasterCard (and to American Express)—which means in reality to U.S. banks since Visa and MasterCard themselves provide branded products to banks that the banks then offer to their customers—was ingenious. We will use your existing credit card system and processing network. Cut you out of the system? Who would even think such a thing? We, Apple, will, of course, charge a fee for each transaction through Apple Pay but it will be so small that you won’t even notice—just 0.15% of the amount of a credit card transaction and 0.5 cents for each debit card transaction. (And we’ll also let you, Visa and MasterCard charge a fee—50 cents at MasterCard and 7 cents at Visa—to add the token to each card that will mask the actual credit card account number when a consumer uses Apple Pay for a purchase.) Before you start to think we’re talking nickels and dimes here remember that Visa and MasterCard handled 563.4 billion transactions in the U.S. in 2013 with a value of $3.32 trillion. The third credit card company in the Apple Pay system, American Express (AXP) is the biggest credit card issuer by purchases with a total of $637 in 2013. (U.S. GDP was $16.8 trillion in 2013.)
But the real attraction that Apple Pay—if successful—offers Visa and MasterCard and American Express is a path into a future where more and more financial transactions (like everything else) are conducted on mobile devices. Apple Pay with its tokens and improved security, with its fingerprint reader, and with its ease of use gives the U.S. credit card sector—never known for its cutting edge technology—a way to catch up and even leapfrog markets such as Europe that have already put chips in credit cards and created a network of sales terminals that can read them.
If instead of having to play catch up and having to browbeat merchants into upgrading to a chip on card system, Visa and MasterCard can leap straight into the transactions on a mobile device future, then I think the growth rate that is embodied in the Wall Street consensus is conservative.
Not next month mind you or even next quarter, but certainly over the next year—if Apple Pay works where other payment systems such as Google Wallet have struggled. (And I would expect that if Apple Pay succeeds in jumpstarting this market, then we’d see payment systems on Android phones showing new technology and new life. And at that point we’re talking about putting payment systems processed by Visa and MasterCard on phones that cost way less than Apple’s iPhone.)
At the moment, I prefer Visa to its competitor MasterCard. It has the largest market share by card numbers—at 38.3% of credit cards and 63% of debit cards—in the U.S., which gives it bigger base for expanding into mobile payments. Visa shows a higher operating margin at 62% versus 56.7% than MasterCard suggesting that it should be able to negotiate more lucrative deals going forward. It pays a slightly higher dividend than MasterCard—at 0.79% to 0.52%–but both companies have aggressively raised dividend payouts and increased buybacks over the last five years.
I’m starting Visa off with a conservative short-term target price of $270 a share by April 2015. That’s a potential of about 11% in six months. After that, I think, Visa growth potential on mobile devices should start to become clearer to the general market.