Investing For a Post-Cash Future

Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Cash will never completely disappear.  There will always be some marginal room for good old fashioned paper money, but it´s certainly losing popularity as a payment method all over the world. As the trend towards more efficient payment methods becomes stronger over the next few years, investors will have plenty of opportunities to profit by investing in the different companies which benefit from the new paradigm.

An Inexorable Trend

According to McKinsey, cash payments accounted for around 29% of retail transactions in the US during 2012, down from 36% a decade ago, and expected to fall further over the next years. McKinsey estimates that the percentage of transactions done by paper money will drop to 26% by 2020 and to only 10% of transactions in three decades.

Cash is uncomfortable and inefficient, you need to regularly monitor the amount of money in your wallet, and there is always the risk of loss, damage, or being robbed. Debit and credit cards are superior in that sense, and the new e-wallets that allow customers to pay via their smartphones take the simplicity and convenience one step further.

Cash will never completely die because some people will always prefer paper money, particularly those who don’t trust new technologies or want to keep their transactions undercover. But the long term trend is away from cash and towards better payment methods, so investors would be smart to pay attention to the opportunities emerging from the demise of cash.

Debit Cards

Debit card companies like Visa (NYSE: V) and MasterCard (NYSE: MA) are the prime beneficiaries from this trend. These companies operate like gigantic global networks connecting banks and merchants, while making a profit every time a customer swipes a debit card. They are very profitable companies with pristine balance sheets, and they look outstandingly positioned for growth in the long term.

Both Visa and MasterCard benefit from rock solid competitive advantages. Their well established networks are very hard to replicate by potential new entrants, and they have invested for decades in marketing and branding to build their reputation and earn customer’s trust--an invaluable, or “priceless,” asset in this business.

Network effects play a crucial role for these companies. Merchants need to accept those cards which attract customers, and customers gravitate towards cards which are accepted everywhere by everyone. Adding more users increases the value of the service, which at the same time attracts more users, creating a virtuous circle of growth and increased competitive strength.

Visa is the market share leader with more than 60% of the market, while MasterCard has around 30% of the global share. But MasterCard is better positioned in emerging markets, where card penetration is comparative low and economic growth is more exciting, so it has better growth prospects.

Credit Cards

Credit card companies like American Express (NYSE: AXP) and Discover Financial (NYSE: DFS) are also benefiting from the move away from cash, and they are trading at much lower valuations tha, the debit cards companies. While investors need to pay a forward P/E ratio of 18.8 and 17.1 for Visa and MasterCard, respectively, American Express trades at a forward P/E of 11.3, and Discover Financial at an even lower ratio in the area of 8.6.

But they don´t have the same kind of scale and global reach that make debit card plays so compelling, and they provide lending to their clients, which makes their business much more risky and volatile. As we can see from the chart, debit card companies have shown more resilient revenues through the last recession, and their growth rates are far superior.

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None of these means that credit cards companies can´t outperform, especially if the economy collaborates. Consumers will one day decide that they´ve already had enough deleveraging and that it’s time to start using their credit cards again, and credit card companies are attractively valued to benefit from a recovery scenario.

But from a long term perspective, the debit card companies look like stronger bets on the demise of cash due to their bigger networks and low risk business model.

The Frontrunner

Many tech companies have been riding the online payments boom, from innovative startups like Square and many others, to gigantic corporations like Google and Apple. But the one player that looks specially promising among these alternatives is eBay (NASDAQ: EBAY).

PayPal has emerged as a leading electronic payment system, and it has plenty of room for growth over the next years. eBay recently reported that PayPal has now nearly 123 million active accounts; it added around 2 million accounts a month in the fourth quarter. Net total payment volume (TPV) increased by 24% annually in the last quarter of 2012.

PayPal is already accepted by more than 60 of the top 100 online retailers in the U.S., and it processes more than 25% of online retail transactions in the country.  Mobile payment volume reached nearly $14 billion in 2012, up more than 250% over the prior year, as consumers are increasingly using smart phones and tablets to pay online.

The same network effect that benefits Visa and MasterCard is in play for eBay and its PayPal business. The more users it has – both among customers and merchants – the more valuable and trustworthy the payment method becomes. PayPal is ahead of the pack in online payments, and this is a tremendously valuable competitive advantage which bodes well in terms of future growth prospects.

Bottom Line

One of the most interesting ways to make money over the next years will be betting on the companies which benefit from the demise of cash. It may sound a bit ironic, but that doesn´t make it any less profitable.

acardenal has no position in any stocks mentioned. The Motley Fool recommends American Express, eBay, and Visa. The Motley Fool owns shares of eBay and MasterCard. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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