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The payments industry is constantly changing, but if you are a business and you want to grow, you have to accept Visa (NYSE: V) and MasterCard (NYSE: MA). These two companies define the industry and are generally regarded as the most widely accepted forms of payment besides cash. When merchant salespeople go to businesses, they are normally quoting rates for accepting Visa or MasterCard. When people walk into a business, many times they are looking for the Visa and MasterCard logo. With this type of brand recognition, these two companies have the potential to define the future of electronic payments. Newer companies like eBay's (NASDAQ: EBAY) PayPal unit and Square are creating new ways to get paid, but not really a new network. Let's look at how the industry is changing and how MasterCard stands to be one of the primary beneficiaries.
The Traditional Merchant Setup:
The payments industry is essentially a conduit where the buyer wants to pay for something from the seller. The bottom line is Visa and MasterCard help buyers buy and sellers sell. While I've heard a lot about PayPal and Square and their potential to disrupt the industry, both of these services actually just expand the ability of Visa and MasterCard to dominate the industry. Just as an example, let's say you are a small business owner and you want to accept Visa and MasterCard. Traditionally, you would either go to your bank or you might be approached by a merchant provider to set you up with a card reader. The merchant provider would ask you questions like, what your average ticket size is, or how many transactions do you expect to have per day? Based on your answers and some personal credit information, the provider would run your credit, and come up with a quote. You would pay a certain percentage of each transaction plus usually a monthly fee, and a per transaction fee. The business would also either lease or buy a terminal or software to integrate into your system.
The New Way:
With companies like Square and PayPal, you might not have a big terminal at all. Both companies offer free card readers that can be plugged into a smartphone. Businesses can pay a flat fee or a flat percentage rate structure to accept cards. Here is the kicker, with either of these systems you are offering to accept Visa, MasterCard, Discover, and American Express. In both cases the company is acting as a merchant provider. They are not replacing Visa or MasterCard, they are offering a different way to accept these payment methods. To say that they represent a threat to Visa or MasterCard is probably reaching. At this point, PayPal and Square are much more of a threat to other merchant providers. This puts these two companies squarely (pun intended) in competition with many large financial institutions and their internal merchant services businesses. If you want proof, consider that PayPal's own debit card has a MasterCard logo on it. PayPal knows that there are millions of places that accept MasterCard and not all that many that accept PayPal. While that may change somewhat over time, Visa and MasterCard have a several million head start.
What Makes Visa and MasterCard So Great?
To be blunt, they are usually the cheapest cards to accept for the merchant and they are everywhere. When a retailer wants to partner to offer a card, they go to Visa or MasterCard first. We've already mentioned the PayPal debit card has the MasterCard logo. Capital One's cards are largely Visa branded. In fact, I would venture to say that 99.9% of credit and debit cards issued by financial institutions are either Visa or MasterCard branded. This explains why businesses want to accept these cards. It's a well known fact that people spend more on plastic than they do using cash. Business owners might not like paying the fees to accept credit cards, but they realize they will lose sales if they don't offer this payment option. With millions of locations accepting this Visa or MasterCard, and millions of cards in force with the Visa or MasterCard logo, it's not hard to understand why it will be difficult to unseat these two behemoths.
Why is MasterCard Potentially a Good Investment?
The old saying of buy what you know from Peter Lynch rings true here. What's easier to understand than every time you swipe your MasterCard the company makes a little bit of money? All of these small amounts add up, and with more and more transactions occurring on plastic, it's not hard to understand how MasterCard could be a good investment. In their most recent quarter, the company showed revenues up 13% on a constant currency basis, and EPS increased 19%. With gross dollar and purchase volumes up in the teens, and processed transactions increasing 29%, you can see a lot of people use their MasterCard. This is why MasterCard could be attractive, the more transactions are done with plastic, the more money the company makes. While analysts are calling for 19% EPS growth from both Visa and MasterCard, I believe MasterCard offers the better opportunity.
Both company's ability to make more money comes down to transaction volume growth. In their recent quarter, Visa showed transaction volumes up 6%, compared to the 29% increase at MasterCard. I have a hard time believing that Visa will turn significantly slower transaction growth into the same EPS growth as MasterCard. My choice of MasterCard also comes from the fact that PayPal is using the company as their standard when they issue cards. Whether it's a PayPal debit or credit card they issue MasterCard. With new PayPal users growing at 13%, and payment volumes at the company up 20%, it should be no surprise that this relationship has the chance to drive MasterCard's growth for years to come.
Conclusion:
The bottom line is, investors would do well to consider either Visa or MasterCard to cash in on the move toward more electronic transactions. While both will probably do well, MasterCard seems to have better organic growth, and their partnership with PayPal should allow both companies to benefit in the future. While analysts see both companies growing at about the same rate, I don't buy that. Visa has the larger installed base, but is seeing slower transaction growth. Transaction growth drives earnings growth at these companies. These same analysts are calling for Visa's revenue growth to slow somewhat in the next year or so, while they see MasterCard's revenue growth speeding up. Higher transaction growth, the partnership with PayPal, a similar valuation, and one of the two dominant names in payments, equals a great opportunity in my eyes.
MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of MasterCard. Motley Fool newsletter services recommend eBay and Visa. 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.If you have questions about this post or the Fool’s blog network, click here for information.
