Visa Selloff Has Eager Investors Eyeing Fresh Entry Points

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Visa (NYSE: V) shares were recently dealt a severe blow following the historic Federal Court ruling regarding debit interchange rates. A US District Court passed the landmark ruling on July 31 that, in effect, invalidated an earlier ruling regarding debit card fees levied by card companies.

The Wednesday ruling overturned an earlier ruling passed in 2010 and operationalized in October 2011 that allowed the Federal Reserve to place an unprecedented $0.21 cap on debit card fees, the first time debit card fees were capped. Presiding Judge Richard Leon ruled that the Fed had blatantly disregarded Dodd-Frank regulations by inflating debit card transactions and failing to provide card merchants with multiple unaffiliated networks for every debit card transaction.

Sharp drop fails to keep near-term bulls at bay

The ‘‘Kings of Plastic,’’ Visa, MasterCard (NYSE: MA) and American Express (NYSE: AXP) immediately reacted to the historic ruling the minute the news hit Wall Street. Visa shares in particular were badly hammered and left on the ropes seriously bleeding. The shares tumbled a jaw-dropping 7.54% to trade at just $173 following the announcement, while American Express declined by 1.89%. MasterCard was the only exception to the tanking share prices, its shares managing to close the day 1.53% up, mainly buoyed by the firm’s sterling second-quarter 2013 results.

Visa was the worst hit of the three companies, owing to its huge lead in the global card industry; the company holds pole position in terms of market share, and commands an unassailable 72.7% of the global market. MasterCard comes in a distant second with a 22% slice of the market.

The massive decline of Visa shares has, however, undeterred some bulls who are now looking for fresh entry points into the recovering stock. The shares are trading at $182.89, 0.89% down from yesterday’s close of $184.54. Perhaps in a strong show of confidence in Visa in spite of the ruling, a massive 57,000 calls switched hands on August 1, the day after the court decision, close to eight times the stock’s average daily volume. At the opposite end of Visa’s option spectrum, 36,000 puts changed hands. The August $190 call was at the helm, and close to 7,700 option contracts crossed the tape, with a large percentage at the asking price. These calls were deep out-of-the-money and were traded at a VWAP (Volume-Weighted Average Price) of just $1.69. This means that traders were betting on Visa shares to move North of the break-even price of $191.69 ($190 strike price + $1.69 VWAP).

Many investors have found it intriguing that American Express, a credit card company with zero-exposure to the debit card industry and whose business was, consequently, not affected in any way by the ruling, was caught at the crossroads by the debit card fiasco. Investors looking for positions in the company can now look for new entry points.

What the ruling means for debit card companies

The effects of the landmark court ruling will have far-reaching consequences for debit card companies. Debit card fees could possibly be cut in half. This will negatively impact the bottom-lines of both Visa and MasterCard. The Federal Reserve is very likely to appeal the court decision; even if it chooses not to, the process of creating and implementing new rules is likely to be long and arduous.

Visa and MasterCard annual reports do not give a clear picture of how much the companies make from fees levied on debit card transactions. Guggenheim Partners estimates that debit card fees per transaction will settle at $0.07- $0.12. Visa and MasterCard can still take some solace in the fact that the lowered fees are likely to lead to a considerable growth in overall transaction volume, and will therefore offset, at least partly, the lost revenue. Moreover, the prevailing interchange rates are likely to remain unchanged until the Fed develops new standards or a resolution occurs.

In reality, the major beneficiaries of swipe fees are banks, and not debit card companies such as Visa and MasterCard. Banks pay card-issuing companies to use their systems, which in turn collect the fees and pass them on to the card-issuing banks, although the fees are set by the card companies. This revelation should not come as a surprise given that it is intense lobbying by banks that prompted the Fed to raise swipe fees by $0.09 from $0.12 to $0.21 in the first place.

Peer analysis

MasterCard tops Visa when it comes to credit services. The company’s revenue base is also more diversified than Visa’s since the US market contributes just 39% of its revenue compared to 56% for Visa. MasterCard has also taken several bold initiatives to grow its presence in online and mobile transactions. This means that its business is now more market-driven.

American Express posted good results in the first quarter of 2013. 50% of its revenue comes from the American market. The company’s US business division recorded a 5% growth in revenue. The improved macroeconomic conditions and better consumer sentiments will likely help American Express continue with its impressive performance. The company is expanding its international business and has teamed up with several financial institutions to issue third-party cards in these countries.

Ratio analysis

 

P/S Ratio

Forward P/E

PEG Ratio

EV/EBITDA

Visa

11.14

21.70

1.35

17.22

American Express

2.87

14.77

1.38

N/A

MasterCard

9.61

19.75

1.32

15.76

Visa is therefore trading at a premium with respect to its two peers. Investors, therefore, believe that the company’s future prospects are considerably better. Visa’s huge lead in global market share as well as its future business strategies that encompass developments such as expanding its foothold in emerging markets, where the shift from cash to electronic payments in a lot of developing countries as well as mobile banking and e-commerce growth, will all provide some lift to the card giant.

Conclusion

The heavy reliance on debit cards for its revenue is the biggest reason why Visa was more hurt by the debit card court ruling than its peers. But mark my words: Visa might be down, but most definitely is not out. It is highly unlikely that either Visa or MasterCard will suffer economically from any changes in the current interchange cap. Major banks will probably try to renegotiate their fees, since they seem to have an uncanny ability to make up for lost revenue by any means possible. Despite this, it is hardly likely that they will be willing to strain their delicate relationships with card purveyors such as Visa and MasterCard. Once investors fully digest the real meaning of the historic ruling, Visa shares are likely to rebound strongly. Visa returned impressive second-quarter results and is likely to continue with this trend in the coming quarters. The unfortunate blip cannot hold the credit card giant down for long.

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Boniface Murigu has no position in any stocks mentioned. The Motley Fool recommends American Express, MasterCard, and Visa. The Motley Fool owns shares of 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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