Which Credit Card Company is in Charge?

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

The credit card business is a great business to be in. 

According to a Nilson report update, global credit cards accounted for 62 billion transactions in 2011, worth a stunning $6 trillion worth of purchases.  The number of transactions was up 11% compared to 2010, and the value of the purchases was up nearly 16%.  That's no small change!

Needless to say, the world is quickly evolving from one that transacts using cash to one that uses cards.

There are a few distinctions between the related parties of the credit card business that we should keep in mind as we look in this space for investment opportunities:

  • The merchants are the Wal-Marts (NYSE: WMT) and other retail establishments of the world that are glad to sell you anything and everything that you could possibly want to buy.  Over the years, this has included Pet Rocks, Beanie-Babies, and Tickle-me-Elmos (disclaimer: I do not actually own any of these).  The merchants typically must pay a fee, known as the 'merchant discount', every time that a customer makes a purchase with a credit card.  According to Bloomberg, the average merchant discount in 2009 was 1.9%.
  • The issuing banks are those that issue the credit cards to consumers.  They also receive the majority of the merchant discount that is paid by retailers.  This percentage taken by the issuing bank is known as the 'interchange fee', and it averaged 1.7% in 2009.  These banks include Chase, Bank of America, and others.  They hold the monthly balance held by consumers and carry the risk of them defaulting. 
  • The acquiring banks are the banks of the retailers.  They receive payment from the issuing banks every time that there is a purchase. 
  • Lastly, as e-commerce makes international trade easier and easier, there is a growing network that is comprised of companies that connect the issuing and acquiring banks.  This makes it possible for consumers to buy something from a retailer on the other side of the world almost instantly -- because the network serves as the middle-man to clear and process the transaction. 

The network is more or less an oligopoly.  There are a few well-branded companies that make money by giving the rights to issue cards to the issuing banks and by taking a small percentage of the merchant discount every time there is a transaction.  There are also two types of networks: open and closed.  In an open network, the companies serve only as a bridge between the issuing and acquiring banks.  However, in a closed network, the network company also serves as the issuing and acquiring bank.  This means that closed network companies can directly issue cards to consumers and pay merchants for transactions.  What's important to remember is that the companies in the network - whether open or closed - have huge competitive advantages.  They have strong brands and become more entrenched with each newly issued card and transaction, which builds incredibly strong barriers to entry.

With all of that background said, let's take a look at three of the largest companies in the credit card network:  American Express (NYSE: AXP), Mastercard (NYSE: MA), and Visa (NYSE: V).

How They Cheque Out

Looking at the current financial statements, here is how the three companies stack up against one another.  Share prices are current as of Friday, July 27.

  American Express (AXP) Mastercard (MA) Visa (V)
Open or Closed Loop Network Closed Open Open
Price Per Share (7/27/12) $57.85 $428.20 $127.91
Market Cap ($billion) $67 $54 $104
Trailing P/E (TTM) 13.6 26.6 29.7
Forward P/E 12.4 16.1 18.0
Revenues ($billion) $30.5 $7.0 $9.8
Operating Margin (%) 23% 41% 60%
Net Margin (%) 16% 29% 43%
Goodwill (as a % of Total Assets) 0% 9% 34%
Dividend Yield (%) 1.3% 0.2% 0.6%
FCF Yield (TTM, %) 18.3% 4.7% 3.8%

 

As was stated above, there are a few differences in how these companies operate (notably that Visa and Mastercard are open network, while AXP is closed), which appears in their financial statements.

A Few Things to Note

American Express is a different beast than Mastercard or Visa.  They are the world's largest card issuer, and accounted for 24% (by $ value) of credit card transactions in the US in 2008.  Because they are a closed-loop network, they can benefit from many upsides - including increased number of transactions and revenue from interest rates for carrying balances.  But they are also exposed to a greater deal of risk.  It is this risk that is perhaps the reason that they trade with a lower P/E on the market.  They are also the greatest payer of dividends of the three companies compared.

Mastercard is slightly cheaper than Visa on a P/E basis, though with lower margins and a smaller dividend.  But Visa's acquisitions over the years have resulted in them carrying a massive amount of goodwill on their balance sheet.  In terms of free cash flow, Mastercard also keeps more of its revenues as cold-hard-cash at the end of the day.

So Who's the Best Bet?

First, let me say that you can't go wrong with any of these picks.  Credit card services is a wide-moat industry that benefits from a massive user base and incredible brand recognition.  Couple that with the Nilson report, and it's clear we're looking at an industry that continues to grow rapidly.

My personal pick of the litter is Mastercard.  They have the lowest revenues and operate a smaller network than Visa, but this just means that they have more room to grow.  They also have much less risk than AXP (open vs. closed network) or V (goodwill).

Mastercard is already an 8-bagger since 2006 and I don't see signs of them slowing down any time soon.  Though I do agree that there are some things that money can't buy...for everything else there's Mastercard.


TXinvestor82 has no positions in any of the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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.

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