Allen Bond, CFA, Portfolio Manager
Entrenched Player Integral in Growth of Electronic Payment Transactions
Founded in 1966 as part of a multi-bank consortium, MasterCard is a global leader in facilitating electronic payment transactions. The company processed more than 70 billion such transactions in 2017, providing a key link among consumers, banks, and merchants. For their part in this ecosystem, MasterCard earns a small fraction of the dollar value of each of these transactions.
As a result, transaction volume and transaction growth form the foundation of the investment case for MasterCard. MasterCard is the world’s second largest electronic payments processor, trailing Visa but ahead of China-based UnionPay and meaningfully larger than American Express and Discover in terms of purchase volume1.
Scale is a critical success factor in the electronic payment business, both in terms of growth and profitability. On the surface, the importance of scale indicates a tremendous advantage for industry-leader Visa, relative to all competitors. However, our analysis suggests that MasterCard is equally well-positioned, boasting a top-100 global brand2 and a similarly sized global acceptance network3. Consequently, we believe both companies are similarly poised to benefit from the global trend in which electronic payments are increasingly displacing cash payments.
Beyond traditional credit card transaction processing, MasterCard is developing infrastructure in new payment ‘rails’ and new forms of acceptance. New payment rails include MasterCard debit, used to conduct nearly 40 billion transactions last year, and ‘fast ACH4’, which is expected to advance MasterCard’s inroads with business-to-business (B2B) and business-to-consumer (B2C) transactions. New forms of acceptance include the use of QR codes5 that can turn nearly any smart mobile device into an acceptance terminal. This type of innovation is key to growth in emerging economies that may lack traditional acceptance infrastructure.
All told, we expect MasterCard to post annual double-digit revenue and mid-teens EPS growth for the foreseeable future. This expectation is supported by the company’s strong global market position, the increasing prevalence of electronic transactions, and the powerful operating leverage inherent in MasterCard’s business model.
Our most frequently received question regarding MasterCard is as follows: ‘Why invest in MasterCard and not Visa?’ The simple answer is that MasterCard meets our requirement of consistently high Return on Equity whereas Visa does not, due to Visa’s more equity-weighted capital structure. Beyond that, we believe the companies are nearly identical but that MasterCard’s smaller size implies greater growth opportunities.
Aside from competition by Visa and other traditional payment processors, we are monitoring a variety of emerging potential competitive threats. These include relatively established companies such as PayPal and Square, as well as newer alternatives such as Apple Pay, Google Wallet, Zelle, and Venmo. In all cases, our business risk analysis centers on whether or not the adoption a new payment solution would result in lost traffic on MasterCard’s networks.
Thus far, traditional credit card networks have maintained their role in the bulk of electronic payment processing. We attribute this resilience to the consumer popularity of credit card rewards programs, the economic benefits derived by banks from enabling credit card payments, and the proven security and convenience of credit card platforms.
We first purchased MasterCard shares for the Quality Growth Strategy in September 2015. The subsequent two-plus year holding period is meaningful, but it places MasterCard squarely into the ‘newer holdings’ category within a portfolio characterized by a six-to-seven year average holding period. Since we initiated the position, MasterCard shares have produced a total cumulative return of approximately 30%, outperforming the S&P 500 Index by approximately 11%6. We attribute this market-beating return to the company’s strong business execution, which resulted in sales and EPS growth ahead of expectations.
MasterCard demonstrates many of the key business characteristics we look for in investment candidates. These include strong competitive advantages, well-defined long-term growth drivers, and consistent free cash flow generation. Looking forward, we believe MasterCard is well-positioned for continued growth and business value creation.
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2Source:Per Interbrand.com, MasterCard is the world’s 76th best brand and Visa 61st. http://interbrand.com/best-brands/best-global-brands/2016/ranking/
4ACH: Automated Clearing House, an existing payment network commonly used for electronic bank deposits.
5QR Code: Quick Response Code, an increasingly common form of barcode.
6Internal Source:Total return as of 12/31/17.
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