(Source: WalletHub)

Investment Thesis

The consumer payments infrastructure market is a de facto duopoly between Visa (V) and Mastercard (MA), though American Express (AXP) and Discover (DFS) combined do possess a noteworthy share. While all of them have historically served as card-based transaction infrastructure plays, a new wave of fintech is currently washing ashore, and the strength of any of the companies will reside in their ability to adapt to these new realities.

My vision for these companies isn’t necessarily contingent solely on the “death of cash” so to speak. If Visa and Mastercard want to remain relevant throughout the 21st century (and therefore good investments), these companies must be able to diversify their revenues in the same way Amazon (AMZN), Apple (AAPL), Facebook (FB), and Alphabet (GOOG) successfully have over the last decade.

In a recent article, I referred to Microsoft’s Azure and Amazon’s AWS offerings as the “modern-day railroads of data” in the 21st century.

Well, whether we realize it or not, purchasing Visa or Mastercard is directly akin to purchasing railroads in the early and mid-20th century. These are truly the rails of money in the 21st century.

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And if you don’t take my word for it, stay tuned for the rest of the article, as I share a quote from Mastercard’s management regarding the company’s position as the money railroads in our modern era.

To this end, today, I am going to compare both of the companies’ core businesses, after which I will explore their acquisition strategies to determine which company will deliver superior results in the coming decades. I am going to analyze the companies highlighting that both will generate market-beating returns, and at the end of the article, I will answer the question of which one you should buy today.

Let’s find out!

Superior Presence

(Source: Market Share by Credit Card Network)

Visa is the more established business, as it has a stronger market share and more revenue than its competition. I simply think of Visa as Coca-Coca (KO) and Mastercard as Pepsi (PEP), and as we’ve seen over the last decade, just because one has a better-tasting drink doesn’t mean that its stock will outperform (that is, PEP has outperformed KO, as can be seen below).

(Source: YCharts)

So just because one has been more dominant doesn’t mean it will continue to be so in the future, hence we are conducting this analysis.

Both companies have benefited from the decline in cash and the rise in digital and card payments. This trend has led to tremendous revenue growth for the two companies in the past 10 years. As people have turned away from using cash, they have started using credit and debit cards as well as various payment platforms, which are nearly ubiquitously enabled by Visa and Mastercard’s payment networks.

(Source: YCharts)

As can be seen above, both companies are steadily increasing revenues, though they both project a modest dip in 2020 due to the virus.

Mastercard increased revenue by 13% in 2019 and 20% in 2018, while Visa increased its revenue by 11% and 12% in those years. Mastercard is growing slightly faster, while Visa already has a greater presence because it processes more transactions, which can be seen below.

(Source: GlobeNewswire)

The graph above captures Visa’s superior presence. The chart below further highlights this dominance.

Annual and Monthly Purchase/Spending Volume in 2018

(Source: Market Share by Credit Card Network)

So far, this is information to which you’ve already likely been exposed. Next, I will highlight where I believe “the rubber will meet the road”.

That is, V and MA cannot continue to generate market-beating returns without becoming de facto venture capital funds, in which they bolt-on rapidly growing fintech startups with revenues in the hundreds of millions (as Visa successfully did with Plaid recently). This is referred to in the industry as a “multi-rail” strategy, as I will highlight in the coming paragraphs.

Mobile Payments and E-commerce

E-commerce and digital wallets are becoming more popular as technology evolves. In light of this, Visa and Mastercard are positioning themselves such that they will continue to dominate the payments infrastructure arena. As can be seen below, the amount of non-cash transactions is supposed to steadily increase across the globe.

(Source: Stripe reaches $35 billion valuations after $250 million funding round)

Visa and Mastercard will in all likelihood continue to capture this growing trend. Furthermore, global e-commerce sales are still growing rapidly.

(Source: eMarketer)

Now, let’s take a look at this “multi-rail” strategy, which I’ve mentioned a couple of times heretofore.

Building Visa’s Tracks

(Source: Medium.com)

Visa’s portfolio consists of a variety of solutions that include contactless technology, digital products, and risk management protection. As can be seen above, the company has built a fortress of solutions by which I see it insulating itself from disruption, while also planting the seeds for future accelerated revenue growth.

For example, the Plaid acquisition provides just another rail on which money will travel in the 21st century, and Visa will be there to collect its tolls.

(Source: Quartz)

Plaid allows people to access their bank accounts from a variety of apps and websites. This is just one highly successful example of Visa making a strategic acquisition to further strengthen its moat as the premier global payments infrastructure company.

Earthport was another acquisition in 2019 that enables Visa to strengthen its international presence. Visa also strengthened its fraud management system with its acquisition of Verifi.

While the company’s core business of providing the rails on which money transfers between individuals and their banks slows, its strategic acquisitions will continue to ensure it remains a fantastic investment with plenty of “cargo” still traveling on its tracks.

Now, let’s check out some examples of Mastercard’s rail building.

Building Mastercard’s Tracks

(Source: Mastercard held deal talks with Sweden’s Tink | Sifted)

As illustrated above, Mastercard is steadily acquiring and investing to strengthen its position as a dominant payments infrastructure company. In addition to the above “tracks”, it also offers a variety of solutions, including fraud protection and digital payments.

In the fall of 2019, Mastercard entered into an agreement to purchase Nets, a real-time payments infrastructure play hailing out of Denmark. Since entering into the agreement, the antitrust authorities of the EU have decried as anticompetitive behavior.

So, we will continue to monitor developments related to Nets. However, it truly highlights my point about these companies needing to become diversified. In the words of Mastercard’s management, they want to become “multi-railed”.

“This is really about continuation of Mastercard’s expansion into being a multi rail provider.”

– Paul Stoddart, president of New Payment Platforms at Mastercard

Another example of Mastercard diversifying its revenues was its acquisition of Ethoca, a technology solutions company that identifies and resolves digital fraudulent activity. Moreover, Mastercard now offers enhanced cross-border account transfers internationally through Transfast.

Mastercard’s acquisitions are further diversifying its revenues and thereby creating a multi-rail company.

Now, let’s find out which is the better investment based on our proprietary valuation model.

L.A. Stevens Investment Model

To determine a fair value for Visa and Mastercard, we will employ our proprietary valuation model. Here’s what it entails:

  1. Traditional discounted cash flow Model using free cash flow to equity discounted by our (as shareholders) cost of capital.
  2. Discounted cash flow model including the effects of share count fluctuations.
  3. Normalizing valuation for future growth prospects at the end of the 10 years. Then, using today’s share price and the projected share price at the end of 10 years, we arrive at a CAGR. If this beats the market by enough of a margin, we invest. If not, we wait for a better entry point.

Now, let’s check out the results!

Assumptions

Assumption

Visa

Mastercard

Free cash flow per share

$5.56

$7.44

Free cash flow per share growth rate

10%

12%

Terminal growth rate

2%

2%

Years of elevated growth

10

10

Total years to stimulate

100

100

Discount Rate (Our “Next Best Alternative”)

9.8%

9.8%

Present Value (accounting for buybacks)

$192

$281.72

Using the L.A. Stevens Valuation Model, I found that Visa and Mastercard are technically overvalued from a discounted cash flow perspective, as Visa trades at ~$190 and Mastercard at ~$297.

However, this is why the L.A. Stevens Valuation Model is highly useful. DCF models can oftentimes prevent us from making great investments, as they reject the reality that in 2030 the respective companies will likely trade at elevated multiples due to their stable and, albeit modestly, growing cash flows.

So, in order to determine expected returns, I simply grew the above free cash flow per share at the above assumed growth rates. Then, in year 2030 (or thereabouts), I assigned a conservative price to free cash flow multiple of 25x. For companies with gross margins of above 75%, operating at the heart of secular growth trends, 25x should be easily attainable, as companies like Proctor & Gamble (PG) and Apple (AAPL) trade at 25x+ price-to-free cash flow with less than 5% top line growth and even worse margin profiles than those of Visa and Mastercard.

Visa

Mastercard

Expected Return

~12%

~14%

(Source: L.A. Stevens Valuation Model)

Now, the L.A. Stevens Valuation Model includes a 4th component that factors in dividends without reinvestment and with reinvestment on a quarterly, semi-annual, and annual basis.

It’s really useful, if I do say so myself, and above you can see the approximate results based on an annual DRIP setting.

Margin of Safety

There are numerous methods by which one can implement a margin of safety. In most cases, I simply use conservative estimates to arrive at a valuation for a company. Here’s an example:

For the model, I used conservative estimates to account for growth and buybacks over the next 10 years. Visa bought back ~30% of shares outstanding in the past 10 years, while Mastercard bought back ~28% over that same period. Therefore, I assumed that both companies will buy back only 25% of their shares over the next 10 years.

Concluding Thoughts

Visa and Mastercard operate in a highly lucrative industry… with disruptive vultures circling it every day.

From my perspective, retailers would pounce at the opportunity to reduce the transaction fees precipitated by the present payments infrastructure regime. Therefore, I highly approve of the “multi-rail” strategy that both companies have assumed. And ultimately, I rate both companies buys at their present prices.

With that being said, I would not bet the farm on either company and would prudently diversify into the handful of fintech players my Beating The Market subscribers and I have purchased.

In sum, I label Visa a buy at $200 and below and Mastercard a buy at $300 and below.

As always, thanks for reading; remember to follow for more, and happy investing!

Beating the Market: The Time Is Now

There has never been a more important time in stock market history to buy individual stocks at the heart of secular growth trends. Mature market performers/underperformers and index funds simply will not cut it, as we face a decade during which there is absolutely no guarantee the overall markets will rise. 

This is why the time is now to discover high-quality businesses with aggressive, visionary management, operating at the heart of secular growth trends. 

And these are the stocks that my team and I hunt, discuss, and share with our subscribers!

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.