Mastercard Randolph McDuff
I will repost this for those who may want to read it.
May 9, 2010
Mastercard (nyse: MA, $223.09). Priced by Fear, Rather Than Success
MA shares outstanding: 131 million.
MA net liabilities (as of 03/30/2010): $1.34 billion.
MA enterprise value: $30.8 billion.
MA 2010 est. EBITDA: $2.8 billion.
MA 2011 est. EBITDA: $3.3 billion.
Est. 2010 closing EV/EBITDA ratio: 10.5X
Est. 2011 closing EV/EBITDA ratio: 8.5X
Mastercard's global growth rates seem to be unappreciated by North American investors.
Q1, 2010 revenues came in a $1.31 billion, up by 13.1%. This surpassed the highest view of $1.28 billion for Q1 and the analyst consensus of $1.27 billion. Earnings came in at $3.46 US per share, ABOVE the highest view of $3.40, ABOVE the whisper number of $3.35 per share and 10% above the consensus estimates of $3.14 per share for the quarter.
EBITDA in the quarter was $735 million, or 55.8% of net revenues, a record since inception. Net liabilities fell by $568 million in the quarter.
click here to download the company's press release
click here to see the transcript of the company's earnings call
Mastercard has little respect from a "US centric" North American analyst community.
Mastercard became a publicly traded company in May 2006. At year-end 2005, the firm reported total revenues of $2.937 billion and EBITDA of $592.4 million, a margin of 20.1%.
At the end of fiscal 2010, Mastercard revenues may exceed $5.75 billion, with EBITDA surpassing $2.8 billion, a margin of 48.7%. Should this be proven correct, on an absolute basis, EBITDA will grow by approximately 472%, on revenue gains of 96%, during a five year period.
EBITDA increases of this magnitude occur at companies with largely fixed costs. Mastercard has proven an ability to keep costs in check throughout the past five years, while expanding revenue at a 14.5% compounded annual clip.
Despite a share price gain of more than 540% since issue, Mastercard is selling for roughly the same forward relative valuation, as in 2006. EBITDA growth has risen, virtually lock-step, with share price appreciation. The balance sheet improvements are equally notable. At the end of 2010, Mastercard's balance sheet will have moved from a position of net liabilities, in the range of $2 billion, to what looks to be a totally debt free position and a modest net cash balance. 4 million outstanding shares will have been retired through share repurchase since IPO.
Subsequent to IPOissue, MA has beaten analyst views on revenues and earnings EACH and EVERY quarter, sometimes by amounts sufficiently high, so as to call into question, the modelling systems adopted by various analysts. Q1 2010 proved, yet again, that analysts do not seem to be able to accurately compile various components of the international revenue streams. Visa, the larger competitor, did not beat consensus expectations on revenues and earnings by analysts. This represents a paradox for analysts. One can easily and logically conclude a confirmation bias exists in favour of Visa, and against Mastercard.
Mastercard is a larger issuer of credit cards than debit cards. Analysts are bullish on the outlook for debit, less so for credit. Mastercard's historic emphasis on credit, rather than debit, represents another point of contention with analysts. Many are of the opinion that Mastercard will not be able to fully participate in a secular trend towards debit.
Analysts and individual investors alike often report that Visa is more than 2X the size of Mastercard in the US, and extrapolate this market share on a global basis. Such a view represents a fallacy. Globally, Mastercard's business is roughly 67% the size of Visa.
Mastercard derives more than 55% of revenues outside of the United States, and has key strengths in emerging markets such as Brazil, Asia and Mexico. 66% of the total number of cards, carrying the various Mastercard brands, are outside of the United States. 60% of gross dollar volumes (GDV) processed by Mastercard are generated outside of the United States.
phx.corporateir.net
The Asia Pacific region is Mastercard's fastest growing market. In Q1, 2010, GDV in this region represented 22% of total volumes, up by 20.9% year over year. In 2009, Asia Pacific GDV represented 18.7% of the total.
phx.corporateir.net
Latin America GDV accounts for 7.8% of Mastercard's total. A year ago, Latin American GDV was 6.7% of the total.
In aggregate, Asia and Latin America are Mastercard's second largest overall market, ahead of Europe and behind the US. Should present trends continue, by mid- 2011, Asia and Latin America will become Mastercard's largest market, as measured by GDV.
While Visa and Mastercard represent a de-facto duopoly in global credit/debit, there is a substantial difference in valuation, between the two firms.
Visa (V-NYSE, $83) has 737 million shares outstanding on a fully diluted basis and currently has net liabilities of $3.52 billion. This represents an enterprise value of $64.9 billion. Visa should report 2010 EBITDA of $4.7 billion. Visa has currently made a dilutive purchase (Cybersource) to be completed later this year; total liabilities should remain unchanged through the 2010. Visa's 2010 year end EV/EBITDA looks to be in the range of 13.9X.
Mastercard has a current enterprise value of $30.8 billion and should report 2010 EBITDA in the range of $2.8 billion. The year-end EV/EBITDA ratio looks to be 10.5X.
Mastercard generates less than 67% the revenue of Visa and produces 62% of Visa's EBITDA. As an offset, Mastercard sells for roughly 44.6% of Visa's 2010 year end EV/EBITDA ratio.
Both Mastercard and Visa are well positioned to capture the secular global move to a cashless society.
As processors, Mastercard and Visa remain immunized from direct credit risk. They generate revenues from license fees, cross border assessments and a modest percentage of the interchange fee charged to merchants who rely on their global payment systems.
There has been periodic upheaval in the share price of Mastercard throughout the years 2008-2010. At first, criticism was levied regarding the earnings reliability throughout the global slowdown in 2008-2009. Such fears of earnings compression proved to be wholly unfounded.
In the case of Mastercard, revenues have grown by a solid 25.3% from 2007 to year-end 2009. Processed transactions were up 19.5% over the same period. Operating expenses have not changed significantly in the last several years. Almost all of the increase in revenues fell directly to EBITDA, and subsequently to the bottom line.
Capital expenditures to support and grow the Mastercard network have approximated $162 million per annum, for the last 3 years. This is approximately 3% of annual revenues.
The initial fixed costs of setting up competing businesses are extremely high, which is a key barrier to entry. Fees paid to processors are miniscule on a per transaction basis. Economies of scale are therefore almost impossible to achieve for new entrants to the business, which represents the other barrier to entry. For these reasons, I do not own the smaller processors, which include American Express and Discover. Visa and Mastercard produce some of the highest non-cyclical profit margins on the planet. With fixed costs in check and rapidly declining interest charges, future revenue gains may produce disproportionately high bottom line profits. Frankly, they both operate terrific businesses that are virtually impossible to replicate, in scope and scale.
Two banks are attempting to set up a credit and debit processing partnership in Brazil, which will report start up assets in the range of $8.5 billion, before adding in debts. The partnership hopes to generate roughly $600 million of total profits in the next five years, ($120 million per year), a modest 1.4% annual return on invested capital. Such a start-up cost certainly reinforces the current value of highly profitable businesses operated by Visa and Mastercard.
Visa is certainly more advanced in the debit card market.
US consumers completed more debit transactions than credit transactions in 2009. Analysts reported this as a tipping point. Whether or not the emphasis on the use of debit vs credit can be considered a permanent trend remains to be seen. It is my contention that at least a portion of the debit increase in the US, and to a lesser extent Canada, is largely cyclical. Should the US economic recovery continue, it is my belief that credit trends will revert to the norm. Debit usage will continue to increase, but credit could recover very quickly.
Globally at Visa, debit card use accounted for approximately 57% of gross dollar volume
finance.yahoo.com
Mastercard's perceived current weakness in US markets are not nessarily reflective of a global trend.
Insofar as debit is concerned, Mastercard's international operations represented 17% of gross dollar volumes for Q1. Total debit (including US) represented 33.7% of gross dollar volumes for the quarter. As with Visa, Mastercard also reported US that debit usage surpassed the use of credit in Q1, 2010.
Internationally, Mastercard reported debit volumes were up by 33.2% in Q1. On an absolute basis, Mastercard debit is smaller both domestically and globally, than Visa. However, Mastercard's growth rates in debit are quite comparable to that of Visa.
phx.corporate-ir.net
Recent criticisms impacting Mastercard's share price, as well as that of Visa, reflect the possibility of interchange fees moving towards a regulated structure, in the US.
Retailers continue to try to have US congress cap the interchange fees. The implication put forth by mainstream media is that the lobby group of Visa and Mastercard is weaker than the lobby groups of retailers, and will therefore lose out in some sort of regulatory end run.
reuters.com
gao.gov
What media outlets fail to take into account, is that a full 85% of interchange assessments go to the member banks of the credit and debit card systems. Almost $40 billion of total interchange fees were paid to the issuing banks in 2009. Retailers are really fighting banks. Mastercard and Visa, as partners with the banks, are certainly exposed, but represent more peripheral players.
Banks and financial services presently account for more than 2X the amount of US GDP, when compared to retailers. Banks are an incredibly powerful lobby group (some argue too powerful) and will neither willingly give up either current fees, nor will they give away potential fee growth, without a fight. Both banks, V and MA argue that assessments are made against merchants, not consumers; the issue in their mind is one of "business to business" and need not be regulated.
online.wsj.com
In a worst case scenario for Visa and Mastercard, any potential cap on interchange fees could, in all likelihood, simply be replaced by a new type of fee which would be levied, so as to offset interchange caps. Such a fee could be similar to the dreaded "system access fees" consumers pay for mobile cell services in certain parts of the world.
What businesses are doing, essentially, is attempting to shift the burden of the interchange payments off of their backs, and directly to the backs of consumers. There is no free lunch. Consumers are already indirectly paying the interchange fees; merchants build into merchandise selling prices an amount equal or greater than, the current assessments. In the event that interchange fees are capped or reduced, it is highly doubtful that merchants will then reduce product prices by an amount equal to interchange fee reductions. What is attempting to be accomplished, is simply a lateral transfer of profit away from card issuers to merchants.
Since the earnings report of May 4th, 2010. Mastercard shares have fallen by 12.1%, far greater than the average decline of US equity markets as a whole.
Visa shares have also fallen by approximately 12.5% since the release of their last quarterly financial report. It would appear that a portion of the pullback may be attributable to the potential for some regulatory fee cap being imposed at a congressional level. Whether or not this comes to pass, or whether it will have an impact on the business remains to be seen. Interchange fees are now regulated in Australia; according to financial reports ay Visa and Mastercard, no material challenges to the business model or profitability in that market occurred. Many of Mastercard's primary markets already carry higher degrees of regulation than the US. With a larger US business, Visa will be potentially impacted to a greater degree than Mastercard, should punitive regulations go into effect.
Investment markets have generally been weakened by a key national issue coming from Europe.
The current risks of a default in the national debts of Greece are cause for concern but are possibly very overblown. Greece is not a substantial economic power. With a population of just 10.8 million persons, Greece is the 34th largest economy on the globe, but is the 17th largest external debtor. It is a government heavy nation; more than 40% of GDP comes from public sector employment. Some government employees are paid bonuses simply for showing up to work on time. Direct EU aid represents about 3.3% of Greek GDP per annum. GDP is about 2/3 per capita that of leading Eurozone nations. National tax policies are lax, collections are uneven and the cash economy is rampant.
cia.gov
Through direct subsidy, Greece has been effectively "propped up" by EU aid for many years now, and will continue to be afforded substantial aid in the future.
A country of 10.7 million people is simply is too small to have meaningful negative impacts upon forecast global growth. However, investors are now becoming preoccupied with a fear that Greek "contagion" will spread to other nations in the EU. Three nations have come under increased scrutiny of late, Spain, Portugal and Italy.
Spain has a 20% official unemployment rate, to be sure. This is not a new phenomenon; in fact Spanish unemployment rates have been structurally high for more than 20 years.
allbusiness.com
High unemployment rates in Spain are a more or less permanent paradox. Many of the officially unemployed in Spain are actually "double dipping"; they generate tax free cash incomes in Spain's large underground economy, while simultaneously obtaining tax assisted government benefits, or "Paro". It is widely assumed that the black market economy now equals 25% of reported Spanish GDP per year.
Portugal has a more diversified economy, a lower budget deficit and workers willing and able to be work for wages roughly 2/3 that of Greeks. Spain, Italy and Portugal are less dependent upon EU aid, and are not in the same leaky boat as Greece.
Italy has the largest black market, or "shadow" economy in all of Europe.
theflorentine.net
In my view, the risks of a Greek domestic capital crisis spreading throughout the rest of Europe are as likely today, as was the likelihood of the swine flu becoming a true pandemic last year; not likely. However, a common underlying thread of Italy, Portugal, Spain and Greece is the absolute size of their underground cash economies. Reform is required to "out" these substantial shadow economies, so that tax revenues can be paid. Some external shock is required to affect the changes, as their domestic governments refuse to do so. Hopefully, this is presently underway.
finance.yahoo.com
A greater blow to the credibility of North American markets recently came about from the VERY recent disclosure of Goldman Sachs discussing an SEC settlement on their mortgage securitization issuance activities.
online.wsj.com
Such a settlement, if reached, will confirm long held suspicions by investors at large that we operate at a considerable disadvantage to a select number of financial institutions.
It is equally important to note that true financial reform cannot occur, when those who are supposedly overseeing the financial firms, find themselves in a position to earn outsized financial benefits by trading on material non-public information.
finance.yahoo.com^dji,^gspc,^ixic,brk-a,brk-b,gs,xlf&sec=topStories&pos=9&asset=&ccode=
Key government officials have clearly demonstrated their abilities to drive down the shares of Mastercard and Visa by more than 6%, over and above normal market fluctuations. This was effectively accomplished simply through discussing the placing of an addendum to a bill. Competing bank lobby groups will now go to work on lawmakers. Nevertheless, negative media attention has been generated. Unfortunately for investors holding securities other than Visa and Mastercard, such negative government pronouncements for index stocks created a ripple effect one that spilled over into other securities. So long as officials are also in a personal position to sell shares short, without the requirement of disclosure, their motivations for spreading rumour may certainly be called into question. I estimate that more than $8.6 billion of the market cap decline in Visa and Mastercard is directly attributable to potential interchange proposal. Quis Custodiet ipsos custodes?
rightsoup.com
Trading volumes and selling pressures for Visa and Mastercard spiked VERY dramatically for 2 days, immediately prior to the announcement that a government official is considering adding an interchange fee amendment, to a forthcoming bill.
Pundits may shortly discuss potential negative impacts of a spending slowdown in the Mediterranean Eurozone nations.
Some have already concluded that Greece will fall into a period of economic malaise that will require a decade or more to recover. More worry that Italy, Spain and Portugal will soon follow suit. An inference might be made that conclude Mastercard and Visa will experience sharp reductions in European processing. This is unlikely.
What the mass media will inevitably fail to take into account, and what this article has pointed out earlier, are that Italy, Greece, Spain and Portugal represent the four largest "cash" economies in the EU. Even should all four nations fall into an economic recession, payment processing rates are likely to be unaffected. Those who pay with cash don't generate a dime of revenue for V and MA. Credit and debit volumes, according to Visa and Mastercard, in Q1,2010, grew by rates significantly above that of the US. Most of this growth came from the northern and central regions of Europe. Recent declines in the Euro will make these nations, which are the key "producing" economies of Europe, even more competitive going forward. In fact, there may be longer term unintended benefits of PIGS (Portugal, Italy Greece and Spain) reform for V and MA. Any substantial reforms in these cash economies will create more non-cash processing, down the road.
Mastercard represents one part of a duopoly presently benefitting from one of the planet's defining secular trends; a move from cash to electronic payments.
The business model of Mastercard and Visa proved itself out during a period of below average global growth. At less than 10X my 2011 forward EV/EBITDA estimate, shares of Mastercard now look to be about as cheap, on a forward basis, as they were shortly after the IPO.
I feel that Mastercard has significant earnings leverage, should credit use increase in a more broadly based economic recovery. The secular trend towards increased debit use will continue; Mastercard seems well positioned to grow the debit business as well.
After several years of holding shares of Mastercard, without either buying or selling, RMG#1 has recently moved to add some shares of Mastercard to the account.
At the current price, it is my view that Mastercard is presently valued as a broken growth stock. Mastercard is the more international investment in the card processing market, as compared to Visa. In about a year, Asian and Latin American processing by Mastercard will surpass that of the US.
Mastercard's growth story, which never abated during the economic slowdown, is likely to accelerate in the near to mid-term. Interchange fees improve for Mastercard and Visa when average ticket size increases. Purchases on credit are historically much higher than purchases on debit. Mastercard's revenue stream is credit oriented. Only modest growth in the use of credit cards is necessary in order to produce a material revenue "shock" to the top line.
By the end of 2010, even using my conservative determination of EV, Mastercard should boast a net cash balance. Significant forecast net cash balances, in the years to come, may be used to repurchase stock, raise the dividend and be invested for organic growth.
Opportunities to invest in a strong, highly profitable and non-cyclical company, for less than 9X 2011 EV/EBITDA, generally only present themselves during bouts of fear. The Dow Jones Industrial Average is now down for the year, as of the close of business on Friday, May 7th, 2010. Clearly, this appears to be such a time.
Visa is also currently selling for a valuation well below its growth rates in revenue, EBITDA and earnings. I consider the shares of Visa to be attractively valued. Visa has recently increased their merchant assessment rates, to be effective July, 2010. Q3, 2010 earnings for Visa could surprise to the upside. I will seek to increase the RMG#1 position in Visa shortly.
On Friday, May 7th, 2010, I added to my personal position in Mastercard.
Posted by Randolph McDuff at 11:47 PM | Permalink |
