Visa and MasterCard: A scale and scope that is almost impossible to replicate

Card networks play a critical role in facilitating payments between the card user and the merchant. Not only do they play a critical role within the payment ecosystem, they also have a scale and scope that are almost impossible to be replicated by others. Find out why we believe Visa and MasterCard are in a good position to capitalise on the shift towards a cashless society.

Ferlyn Tan
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Published on 03 Feb 2021

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• Card networks play a critical role in facilitating payments between the card user and the merchant. As of 2019, the card network industry is dominated by three companies, Visa (NYSE:V), UnionPay, and MasterCard (NYSE:MA).

• Every single card transaction goes through a card network. With global card transactions expected to grow in the next couple of years, this certainly bodes well for card network companies.

• By utilising tokenisation services from the card networks, digital wallets have grown to collaborate with card networks by allowing their customers to store their cards on their respective platforms.

• Not many companies have the level of scale that the global card networks possess to compete in the cross-border payments space.

• As the two largest card networks in the world, Visa (NYSE:V) and MasterCard (NYSE:MA) are bound to benefit from the secular shift towards cashless and digital payments systems. We see an average upside potential of about 13% based on 2022E earnings.

• If you are looking for a more diversified option, we believe you can consider investing in the ETFMG Prime Mobile Payments ETF (NYSE:IPAY), which is designed to track the mobile and digital payments industry.

Consumers today are demanding for more “anytime, anywhere” forms of payment services. As explained by the product head of Visa, “consumers’ expectation of how quickly and easily they can move their money has changed”, and this “has been influenced by how quickly they could download a movie or an app”. This whole need for instant gratification has driven the demand for digital payment systems, which has proven to be much faster and more convenient compared to traditional cash payment modes.

To recap, some of the prominent players in the digital payment ecosystem include the banks, payment gateways, payment processors, card networks, and new payment companies that offer a digital platform for consumers. In this article, we will be diving deeper into the card networks sub-industry.

The role of card networks

Card networks play a critical role in facilitating payments between the card user and the merchant. When the user makes a payment, the money does not go straight to the merchant. Instead, it goes through the issuing bank (the bank that issued the credit card) and acquiring bank (bank account of the merchant) to approve this transaction.

You may think that the respective banks can work among themselves to transfer the payment information and funds, but in reality, banks simply do not have the resources or infrastructure to safely and efficiently engage in this entire process with over thousands of other banks in the world.

Therefore, a card network is required to make these card transactions possible, helping the banks to verify and authorise the payments to be processed. You can also think of a card network as the glue that connects all the different banks around the world together, helping to authorise, process and transfer payments between the users and merchants through their respective banks, regardless of where the banks are located (Chart 1). The card networks earn primarily from the number and volume of transactions processed on their respective platform.

Chart 1: The role of card networks

As of 2019, the card network industry is dominated by three companies, as measured by the number of transactions processed (Chart 2). Visa (NYSE:V) continues to be the leading player, followed by UnionPay, a Chinese private company, and MasterCard (NYSE:MA).

Chart 2: Global payment network transactions in 2011 and 2019

In our previous article, we highlighted that payment companies will benefit as we shift towards a cashless society. From communication, gaming, online videos, to payments, everything is increasingly conducted in the digital space. The rise of e-commerce, as well as rising smartphone and Internet adoption rates, will drive digital payment transactions, which will, in turn, translate into a bigger user base and earnings growth for the payment companies, including the global card networks.

These global card networks play a critical role within the payment ecosystem. They also have a scale and scope that is almost impossible to be replicated by others. Therefore, we believe they will continue to dominate the card network space in the coming years, putting them in a very good position to capitalise on the shift towards a cashless society.

Growing card transactions across the globe

Every single card transaction will have to go through a card network. With global card transactions expected to grow in the next couple of years, this certainly bodes well for the card network companies (Chart 3).

Chart 3: Growing global card transactions till 2023

As of end-2019, it was reported that 75% of China’s population aged 18 and above did not own any credit cards, which could be one of the reasons why the majority of the users of Chinese digital wallets, such as Alipay and WeChat Pay, generally use only bank accounts for funds transfer. However, the rise in consumption and increased willingness to use credit for consumption will likely drive credit card adoption in China, as evident in the chart above.

Earlier this year, the Chinese government has mentioned that they will speed up the opening of the market to foreign card networks, such as Visa and MasterCard, to allow them to process local currency transactions in China. In fact, American Express (NYSE:AMEX) has won the approval to start its services in June 2020, making it the first foreign payments network to be allowed to operate in China.

By doing so, these card network giants can finally enter China’s USD 27 trillion payments market, which will serve as a key driver for growth in transactions processed through Visa and MasterCard’s platforms moving forward. This move will also allow Visa and MasterCard to become true global card networks that will benefit from the growing card transactions across the globe.

Digital wallets are collaborating with card networks instead of competing against them

Debit and credit cards have been the preferred cashless payment method for a long time. However, over the years, digital wallets have grown significantly, with new companies like Square and Alipay entering the market. PayPal is also one of the oldest and most widely used digital wallets, helping to process payments and allowing users to transfer funds between different parties on their platform.

With the rise of digital wallets and e-commerce, some investors became worried that it will replace debit and credit cards. However, to keep up with this trend, Visa and MasterCard launched its tokenisation services, which is the process of replacing the traditional payment card account number with a unique digital token in online and mobile transactions.

By utilising tokenisation services from the card networks, the digital wallets have grown to collaborate with the card networks by allowing their customers to store their cards on their respective platforms. For instance, PayPal started accepting Visa cards on its platform in 2016, and MasterCard cards in 2017. Alipay and WeChat Pay have also started to accept foreign cards in 2019 as well.

A recent survey conducted by Deloitte has also shown that payment through debit or credit cards is still the preferred method across many popular digital wallets users as shown in the chart below (Chart 4).

Chart 4: Payment through debit or credit cards continue to be the preferred payment method

While the majority of Chinese digital wallet users are still relying on only bank accounts, the card network giants could increase their market share in this space as more consumers start adopting credit cards. The opening up of China’s payment market bodes well for potential user base growth for both card networks, which will in turn boost their bottom line.

Growing demand for cross-border payments

Consumers have grown accustomed to immediacy over the years and this whole need for instant gratification is driving the demand for real-time payments services. Within each domestic market, there is usually a national fund transfer service (e.g. Singapore PayNow) that allows consumers to transfer and receive money with one another instantly (P2P). However, this becomes a tricky issue when it comes to cross-border payments, regardless if it is P2P, B2C, or B2B.

Payment infrastructure and regulation concerns are usually the bottlenecks, but given the rise in global trade and international e-commerce, the demand for real-time cross border payment solutions has increased. To take part in this growth, Visa and MasterCard decided to leverage their global presence to fight for a place in the cross-border funds transfer space by offering new services, such as Visa Direct, Visa B2B, MasterCard MoneySend, and MasterCard Track. These are some of the new products of the two companies, offering seamless and real-time cross-border payments services to their customers.

A little quick background on international payments: cross-border payments today go through the Society for Worldwide Interbank Financial Telecommunication, or better known as SWIFT. It is a messaging network that enables over 11,000 financial institutions worldwide to send and receive money transfer information from one another. The basic idea of how this process works is that each financial institution will tap on the existing infrastructures in their respective countries, such as the FAST system in Singapore or Target Instant Payments Settlement (TIPS) in Europe, to facilitate the cross-border payment transaction. Most of the banks are also not connected directly to each other, therefore a payment that originates from one bank may need to go through several banks before reaching its final destination, with each bank extracting a fee at each stop.

Therefore, under the SWIFT system, there will be multiple layers between the payer and the payee, making this legacy banking system complicated and expensive to stakeholders. As such, this has allowed other players to enter the market by offering less complex alternative models, such as the ones provided by the global card networks, which are more efficient and secure, but yet cheaper than the traditional payment method.

To process cross-border payment transactions efficiently, one will need to have an extensive global network. Evidently, not many companies have the level of scale that Visa and MasterCard possess, in terms of the number of currencies they can process and the number of countries/territories they have a presence in. This gives Visa and MasterCard a strong competitive advantage over potential competitors who wish to tap into this market.

Besides, not only are clients demanding for immediacy, they are also expecting cheaper alternatives given today’s competitive environment. Visa and MasterCard’s new products aim to add value to their clients by connecting banks more directly, thus lowering the cost of cross-border fund transfers. Therefore, this puts the two global card networks in a great position to capitalise on the increasing cross-border payments trend, providing tremendous room for the card networks to grow in this space.

Key investment risks

One of the biggest investment risks for Visa and MasterCard would be the various rules and regulations imposed on the two companies. Both Visa and MasterCard are global companies that generate revenue from all around the world. Given the nature of their business, they tend to be under strict scrutiny at all times.

Regulators around the world have been increasing their authority to intervene certain aspects of the payments industry over the years. For instance, in 2015, the European Parliament decided to cap the card transaction fees for payments made in the European Economic Area (EEA) with cards issued outside of EEA. This essentially limits Visa and MasterCard’s growth in terms of the fees they can charge per transaction. Similarly, Visa and MasterCard may also be denied from entering China’s payments market if the US and China’s relationship continues to worsen, translating to a huge opportunity cost for both companies.

Such restrictions will inevitably have a direct or indirect impact on Visa’s and MasterCard’s profits. However, despite the regulation implemented by the European Parliament, we believe the shift towards cashless payment modes will outweigh the impact of the card transactions fee cap. Visa and MasterCard still have plenty of room to grow given how most of the countries in the EU zone continue to be reliant on cash payments. This trend will continue to drive the number and volume of transactions, which are the primary drivers of Visa and MasterCard’s revenue.

Focus on the longer-term growth opportunity

As the two largest card networks in the world, Visa (NYSE:V) and MasterCard (NYSE:MA) are bound to benefit from the secular shift towards cashless and digital payments systems. We like how their business models are characterised by strong recurring revenue and high margins. Given their strong dominance in the market, we continue to favour them for the longer-term growth opportunity.

Our valuation is built on a 35X fair PE ratio derived from the Gordon Growth Model. While we have assigned a slightly higher PE ratio for them as opposed to the broader payments industry and other technology stocks, we believe it is justifiable given how the competitive advantage that Visa and MasterCard possess (scale) is almost impossible for competitors to replicate.

Table 1: Valuations of Visa and MasterCard

	PE ratio (X)	Target price (USD)	Share price (USD)	Upside potential	Dividend yield
Visa (NYSE:V)	35.0	230.0	202.0	13.9%	0.6%
Mastercard (NYSE:MA)	35.0	375.0	334.0	12.3%	0.5%
Average:				13.1%	0.6%
_{Source: Bloomberg Finance L.P., iFAST estimations} _{Data as of February 2021}

If you are looking to capture the potential of the entire payments ecosystem, you can consider investing in the ETFMG Prime Mobile Payments ETF (NYSE:IPAY), which is designed to track the mobile and digital payments industry. It focuses on credit card networks, payment infrastructure and software services, payment processing services, and payment solutions, with Visa and MasterCard holding more than 10% weightage collectively.

Chart 5: IPAY ETF price vs. earnings

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Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) holds a NIL position in the abovementioned securities. The analyst who produced this report holds a position in ETFMG Prime Mobile Payments ETF (NYSE:IPAY).

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Visa and MasterCard: A scale and scope that is almost impossible to replicate

Ferlyn Tan

Published on 03 Feb 2021