Visa Inc.

Industry Overview - Financial Services - Financial Transactions Processes

The global payment services industry facilitates the transfer of money in physical and digital form between all market participants (consumers, businesses, governments). It aims to provide safe, reliable, fast and easily accessible ways for these market participants to transact payments in exchange for goods and services provided.

The industry is constantly evolving and until recently has been classified under the Information Technology sector, rather than the financial services sector, reflecting the heavy use of IT services, systems and technology to transfer money globally. Mobile payments and contactless payments are becoming increasingly popular as customers move away from cash, checks and cards toward paying by tapping their smartphones against billing machines.

 The industry is heavily regulated by various national and regional institutions and affects key aspects of the companies’ operations such as the use and sharing of consumer privacy data, and limits on interchange reimbursement fees. The PSD2 act in Europe aims to increase competition in the industry by lowering the barriers to entry for new companies by allowing them to access payment networks of larger established companies (Visa, Mastercard).

Company Overview

Visa is one of the largest global digital payment providers, facilitating payments between consumers, merchants, financial institutions and governments across more than 200 countries.  For the 12 months ending June 30, 2022, the company handled 255.4bn transactions totaling a volume of $14tn, across its network of 14,900 financial institutions and +80mn merchants.

 Revenue for FY2022 totaled $39.6bn minus $10.3bn of client incentives, amounting to total net revenue of $29.3bn. Visa has three streams of revenue:

1.     Services revenue ($13.4Bn)

Revenue is generated by charging a fixed fee on the size of the transaction processed. The larger the volume of transactions handled, the larger the amount of revenue earned.

 Fees are also earned by charging financial institutions when issuing and acquiring new Visa cards (debit, credit, prepay). Approximately 3.9bn Visa cards are currently circulating globally.

2.     Data processing ($14.4bn)

Earned for authorization, clearing, settlement, value added services, network access and other maintenance and support services that facilitate transaction and information processing among global clients. This includes fraud prevention and detection services as well as providing access to Visa’s proprietary payment network, VisaNet.

 Data on consumer spending collected via VisaNet can also be sold to third parties to identify spending habits and allow for targeted marketing.

3.     International transactions revenue ($9.8bn)

Earned via cross-border transaction processing and currency conversion services provided. Visa may benefit from favorable exchange rates and charge a fee on the size of payment volume. This revenue stream relies heavily on international tourism and is still recovering from a drop in cross-border travel resulting from the pandemic. 

 Revenues are reduced by incentives provided to financial institution clients and merchants to grow payment volume, increase Visa product acceptance and gain market share for the Visa payment network.

Key Fundamentals

Margins

On a 5-year average basis, all meaningful margin ratios (EBITDA, operating, and net income) are above 50%, with an upward trend over the past 10+ years, but a stalling or slightly downward trend more recently. It may be pointed out that EBITDA margins of 69% achieved during the pandemic years are difficult to maintain and that a minor revision in margins closer to the long-term mean could be possible. These 5-year average margins of 50%+, however, support Visa’s narrative of being a high quality company with first-in-class financial strength and metrics that have potential to outperform the broader market as well as peers.

Return on Equity

Over the past 5 years, Return on Equity averaged 39.3% and a strong upward trend from 24.6% in 2017 to 44.1% in 2022. Visa’s RoE is significantly above the market average (16.2% over 5 years) and also above its peer group's 5-year average of 11%, but falls noticeably short of Mastercard’s 5-year average of 111%. Mastercard’s higher RoE is in large part due to its significantly higher debt-to-equity ratio of 1.98x vs. 0.65x for Visa. 

Stable operating history:

Visa was originally founded in 1958 by Bank of America and called BankAmericard, but by 1970, BofA had given up control of the subsidiary to various issuer banks that were part of the payment network and eventually changed the company’s name to “Visa” in 1976. Visa did not IPO until 2007, meaning that the company’s financial history is publicly available only from 2005 onward.

Since 2005, Visa has grown its revenue by at least 7% (7.8% in 2014) every year, except for one decline of -4.9% in 2020 during the outbreak of the COVID-19 pandemic. 

Earnings were more volatile during its IPO and the following GFC years. From 2009 onward, however, Visa has steadily increased its net income, resulting in a more than six-fold increase in just 13 years ($2,353mn in 2009 to $14,597mn in 2022), outpacing the S&P500 increase in earnings and the overall growth rate in the global economy.

Given Visa’s business model, its steady growth in earnings, and its positioning in the payments industry, this can be considered a more than stable operating history.

Long-Term Prospects

Visa is the leading provider of financial transactions in the payments industry. According to a McKinsey research study of October 2022, the industry is expected to grow its total revenue to $3tn by 2026 (from $2.1bn in 2021) as it rebounds sharply from its brief decrease in 2020, yielding an expected 5-year CAGR of ~7.5%. Given its leadership role in the industry, Visa is likely to capture a large share of the growth in transaction volume which will allow it to continue its growth in top-line revenue and earnings. Payment services are central to the functioning of the entire economic system and will grow in volume as the economy itself grows, implying that even during times of rising prices payment providers tend to benefit from rising transaction volumes. Only during recessionary periods, often following times of heightened inflation, are payment providers likely to see a decline in revenue as the economy and transaction volumes, contract (as seen in 2008 and 2020). Note that this report takes the view of a long-term shareholder who is not concerned with short-term fluctuations in the business cycle. The long-term growth of the global economy will benefit Visa’s business outlook over the next 10 to 20 years, especially as more consumers in Asia and EMEA gain access to bank accounts, financial services and switch from cash to card payments.

Comments on Management

In December 2021, Visa authorized a $12.0 billion share repurchase program and repurchased 56 million shares of class A common stock in the open market for $11.6 billion, in 2022. As of September 30, 2022, the share repurchase program had remaining authorized funds of $5.2 billion. In October 2022, Visa authorized a new $12.0 billion share repurchase program. Additionally, Visa also paid $3.2bn and $2.8bn in dividends over the last two fiscal years to its shareholders. 

Repurchase and dividend programs are important signals to look for in shareholder-friendly management to ensure that company executives’ actions are aligned with long-term shareholder interests. They indicate that management reasonably reinvests excess cash in profitable growth opportunities within its business if they exist, or alternatively pay out any excess cash back to shareholders if such value-adding opportunities are not available. Efficient capital allocation of excess liquidity into projects that yield returns above the firm’s cost of capital is imperative to generating attractive returns for long-term shareholders.

Meanwhile, note that management has more than doubled retained earnings on the firm’s balance sheet from $7.8bn in 2012 to $16.1bn in 2022, which might question the excessive accumulation of shareholder capital. During the same period, however, management has added $245.9bn in market value, meaning that for every dollar retained in the business market capitalization has grown by $31.5. These results are far above satisfactory and warrant no further questioning of the accumulation of equity capital, for the time being.

Competitive Advantages

1.     Competition

According to the Forbes 2022 ranking, Visa has the #18 most valuable brand in the world, placing it ahead of its immediate industry rivals Mastercard (#38) and American Express (#28). Visa’s brand is internationally well known and enjoys a loyal customer base, which it has built over the past 47 years of the brand’s existence.

2.     Trustworthy and Secure Network

Visa has invested heavily in the security, fraud prevention and detection, and reliability of its payment network, giving customers high confidence and trust in transferring payments via Visa’s network. This trust in the security of its services gives Visa a competitive advantage over e-commerce payment systems and new players in the market who are less known to consumers. It also provides a barrier to entry for potential new competitors.

3.     Wide Acceptance of Visa Cards and High Market Share

Visa generates more than half of its revenue outside of the US compared to ~40% for American Express. Mastercard earns a similar portion of its revenue outside of the US as Visa, implying that both brands are more widely accepted than AmEx and set to better capture the global growth in transactions.  However, Visa dominates the largest market share of the global payment industry by accounting for 53% of total transaction volume in 2021, while MA comes in second with 25% and Amex third with 20%. Visa is well positioned as the market leader with a strong brand in a growing market, giving it an unmistakable competitive advantage over the foreseeable future.

Peer Group Comparison

Visa’s main competitors are Mastercard and American Express, and to a lesser extent Discover. The table below provides key metrics that highlight Visa’s superior quality compared to its peers. First, it is important to point out that Visa and Mastercard trade at much higher multiples compared to AmEx and Discover, which is justified by their higher profitability (margins) and their higher growth rates (10Y ann. EPS Growth). Focusing on the bottom half of the table, Visa clearly dominates on all profitability and balance sheet metrics except for return on equity, which is due to Mastercard’s higher leverage as noted above. Visa is virtually debt free on a net debt basis and has the highest interest expense coverage, making it particularly resilient to macroeconomic downturns and more attractive than Mastercard.

 It is worth mentioning that Discover delivers some important features that might be appealing to a Value investor as it trades at lower valuation multiples (specifically P/E and P/B), provides a higher dividend yield, has the lowest net debt of the group, and has seen higher growth over a more recent 5-year period. These attractive features certainly encourage further investigation whether Discover might be a suitable investment for a Value-oriented strategy.

Visa appears more attractive at the moment as it provides a higher Quality-style investment, has a more stable balance sheet, and, as mentioned above, owns a larger share of the market and has a stronger brand than Mastercard and AmEx.

Valuation

Visa currently (February 11, 2023) has a market cap of $473bn. Using the methodology below, my estimate of intrinsic value is approximately ~$693bn, or $425.7 per share over a 10-year horizon.

 We start with the Bloomberg consensus forecast for levered Free Cash Flow for year-end 2023 and then grow them using the growth schedule listed below. The discount rate is calculated using CAPM and the terminal growth rate is 2.5% which is in line with the long-term growth forecast for the US. 

 Cash Flow Growth rate first 5-years: 15% (below average growth rate of past five years of 19.1%)

Growth rate years 5 to 10: Assume growth rate declines linearly from 15% to terminal rate of 2.5% each year.

Terminal growth rate from year 10: 2.5%

Discount Rate: CAPM = 3.45% + 0.98*(8%-3.45%) = 7.9%

 The table below indicates Visa’s value at different discount growth and discount rate assumptions. Over a 10-year horizon, the valuation model suggests that Visa is trading well below its intrinsic value and provides a margin of safety of roughly 31%, which is sufficiently above 25% but not as close to the preferred 50% margin. It may be pointed out, however, that the growth assumptions are conservatively managed as it could be very likely that Visa continues to grow at a much higher rate, especially during the second stage of the model, while it also seems conservative that Visa would only grow in line with the economy (2.5%) from year 10 onward.

Risks

We see three main risks facing Visa:

1.     Competition

Visa faces strong competition in the payments industry and is reliant on its strong customer loyalty to the Visa brand. This positive brand image is largely dependent on successful marketing campaigns, consumer habits & preferences, as well as the absence of any corporate scandals. Any situation that negatively impacts Visa's reputation such as lawsuits, poor labor relations, cyber security breaches, or deteriorating experiences along the customer journey could severely impact Visa’s transaction volume. If consumer habits & preferences change or Mastercard runs more successful ads against Visa’s market leadership, Visa's profit outlook would be materially reduced.

2.     Regulation

Changes to regulations specifically regarding data privacy and security could impact Visa’s business model and its ability to generate profits. Regulators in Europe and other smaller markets have also made efforts to facilitate the entry of new players into the payments industry to increase competition and reduce the pricing power of the leading brands. Should these efforts be successful or intensified further, Visa may lose market share to local competitors.  

3.     Substitute Products

As technology advances and FinTech firms improve their capabilities, they may one day be able to provide faster, better and cheaper payment services than Visa. At the very least, technological improvements made by FinTechs forces Visa to continuously make costly investments into its proprietary payment system to upgrade it and fend off competitor products. Substitute products such as direct peer-to-peer payments have the potential to replace Visa’s payments services as consumers search for more cost-effective methods to transfer money to each other. Although alternatives such as Zelle are integrated into the Visa network, its more popular competitor Venmo does not rely on Visa services and is run via PayPal and could pose a threat to Visa’s business outlook should it gain in market share.

Conclusion

Visa is an attractive company based on its superior market leadership in a growing industry, its exceptionally high brand value, and its shareholder-friendly management. If Visa is able to successfully overcome the key risks facing its industry, we are optimistic that the company may have favorable prospects going forward. Whether Visa may or may not be qualified as a suitable investment for a long-term investor is, as always, up to you, the reader, to decide.

Contact us if you want to learn more about our latest views on Visa or our other market insights.

Disclosure: This report is designed for a hypothetical long-term investor who is unfamiliar with Visa and is interested in buying and holding the company for at least 10 years. As such, this report ignores short-term macroeconomic forecasts and fluctuations in the business cycle, avoids market timing recommendations, and maintains conservative assumptions to avoid loss of principle by overpaying for the business. Past performance is not indicative of future performance and should not be relied upon to make investment decisions. This article is neither financial advice nor a recommendation to buy or sell securities.