TBR: The Electronic Rails of MA, V & AXP

Electronic Rails & Great Business Models

CA2I recently came across two articles, one from 2011 and the other from 2012, where Chuck Akre from Akre Capital Management gives his view on MasterCard and Visa.

In these articles Akre talks about how MasterCard and Visa both “principally own the ‘rails’ over which electronic payments travel worldwide.” Akre thinks both MasterCard and Visa are examples of great businesses.

Emphasis in quotes and excerpts below are my own.

“Another example of a great business model, which is new to our portfolio in the past year, is MasterCard [MA]. It and Visa principally own the ‘rails’ over which electronic payments travel worldwide. Those rails are exceedingly difficult to replicate, there’s a wonderful tollbooth aspect to revenues, and the business has a giant global wind at its back in the growth of electronic exchange of value away from cash and paper.” (Value Investor Insight)

Below is an excerpt from the interview in the AP article (see link below).

“Q: Shares of Visa and MasterCard have risen sharply. Why do you continue to like these stocks for the long-term?

A: These are extraordinary businesses. They have ‘toll booth’ models and operate in much the same way that Microsoft did when it became the dominant operating system for personal computers. As the PC market grew, Microsoft owned the operating system, and you were going to pay for it. Visa and MasterCard are the dominant players in what we might call the ‘rails’ over which electronic transactions take place worldwide, among the millions of merchants where their cards are accepted.

Their customers on both ends are banks — those that issue cards to customers and banks for the merchants on the other end. It doesn’t make any difference whether it’s a card swipe or a payment made using a mobile device. Many of those transactions are going over the rails of MasterCard and Visa. There’s a lot of growth potential, because 85 percent of the world’s transactions involving an exchange of value are still done by cash or check. The 15 percent done electronically can only go up. It’s a phenomenon that will continue to grow worldwide.

Q: Even with such potential, a company must execute well to generate strong profits. What do you think about MasterCard and Visa?

A: It’s not unusual for them to post after-tax profit margins of greater than 30 percent for a given year. Compare that with the single-digit margins that are typical for American businesses. They are doing something unique that causes them to have such high returns on their capital.

Q: Visa and MasterCard last month reached a transaction fee settlement that requires them along with some major banks to pay at least $6 billion to retailers. Some major retailers will be allowed to charge customers more if they pay using a credit card. Is that a risk for Visa and MasterCard? They could make less from transaction fees if some customers switch back to paying with cash or checks.

A: If it works out the way the settlement has been agreed upon, MasterCard and Visa are both fully reserved for it, and it’s been accounted for in their earnings. (Note: For example, Visa increased its litigation provision by $4.1 billion for its recently ended fiscal third quarter, which led the company to post a loss of $1.8 billion.) But that won’t alter their broad outlooks.

Q: Your fund doesn’t own any shares of American Express and Discover Financial Services. Why?

A: Not as many merchants accept American Express, and I like the ubiquity of the Visa and MasterCard acceptance worldwide. As for Discover, it’s an also-ran. That doesn’t mean it always will be, but that’s where it stands now. Also, American Express and Discover are both lenders, in that they issue cards. Visa and MasterCard are more of a pure play in payment processing. They are the rails.”

Links to both of the articles mentioned above are provided below.

Akre also talks about MasterCard and Visa in the third episode of the Value Investing Podcast, which can be found here.

Earnings Record

From reading the articles referred to above, MasterCard and Visa clearly looks like great businesses that I want to research to improve my understanding of the pros and cons of these owners of, at least for the moment highly profitable, electronic rails.

I also included American Express below, since that business also looks like a great one.

VMA2In the table below I have compiled earnings per share data for the ten-year period 2004-2013 (Source: Morningstar.com). Also included are the trailing twelve month (TTM) earnings per share.

At the moment, I have not looked in to any single year to see if there was any non-recurring income or expense affecting the reported earnings per share (see above and the MasterCard and Visa settlement). This will be done later on.

Price per share data also taken from Morningstar.com per September 22, 2014. Bond yield data taken from FRED at the same date.

EPS1Both MasterCard and Visa have shown great growth in earnings per share over the last couple of years. American Express has also posted good earnings per share numbers, doubling earnings per share in the last ten-year period.

Without further digging into the earnings numbers for the moment, I have made a rough estimate of the earning power for each of the three businesses, see table below.

Different values based on a few earnings multipliers are provided in the table below. A reasonable earnings multiplier for each of the three businesses is likely in the range of 15 to 25 times.

At the moment Master Card is trading at 27.5, Visa at 24.5, and American Express at 16.9 times TTM earnings per share, giving an earnings yield (TTM) of 3.6%, 4.1% and 5.9% respectively, compared to the AAA Bond yield that currently stands at 4.1%.

If MasterCard and Visa are able to post high growth in the coming 5-7 years, the current market price looks justified.

What about growth for American Express going forward? If we assume that future growth for American Express won’t be as high as for MasterCard and Visa, a reasonable value likely lies somewhere in the $80 to $110 range, probably in the mid to high end. A mid value in this range gives $95 per share.

But, this is just a brief overview of all three companies. More research will be done to get a better grasp of the business fundamentals, the industry, competitors, profitability and what any significant risks might look like. Before this has been done, all of them will just stay on the watch list (see link below). To watch out for, and learn more about.

EPS2MasterCard, Visa and American Express will be added to the watch watch list.

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company or individual mentioned in this article. I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. This article is informational and is in my own personal opinion. Always do your own due diligence and contact a financial professional before executing any trades or investments.


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