The Henry Fund Investment Thesis On Visa Inc (V) by HenryFund.org
Visa Inc – Investment Thesis
We recommend a BUY for Visa Inc. (V), with approximately 29% upside. Visa is well positioned to benefit from the progressively cashless consumer and the technological advancements associated with this shift. The Visa Europe acquisition will contribute positive growth through a larger international presence, higher payments volume and an increase in processed transactions. Visa’s strong economic moats, via its network value proposition, scalability and strong brand equity, will widen – sustaining its competitive advantage and high profit margins for many years to come.
Drivers of Thesis
- Over the next 8 years, the increase in non-cash transactions will outpace previous years, growing at a 10.47% CAGR; Visa will capture enough of this growth to boost its payments volume by 7.5% YOY, ultimately leading to an overall revenue CAGR of 8.64%.
- Visa’s partnerships with tech companies, along with its own technological developments, will enable it to insert itself in more transactions to the tune of an 8.98% CAGR in processed transactions from now until 2023.
- The Visa Europe acquisition will add at least 18B processed transactions and bring 1 out of every 5.70 Euros spent in Europe onto Visa’s network. Such additions will increase Visa’s market share to above 60%, thereby improving its revenue growth prospects.
- Visa’s brand, scalability, unique network and value proposition make it the most ubiquitous payments resource for consumers, merchants, and issuer banks alike. Such economic moats will help Visa increase revenue growth, while maintaining a stable and lean cost structure, culminating in continued high operating margins (approximately 66%).
Risks to Thesis
- Non-cash growth rate could stagnate or decelerate, causing Visa’s payments volume and resulting revenues to not meet expectations.
- The Visa Europe acquisition could fall through or not have the expected positive impact on Visa’s growth prospects.
- Consumers could use non-network payments companies, such as PayPal, more than expected, thus bypassing Visa’s network.
Visa is the market-leader in the very profitable credit card networks industry. However, industry may be generous as, Visa and MasterCard are the only two open-loop networks in the world, and thus make-up a stable and lucrative duopoly. Visa is well-positioned to further increase its market leadership, as we expect it to increase its market share of non-cash transactions, from 58% to 64% by 2017.
The main reasons Visa will be able to increase its market share are: the rise in non-cash transactions globally, the Visa Europe acquisition, internal technological innovation, external partnerships and investments in technology, and strengthening the economic moats that surround its profitability.
Visa’s innovation, unique network, and scalability enable it to peerlessly serve the three most important parties in the payments domain: consumers, issuers, and merchants. Moreover, Visa’s extremely high brand equity fosters a strong relationship of trust and loyalty among these three segments. Thus, Visa has developed, and will continue to sustain, a competitive advantage that leads to profit margins in the 65% range.
As such, Visa represents an investment opportunity in a profitable, nimble, and creative market leader. Specifically, we believe Visa’s stock currently has an intrinsic value of $91. This represents approximately 29% upside relative to its current market price of $70.62, hence our BUY recommendation.
Visa is a global payments technology company that aims to “accelerate the electronification of commerce.”i Visa works to achieve this aim through operation of its open loop network, VisaNet, which provides the payment rails for consumers, businesses, and financial institutions to transfer electronic payments.
To clarify, an open loop network differs from a closed loop network, as closed loop networks (i.e., American Express and Discover) can extend credit and/or issue payment products directly, thereby excluding 3rd party issuers and/or acquirers. Issuers are financial institutions that provide payment cards directly to consumers and acquirers are financial institutions that process card payments on behalf of a merchant.
Hence, Visa, as an open loop network, does not issue payment products, extend credit, or set rates, and thus, does not bear credit risk. Rather, Visa signs long-term contracts with issuers that allow the institutions to offer Visa branded payment products to merchants and consumers. This greatly simplifies Visa’s business model, allowing it to focus on its 3 primary sources of revenue.
How Visa Makes Money
Due to its relatively simple business model, Visa only has one reportable segment: Payment Services. Within this segment, Visa has the following revenue streams: service, data processing, and international transactions.
Service revenues stem from Visa’s contracts with its issuer clients and the volume of payments using Visa-branded products.ii However, payments volume, or the total amount of money that flows through Visa’s network, is the primary driver. Hence, service revenues can be thought of the money Visa makes every time someone “swipes” a Visa card – either physically or electronically through a mobile app or a computer.
The frequency of such swipes is important too because Visa makes money every time one of its products is used. Visa’s service revenue yield is the percentage of payments volume that translates into revenue. The greater frequency of swipes, the higher percentage of yield.
The recently announced acquisition of Visa Europe, consumers’ continued transition away from cash and Visa’s ability to harness technological developments all bode well for Visa’s payments volume growth going forward. Specifically, we model Visa’s payments volume averaging just above 7.5% growth YOY from 2016-2023, in line with its historical rate of approx. 8%.
Additionally, the declining trend in non-cash transaction (i.e., transactions excluding cash withdrawals from an ATM with a Visa) size is another good sign for Visa’s service revenue growth. Per the most recent data, transaction size decreased by nearly 1.75% from 2012-2014. This shows that people are using credit/debit cards increasingly for smaller transactions such as parking or taxi rides, which makes sense given today’s increasingly cashless world.
This trend is a good sign: as the payments volume increases, but the size of non-cash transactions decreases, swipes occur at a greater frequency.
This in turn should raise Visa’s service revenue yield. Accordingly, we foresee Visa’s 2016-2023 service revenue yield CAGR outperforming its historical pace by about 15 basis points.
Data processing revenues are based on authorization, clearing, settlement, and other services related to transaction and information processing. Put differently, this is the money Visa makes when it is directly involved with the transaction’s information flow. The number of Visa processed transactions drives these revenues.iii Looking ahead, Visa’s internal technological innovation, as well as its leverage of external technological advancement, have put Visa in strong position to process more transactions.
More immediately, Visa Europe will add at least 18B in processed transactions to Visa’s network – most likely in 2017 as the deal is expected to close in the latter half of 2016.iv Hence our forecast of approximately 90B processed transactions in 2017, versus 71B in 2015. This acquisitive accretion and our expected organic growth spur our 2016-2023 processed transactions forecast.
International transaction fees constitute the revenues Visa earns for cross-border transaction and currency conversion activities.v Given that Visa hedges its currency exposure, the primary driver here is the cross-border transactions. A transaction is deemed “cross-border” when the issuer’s country of origin differs from the merchant accepting the payment and/or from the ATM used for cash withdrawal.
The Visa Europe deal will certainly increase its international presence, and thus Visa’s international payments volume will make up a larger percentage of its total payments volume.vi Specifically, the US made up approx. 53% of Visa’s payments volume in 2015, but by 2017 that number will drop to 45%.
However, it should be noted that the Visa Europe acquisition will bring more contracts with foreign issuers, which decreases the odds of the differing issuer/merchant transactions that trigger cross-border fees. Hence our model forecast, wherein Visa’s international transaction revenue will certainly grow, just not as aggressively as its other 2 revenue streams.
Visa also has a contra revenue account, labeled “client incentives.”vii This amount is deducted from gross revenues to arrive at operating revenues. Here, Visa spends money on the front-end, with the aim of increasing payments volumes and processing rights from issuers and merchants, and thus making more money on the backend. We expect this contra-account to remain stable at 17% of gross revenues.
Beyond The Plastic
Consumers want payment method optionality, issuers need to offer cards and digital products to meet such demand, and merchants need to accept a wide variety of payments to avoid foregoing potential sales. Accordingly, Visa’s business model is quite simple: it has products and services that satiate the consumer, issuer, and merchant appetite.
More importantly, Visa offers the world’s largest electronic payments network, at 150M transactions per day, and a brand that consumers, issuers, and merchants trust alike.viii Indeed, Visa ranked 30th in Forbes’ “World’s Most Valuable Brands” in 2015 and was one of Fortune Magazine’s “Top 50 Most Admired Companies” in 2016.ix Regarding product line, Visa offers the traditional debit cards, prepaid cards, and credit cards. However, Visa’s debit and credit cards are also available electronically through mobile platforms, tablets, computers, etc. In fact, Visa is aggressively expanding its digital products and service offerings.
For example, Visa payWave is a new technology that enables consumers to pay for a product by simply waving their card or phone in front of a reader. This benefits Visa’s 3 main revenue generators: merchants, consumers, and issuers. It is more convenient and secure for consumers because it does not require entering a pin number or signing a receipt. For merchants, it boosts the chances of larger purchases than cash payments and cuts down on checkout lines. Regarding the larger cash payments, a Visa Payment Panel Study in 2012 (most recent data), showed that the average US cash transaction is $17 vs. $66 for credit card.
Also, payWave enables issuers to expand their digital payment offerings and meet customer demand for modern payment methods. Moreover, the number of contactless payments, which use technology such as payWave, is set to double in 2016.xi In short, payWave is just one example of Visa’s internal innovation that adds value for its main customer segments, and in turn should increase revenues going forward.
Visa has also shown a nimbleness to harness external technological developments. For example, in 2011 Visa invested in Square, a merchant services and mobile payments company. Visa owns about 10% of Square’s publicly traded shares, and 1% of the entire share base.xii Square mostly focuses on merchants, and empowers those that could not otherwise accept electronic payments. For example, it used to be difficult and costly for taxi drivers to accept cards, but now they can just plug a Square reader into their phone and accept payments.
Since Square technology makes it easier for merchants to accept mobile and card payments, it should increase the number of purchases via such methods. It follows then, that card and card linked mobile payments volume will increase, and Visa’s service revenues along with it. Therefore, this investment enables Visa to partner with a merchant friendly technology that should boost Visa’s revenue growth.
Similarly, Visa has also invested in Stripe, a young tech company that facilitates online and mobile payments.xiii Stripe’s strength is its payment processing technology, which should help Visa increase its data processing revenues. More specifically, absent a contractual obligation, acquirers and issuers do not have to let Visa process payments – even for transactions involving a Visa card. Clearly, this can be harmful for Visa’s processing revenue growth prospects. However, if Stripe can insert itself in in processing routes that Visa would not otherwise be able to, Visa will still benefit as a shareholder of Stripe.
Such investments show that Visa understands the rapidly changing payments landscape, and is smart enough to get ahead of the curve, and bet early on potentially lucrative partnerships.
In sum, Visa takes its value proposition far beyond the physical credit or debit card. Whether it’s decreasing time wasted in checkout lines through payWave or investing in companies that offer more nuanced payment solutions, Visa is committed to its merchants, consumers, and issuers alike.
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