- If Apple enters the payment processing arena, it will definitely take market share off the big 2 (Visa and MasterCard)
- The Visa Europe deal was expensive as there are no guaranties that Visa Inc will achieve a good return on its investment
- Visa's valuation is out of whack. Value investors are not investing at these levels.
Visa (NYSE:V) is up over 21% year to date and both investors and analysts alike continue to be bullish on the stock especially after the company's impressive set of earnings for its fiscal fourth quarter. There are many reasons to be bullish on this stock right now and clearly the stock has momentum as the holiday festivities start to intensify. Firstly the company's recent set of earnings illustrated that the top and bottom line continues to grow with the company again hitting consensus with an impressive EPS of $0.62. Furthermore the company's current valuations illustrate that earnings are likely to increase meaningfully in fiscal 2016. This may very well be so, especially when you take note of recent partnerships the company has forged. For example Visa recently added almost $80 billion a year in purchases from USAA customers at the expense of Mastercard (NYSE:MA). Furthermore earlier in the year, Visa took a huge account, Costco (NASDAQ:COST) off American Express (NYSE:AXP). Personally, I believe Visa is aware of the risks coming down the track, which is why it wants to scale its footprint meaningfully at the moment. Nevertheless, this company definitely has two big advantages in that the global e-commerce trade is expected to double to $2.5 trillion by 2018 and the world is slowly becoming a cashless society. We can see the latter in some countries where withdrawal amounts from ATM's are getting smaller by the year which is definitely boosting purchases on cards. However where there is more revenue growth potential, more competition will undoubtedly enter the fray.
Firstly the reason (up to now) why other companies have not been able to challenge the big credit card companies was because the barriers to entry in this market have been so high. Branding is everything in this business which is why many credit card users associate visa with their cards even though it is the respective bank that issues the card - not the credit card company. So basically in a credit card transaction, you have the purchaser, the merchant, the issuing bank and the payment processor (Visa). Visa and the issuing bank get a slice of commission from the amount credited to the card at the point of sale. This cycle has worked very well over the years (credit card industry continues to grow) due to the trust involved among all parties. What could disrupt it you may be asking? What about companies such as Apple (NASDAQ:AAPL) and Alphabet Inc-C (NASDAQ:GOOG) with their respective products, Apple Pay and Android Pay. Although these products still rely on credit or debit cards to fulfill the transaction, many analysts believe that Apple's ( as it seems slightly further along in this area than Google) next move will be to enter the enter the payment processing industry itself. It makes sense when you look at the company's history regarding how it dominates every market it enters. I don't see this happening overnight, but it definitely is a risk longer term for Visa shareholders due to increasing amounts of revenue merchants have to shell out every year - especially on mobile. Visa shareholders should stay on top of any updates Apple makes to its Apple Pay product.
This leads on to my second point which is the purchase of Visa Europe for $23.4 billion, which was announced earlier this month. Visa Inc obviously see's value in Europe as both transactions and the number of cards in operation have been growing steadily year on year ( see chart)
2014 figures show that Visa Europe reported sales of $1.3 billion which resulted in profits after tax of $220 million euros which is much inferior to Visa Inc's 2014 results both on a revenue and margin basis ($5.4 billion in net incomes on revenues of $12.7 billion). Where are the risks in the European deal? Well, I believe the reason the jury is still out on this deal is because of the huge amount of money involved in the acquisition, plus the fact that this deal is going to take a lot of years to play out. Visa obviously will be looking to expand its network across Europe as well as increase its margins which should happen over time due to shared resources and synergies but you are going to have integration costs in the near term. The company is quoting 2020 as to when high single digit earnings growth will be achieved but I still think there are risks here no doubt. Firstly competitors like MasterCard could now partner with the 3000 banks who used to own Visa Europe to grow its own network across Europe. Secondly its the time issue that most bothers me. Where will Apple Pay be for example in five years? Visa's objective is to expand its existing North American model (which will take years) but a new model could be just around the corner. Heavy investment at a time when the industry is changing rapidly (more potential competitors) enhances risk in my eyes.
Then you have the whole valuation argument. With a present p/e ratio of over 30, its share price has never been more expensive considering its historic ratio is around the 22 level. Compare Visa'a valuation with American Express for example (p/e ratio of under 13) even though its not a strict like to like comparison as the latter assumes more risk through issuing its own cards but still the difference in valuation is striking. Visa is a great company but I wouldn't pay 30 times earnings to own it. The higher its p/e gets, the more risk there is to the downside. A hiccup with the visa Europe acquisition or more competition in this sector could definitely slow down earnings growth going forward and since Mr market always looks ahead, a slight slowdown in earnings growth would be the only metric needed to bring this company's p/e ratio back to its mean of around 22 which would have the stock trading again in the 60's.
To sum up, I like Visa, but the company has too many risks to the downside for me to consider taking a meaningful position. Apple especially has the potential to disrupt the duopoly in this industry. Furthermore the visa - Europe acquisitions was very expensive considering the low operating margins. Finally the company is trading well above its average p/e ratio which means more things have to go right than wrong for the company to sustain its expensive valuation.