All estimates are solely that of the author, and will differ materially from published analyst estimates. All values are, unless specified otherwise, noted in US dollars. Enterprise value is calculated using net current cash - total liabilities, and will, therefore, differ from conventional analyst ratios. Opinions are solely that of the author and are written for the purpose of entertainment. This article is not to be construed as research.
MA shares outstanding: 131 million.
MA net liabilities (as of 03/30/2010): $1.34 billion.
MA enterprise value: $30.8 billion.
MA 2010 est. EBITDA: $2.8 billion.
MA 2011 est. EBITDA: $3.3 billion.
Est. 2010 closing EV/EBITDA ratio: 10.5X
Est. 2011 closing EV/EBITDA ratio: 8.5X
Mastercard's global growth rates seem to be unappreciated by North American investors.
Mastercard became a publicly traded company in May 2006. At year-end 2005, the firm reported total revenues of $2.937 billion and EBITDA of $592.4 million, a margin of 20.1%. By the end of fiscal 2010, Mastercard revenues may exceed $5.75 billion, with EBITDA surpassing $2.8 billion, a margin of 48.7%. Should this be proven correct, on an absolute basis, EBITDA will grow by approximately 472%, on revenue gains of 96%, during a five year period.
Despite a share price gain of more than 477% since issue, Mastercard is selling for roughly the same forward relative valuation, as in 2006. On a percentage basis, EBITDA has risen, virtually lock-step, with share price appreciation. The balance sheet improvements are equally notable. At the end of 2010, Mastercard’s balance sheet will have moved from a position of net liabilities, in the range of $2 billion, to what looks to be a totally debt free position and a modest net cash balance. 4 million outstanding shares have already been retired through share repurchase, since IPO.
Q1, 2010 revenues came in a $1.31 billion, up by 13.1%. This surpassed the highest view of $1.28 billion for Q1 and the analyst consensus of $1.27 billion. Earnings came in at $3.46 US per share, ABOVE the highest view of $3.40, ABOVE the whisper number of $3.35 per share and 10% ABOVE consensus estimates of $3.14 per share for the quarter.
Net liabilities fell by $568 million in Q1. EBITDA for the quarter was $735 million, or 55.8% of net revenues, a record since inception. Think about that sum for a moment; Mastercard generated 24% more EBITDA in Q1, 2010, than was reported for ALL of 2005.
http://finance.yahoo.com/news/MasterCard-Incorporated-bw-2678385461.html?x=0&.v=1
http://seekingalpha.com/article/202915-mastercard-incorporated-q1-2010-earnings-call-transcript?source=yahoo
EBITDA increases of this magnitude occur at companies with largely fixed costs. Mastercard has kept expenses under control throughout the past five years. Revenues expanded at a 14.5% compounded annual clip.
Mastercard has little respect from a "US centric" North American analyst community.
Since issue, MA has surpassed analyst views, on revenues and earnings, EACH and EVERY quarter; sometimes the degree of beat was sufficiently high as to call into question modelling systems adopted by various analysts. There has historically been only one analyst who has consistently gotten to within a 15% range of Mastercard's reported results. Unfortunately in forecasting, analysts tend to cluster around the mean, even when the mean is determined to be in error. A solitary high estimate, even should it prove to be more accurate than the mean, inevitably gets discarded. It seems incongruous; analysts who prove to be accurate with forecasts are marginalized, by the very systems designed to identify those worthy of merit.
Forecasters clustered around an incorrect mean seldom take their lumps lightly. Analysts who consistently err feel foolish; those who continually feel foolish eventually become angry. This unease was evident in Mastercard's earnings call for Q4, 2009. Rather than being congratulatory, Wall Street questions were practically accusatory. The level of hostility on that "mega beat" of revenues and earnings was palpable.
Q1 2010 proved, yet again, that Wall Street is unable to accurately compile various components of the international revenue streams of MA. The tone from analysts was a bit more muted in the Q1, 2010 conference call, but still not complimentary, by any means.
In contrast, Visa, the larger competitor, failed to beat analyst consensus expectations on revenues and earnings in Q1; Wall Street feted the company regardless. This represents a paradox. One can easily, logically and accurately conclude that a confirmation bias exists in favour of Visa, and against Mastercard.
Mastercard is a larger issuer of credit cards than debit cards. Analysts are bullish on the outlook for debit, less so for credit. They conveniently ignore one point; credit transactions produce higher margins for processors. Despite this reality, Mastercard's historic emphasis on credit represents a point of contention with analysts. Many are of the opinion that Mastercard will not be able to fully participate in a secular trend towards debit.
Analysts and individual investors alike often report that Visa is more than 2X the size of Mastercard in the US, and extrapolate this market share on a global basis. Such a view represents a fallacy. Globally, Mastercard's business is roughly 67% the size of Visa.
Mastercard derives more than 55% of revenues outside of the United States, and has key strengths in emerging markets such as Brazil, Asia and Mexico. 66% of the total number of cards carrying the various Mastercard brands are located outside of the United States. 60% of gross dollar volumes (GDV) processed by Mastercard are generated outside of the United States.
http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9MjY5NTMzOHxDaGlsZElEPTM2ODM5MHxUeXBlPTI=&t=1
The Asia Pacific region is Mastercard's fastest growing market. In Q1, 2010, GDV in this region represented 22% of total volumes, up by 20.9% year over year. In 2009, Asia Pacific GDV represented 18.7% of the total.
http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9Mjk3NzAyOXxDaGlsZElEPTM4MDQxNHxUeXBlPTI=&t=1
Latin America GDV accounts for 7.8% of Mastercard's total. A year ago, Latin American GDV was 6.7% of the total.
In aggregate, Asia and Latin America are Mastercard's second largest overall market, ahead of Europe and behind the US. Should present trends continue, by mid- 2011, Asia and Latin America will become Mastercard's largest markets, as measured by GDV.
Visa and Mastercard represent a de-facto duopoly in global credit/debit; they differ greatly in in valuation.
Visa (V-NYSE, $83) has 737 million shares outstanding on a fully diluted basis and currently has net liabilities of $3.52 billion. This represents an enterprise value of $64.9 billion. Visa should report 2010 EBITDA of $4.7 billion. Visa has recently made a dilutive cash offer to purchase Cybersource; total liabilities should remain unchanged through the 2010. Visa's 2010 year end EV/EBITDA looks to be in the range of 13.9X.
Mastercard has a current enterprise value of $30.8 billion and should report 2010 EBITDA in the range of $2.8 billion. The year end EV/EBITDA ratio looks to be 10.5X.
Mastercard generates less than 67% the revenue of Visa and produces 62% of Visa's EBITDA. As an offset, Mastercard sells for roughly 44.6% of Visa's 2010 year end EV/EBITDA ratio.
Both Mastercard and Visa are well positioned to capture the secular global move to a cashless society.
As processors, Mastercard and Visa remain immunized from direct credit risk. Their business model and revenue stream differs from smaller competitors, including American Express and Discover Financial Services. Mastercard and Visa generate revenues from license fees, cross border assessments and a modest percentage of the interchange fee charged to merchants who rely on their global payment systems.
There has been periodic upheaval in the share price of Mastercard throughout the years 2008-2010. At first, criticism was levied regarding the earnings reliability throughout the global slowdown in 2008-2009. Such fears of earnings compression proved to be wholly unfounded.
In the case of Mastercard, revenues have grown by a solid 25.3% from 2007 to year-end 2009. Processed transactions were up 19.5% over the same period. Operating expenses have not changed significantly in the last several years. Almost all of the increase in revenues fell directly to EBITDA, and subsequently to the bottom line.
Capital expenditures to support and grow the Mastercard network have approximated $162 million per annum, for the last 3 years. This is approximately 3% of annual revenues.
With fixed costs in check and rapidly declining interest charges, future revenue gains may produce disproportionately high bottom line profits. The initial fixed costs of setting up competing businesses are extremely high, which is a key barrier to entry. Revenues on a per transaction basis are miniscule, which makes scaling up almost impossible for new entrants. For the two established processors, very limited capital investment is required to sustain the business. Having achieved the necessary scale, Visa and Mastercard produce some of the highest non-cyclical profit margins on the planet. Frankly, it is a enviable business model, one that is virtually impossible to replicate in scope and size.
Visa is certainly more advanced in the debit card market.
US consumers completed more debit transactions than credit transactions in 2009. Analysts reported this as a tipping point. Whether or not the emphasis on the use of debit vs credit can be considered a permanent trend remains to be seen. It is my contention that at least a portion of the debit increase in the US, and to a lesser extent Canada, is cyclical. Should the US economic recovery continue, it is my belief that credit trends will revert to the norm. Debit usage will continue to increase, but credit could recover very quickly.
Globally at Visa, debit card use accounted for approximately 57% of gross dollar volume.
http://finance.yahoo.com/news/Visa-Inc-Posts-Strong-Fiscal-prnews-1476842592.html?x=0&.v=1
Mastercard's perceived current weakness in US markets are not nessarily reflective of a global trend.
Insofar as debit is concerned, Mastercards's international operations represented 17% of gross dollar volumes for Q1. Total debit (including US) represented 33.7% of gross dollar volumes for the quarter. As with Visa, Mastercard also reported US that debit usage surpassed the use of credit in Q1, 2010.
Internationally, Mastercard reported debit volumes were up by 33.2% in Q1. On an absolute basis, Mastercard debit is smaller both domestically and globally, than Visa. However, Mastercard's growth rates in debit are quite comparable to that of Visa.
http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9MzgwNDA5fENoaWxkSUQ9MzgwMzc1fFR5cGU9MQ==&t=1
Recent criticisms impacting Mastercard's share price, as well as Visa, reflects the possibility of interchange fees moving towards a regulated structure, in the United States.
Retailers continue to try to have US congress cap the interchange fees. The implication put forth by mainstream media is that the lobby group of Visa and Mastercard is weaker than the lobby groups of retailers, and will therefore lose out in some sort of regulatory end run.
http://www.reuters.com/article/idCNN0511837420100505?rpc=44
http://www.gao.gov/new.items/d1045.pdf
What media outlets fail to take into account is that a full 85% of the interchange assessments go to the member banks of the credit and debit card systems. Almost $40 billion of total interchange fees were paid to the issuing banks in 2009. The lobby group retailers are fighting, is not just Mastercard and Visa, but the entire banking system. MA and V, as partners to the banks, are certainly exposed, but represent more peripheral players.
Banks and financial services presently account for more than 2X the amount of US GDP, when compared to retailers. Banks are incredibly influential (some argue too much so) and will neither surrender current fees, nor will they give away potential fee growth, without a fight. Both banks, V and MA argue that assessments are made against merchants, not consumers; the issue in their mind is one of "business to business" and need not be regulated.
http://online.wsj.com/article/SB10001424052748704905704574622722184163510.html
In a worst case scenario for Visa and Mastercard, any potential cap on interchange fees could, in all likelihood, simply be replaced by a new type of fee which would be levied, so as to offset interchange caps. Such a fee could be similar to the dreaded "system access fees" consumers pay for mobile cell services in certain parts of the world.
What businesses are doing, essentially, is attempting to shift the burden of the interchange payments off of their backs, and directly to the backs of consumers. There is no free lunch. Consumers are already indirectly paying the interchange fees; merchants inflate selling prices by amounts equal to, or greater than, current assessments. In the event that interchange fees are capped or reduced, it is highly doubtful that merchants will, in turn, reduce product prices accordingly. The merchant goals are simple; transfer profits from banks and processors, directly to retailers.
Since the earnings report of May 4th, 2010. Mastercard shares have fallen by 11%, far greater than the average decline of US equity markets as a whole. Visa shares have also fallen by approximately 11% since the release of their last quarterly financial report. It would appear that a portion of the pullback may be attributable to the potential for some regulatory fee cap being imposed, at a congressional level. Whether or not this comes to pass, or whether it will have an impact on the business, remains to be seen. Interchange fees are now regulated in Australia; according to the financial reports from Visa and Mastercard, no material challenges to the business model or profitability in that market occurred. Many of Mastercard's primary markets carry higher degrees of regulation than the US. In the event that US regulation occurs, it would appear that Visa wll be potentially impacted, by a greater degree, than will Mastercard.
Mastercard represents one part of a duopoly presently benefitting from one of the planet's defining secular trends; a move from cash to electronic payments.
The business model of Mastercard and Visa proved itself out during a period of below average global growth. At less than 10X my 2011 forward EV/EBITDA estimate , shares of Mastercard now look to be about as cheap, on a forward basis, as they were shortly after the IPO.
I feel that Mastercard has significant earnings leverage, should credit use increase in a more broadly based economic recovery. The secular trend towards increased debit use will continue; Mastercard seems well positioned to continue to earn its fair share of that market as well.
Investment markets have generally been weakened by a key national issue over the past several weeks.
The current risks of a default, in the national debts of Greece, are cause for concern but possibly very overblown. Greece is not a substantial economic power. With a population of just 10.8 million persons, Greece is the 34th largest economy on the globe, but is the 17th largest external debtor. It is a government heavy nation; more than 40% of GDP comes from public sector employment. Some government employees are paid bonuses simply to show up on time. GDP is about 2/3 per capita that of leading Eurozone nations. Direct EU aid accounts for 3.3% of Greek GDP per annum. Through direct subsidy, Greece has been effectively "propped up" by the EU for many years now, and will continue to be afforded substantial aid in the future.
https://www.cia.gov/library/publications/the-world-factbook/geos/gr.html
The largest issue facing Greece is not debt; rather it is tax evasion. Roughly 50% of all Greek households pay no income tax. And, many of those who do declare taxable income fail to remit the amounts owed. Tax collection policies in Greece are porous, penalties for noncompliance are unevenly meted out. When collectors do come to call, a surfeit of anecdotes indicate that the government receives just one third of what is owned; one third is forgiven and the tax collector receives the remaining third in an unmarked envelope. As a result, the most highly sought after profession in Greece is neither a doctor, lawyer, movie star or business mogul; rather the fast track to wealth comes about by being a humble tax collector.
Credible estimates put the amount of tax revenues foregone, via direct evasion, at as little as $30 billion to as much as $39 billion US annually.
http://www.nytimes.com/2010/05/02/world/europe/02evasion.html?hp
http://www.huffingtonpost.com/dean-baker/greek-austerity-should-in_b_561509.html
Assuming that 1/2 of the amount of taxes evaded were paid (which would bring the Greek cash economy in line with tax avoidance estimates for Canada), and if all of the taxes declared, but not remitted, were paid in full to the government (and NOT to tax officials personally), Greece would be in a position to ably retire all foreign debts, within 15 years.
A country of 10.8 million people is simply is too small to have meaningful negative impacts upon forecast global growth. Global markets have now become preoccupied with a fear of Greek "contagion" spreading to other nations in the EU. Three nations have come under increased scrutiny of late, Spain, Portugal and Italy.
Spain has a 20% official unemployment rate, to be sure. This is not a new phenomenon; in fact Spanish unemployment rates have have been structurally high for more than 20 years.
http://www.allbusiness.com/public-administration/national-security-international/524124-1.html
High unemployment rates in Spain are a, more or less, permanent conundrum. Many of the officially unemployed in Spain are actually "double dipping"; they generate tax free cash incomes in Spain's large undergound economy, while simultaneously obtaining tax assisted government benefits, or "Paro". Mass media often televises long lines of persons in Spain queueing up for their unemployement payments...what they don't show are the great numbers of people who then proceed directly to work at their regular "cash" job, sometimes immediately after picking up the government check. It is widely assumed that the black market economy equals 20% of reported Spanish GDP per year.
Portugal has a more diversified economy, a lower budget deficit and workers willing and able to be be employed at wages roughly 2/3 that of Greece. Spain, Italy and Portugal are less dependent upon EU aid and are not in the same leaky boat as Greece.
Italy, on an absolute basis has, by far, the largest black market, or "shadow" economy in all of Europe.
http://www.theflorentine.net/articles/article-view.asp?issuetocId=1262
In relative terms, however, even Italian tax evasion pales in comparison to Greece.
http://www.econ.jku.at/members/Schneider/files/publications/LatestResearch2010/ShadEcOECD2010.pdf
In my view, the risks of a Greek domestic capital crisis spreading throughout the rest of Europe are as likely today, as was the likelihood of the swine flu becoming a true pandemic last year; not likely. However, THE common underlying thread among Italy, Portugal, Spain and Greece is the absolute size of their underground cash economies. Major reforms are required to "out" shadow economies, so that tax revenues can be assessed and collected. Far too many bureaucrats, judiciary and government officials in these nations, are themselves the profligate scofflaws. Hopefully the external forces, now being applied, will affect meaningful change.
http://finance.yahoo.com/news/Stocks-slide-anew-but-its-apf-4109518464.html?x=0&sec=topStories&pos=1&asset=&ccode=
A greater blow to the credibility of North American markets likely came about from the VERY recent disclosure of Goldman Sachs discussing an SEC settlement on their mortgage securitization issuance activities.
http://online.wsj.com/article/SB10001424052748704370704575228232487804548.html#articleTabs%3Darticle
Such a settlement, if reached, will confirm long held suspicions, by investors at large, that we operate at a considerable disadvantage to a select number of financial institutions.
It is equally important to note that true financial reform cannot occur, when those who are supposedly overseeing the financial firms, find themselves in a position to earn outsized financial benefits by trading on material non-public information.
http://finance.yahoo.com/tech-ticker/congress-refuses-to-outlaw-insider-trading-for-lawmakers-478701.html?tickers=^dji,^gspc,^ixic,brk-a,brk-b,gs,xlf&sec=topStories&pos=9&asset=&ccode=
Key government officials have clearly demonstrated their abilities to drive down the shares of Mastercard and Visa, by more than 6%, over and above normal market fluctuations. This was effectively accomplished simply through discussing the placing of an addendum to a bill. Competing bank lobby groups will now go to work on lawmakers to mitigate the threat. Nevertheless, negative media attention has been generated. Unfortunately for investors holding securities other than Visa and Mastercard, negative government pronouncements, on index stocks, create a ripple effect that spills over into other securities. So long as lawmakers are also in a personal position to sell shares short, without the requirement of disclosure, their motivations for speading rumour may certainly be called into question. I estimate that more than $8.6 billion of the market cap decline in Visa and Mastercard is directly attributable to potential interchange proposal. Quis custodiet ipsos custodes?
http://rightsoup.com/insider-trading-illegal-for-you-but-not-for-congress-hr-682/
Trading volumes and selling pressures for Visa and Mastercard spiked VERY dramatically for 2 days, immediately prior to the announcement, that a US lawmaker is considering adding an interchange fee amendment, to a forthcoming bill.
The blog model portfolio is today purchasing an addition 85 shares of Mastercard at the current market price.
If the actions of firms and governments are blatantly stacked against the investor "everyman" in the short term, what remains is either total abdication from investment markets, or more appropriately, the ownership of securities for the long term. At the current price, it is my view that Mastercard is presently valued as a broken growth stock. Mastercard is the more international investment in the card processing market, when compared to Visa. Mastercard's growth story, which never abated during the economic slowdown, is likely to accelerate in the near to mid term. Interchange fees improve for Mastercard and Visa as average ticket size increases. Purchases per ticket with credit are historically much higher than purchases with debit. Mastercard's revenue stream is credit oriented; growth in the use of credit cards may produce a material revenue "shock" to analysts, at some point, in the coming quarters.
This is a company generating above average growth, operating in fast growing economies. In 2011, Mastercard's Asian and Latin American GDV should exceed that of the US. Shares of MA may ultimately rise to a deserved premium valuation, rather than their current steep discount.
By the end of 2010, even using my conservative determination of EV, Mastercard should boast a net cash balance. Such a nest egg could be used to repurchase stock, raise the dividend and simultaneously be invested for organic expansion.
Opportunities to invest in a strong, highly profitable and non-cyclical company, for less than 9X 2011 EV/EBITDA, generally only present themselves during bouts of fear. The Dow Jones Industrial Average is now down for the year, as of the close of business on Friday, May 7th, 2010. Clearly, on the heels of intraday DJIA swings of 1000 points, this would appear to be such a time. To quote Colonel Hal Moore, from the movie "We Were Soldiers"- "It's getting pretty sporty down here, sir!"
Visa is also currently selling for a valuation well below its growth rates in revenue, EBITDA and earnings. I consider the shares of Visa to be attractively valued. Visa has recently increased assessments for July, 2010. Q3 earnings for Visa could surprise to the upside.
The cost of $19,139.45 + purchase fee, to add 85 shares of MA, will be paid for from the current cash balance of $1,689, the sale of 130 shares of Thomson Reuters (TRI-NYSE, $36.35), the sale of 200 shares of Provida (PVD-NYSE, $46.56) and 78 shares of Canon Inc. (CAJ-NYSE, $44.05). All companies being sold are fine firms. The decision to allocate some of their capital, towards Mastercard, is reflective of a policy of being fully invested at all times.
Today, I have also increased my personal position in Mastercard.