The two are often described as "tollbooths" -- companies that generate revenue just by being in the right place. That place is in between a majority of all credit and debit card transactions.
And for years, I've wanted to buy them. I still do today, especially after watching them lag the broader market this year. But there's one concern I can't get over.
They're too good
Visa and MasterCard bring the majority of their revenue down into pre-tax profits. Both have grown their top lines at double digit paces since their respective initial public offerings. And both generate cash and accrual returns on invested capital that might as well be infinite, given the capital-light realities of operating a payment processor.
But that's still my biggest concern. The returns from this industry are almost too good.
We've seen how success can bring problems. In 2010, Dodd Frank changed the game when it limited interchange fees in the United States. The Fed ultimately acted to cap debit card fees to a fraction of what they used to be in 2011.
The European Union is pushing forward with regulations designed to cap the very fees that are the lifeblood to Visa and MasterCard.
And I'm left to wonder, despite the fact that the industry is "competitive" in the sense that there are a handful of competitors, to what extent will regulators go to limit profits for payment processors?
Fees are more visible than ever
Last year, Amazon reported nearly $75 billion in revenue, selling everything from books to server time. Yet, when it came to the bottom line, you can bet that the payment processors -- Visa and MasterCard being the biggest -- earned more from those transactions than Amazon did.
Amazon is a healthy retailer, which is to say nothing of Sears, J.C. Penney, or RadioShack -- many of the struggling retailers that would kill to see payment processing costs added back to their gross profits.
I just wonder, given the poor climate for retailers, if regulatory pressure will only ramp up. After all, Visa and MasterCard are just better utilities -- much more profitable, capital-light, utilities, that is. We all know how regulated utilities are...
Changing my tune
I've tried to change my mind on this countless times. More regulation and lower fees might encourage more payment volume, erasing some of the lost profits. Likewise, certainty in the regulatory environment could only be a boon for Visa and MasterCard shareholders, provided it isn't too onerous.
And for years, I've been dead wrong in my thinking. So, too, have countless other investors. (Billionaire Bill Ackman passed on their IPOs, citing a lack of comfort about regulatory issues.)
The fact is, given the shift toward electronic payments and each company's profitability, I can say with almost certainty that, without regulatory problems, Visa and MasterCard should go on to generate obscene returns for investors over the next 10 to 20 years. But that's in a world without regulatory issues -- in a world where government doesn't cap their profitability.
I'm not sure that's the world we live in. But I'd be very happy to be dead wrong, if only for those who are invested in two of the greatest growth stories on Wall Street today. Maybe you can help me change my tune...
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