There are few more directly comparable companies than payment processors Visa (NYSE:V) and Mastercard (NYSE:MA). Both have essentially the same business model, are capitalizing on some of the same trends, and are pursuing many of the same growth avenues. The big difference is the steps they're taking along the way.
In this episode of Industry Focus: Financials, host Shannon Jones and Fool.com contributor Matt Frankel discuss the most recent results from the two companies and which could be the best stock to buy now.
A full transcript follows the video.
This video was recorded on July 30, 2018.
Shannon Jones: Welcome to Industry Focus, the show that dives into a different sector of the stock market every day. It's Monday, July 30th, and on today's Financials show, we're talking about one of the biggest financial industry rivalries there is. I can guarantee at least one of these companies is likely to be found in your wallet. You've probably guessed it by now, we're talking Visa and MasterCard. Today, we'll discuss their most recent quarterly performance, what sets them apart strategically, and the inevitable question -- which company is the better buy?
I'm your host, Shannon Jones. For our listeners who are not aware, I've recently stepped in to fill the shoes of our Financials podcast host, Michael Douglass. He will be stepping over to cover our Thursday Energy Industry Focus podcast. Be looking out for him on Thursday.
Today, I'm joined in the studio via Skype with financial expert, guru, all-around good guy, Matt Frankel. Matt, glad to have you here today!
Matt Frankel: Always good to be here! [laughs] The hosts have changed, but I'm still here.
Jones: [laughs] Yes, Matt, the one key, consistent factor across the Financials podcast. It's so good to have you, Matt! Let's dive right in.
Visa and MasterCard. We get so many listener emails about this matchup. It seems like the articles written about Visa and MasterCard are some of our most popular. Before we really dive into the two companies, Matt, let's actually take a step back and set the stage for investors who are new to this space, or even just new investors in general. How do Visa and MasterCard actually make money?
Frankel: First of all, I only need to really run down one business model, because both of these companies are 95% the same business. The one thing that, especially new investors to these companies are interested to find out is that these are not the companies that actually issue credit cards. These are what are known as payment processors.
There are generally four parties that are involved in a payments transaction. There's the issuing bank that actually loans money to the customer through their credit card. If you have a Bank of America credit card in your wallet, a Capital One credit card, these are the issuing banks. Then, you have the payment processor, like Visa or MasterCard. Then, you have the merchant. And then, finally, you have the merchant's bank. It's called a four-party payments system. Visa and MasterCard are just the middlemen between the issuing banks that are lending the money and the merchants and the merchants' banks that are receiving the money.
There are three main ways that Visa and MasterCard make their money. Of course, it's a little more complicated than we can get into in a relatively short podcast. But, the main categories are service revenue, which are also known as swipe fees. Every time you swipe your credit card at a point-of-sale terminal, Visa or MasterCard or whoever is backing your card gets a small cut of whatever that revenue is. A long time ago, when I actually helped run a business, it was in the neighborhood of 1%, a little more than 1% for Visa and MasterCard. So, they get a percentage of every transaction, which known as service revenue.
They also get what's called data processing revenue, which is a small, fixed amount that they get for things like actually transferring the money from one place to another, providing settlement data to a merchant, things like that. Then, there's also what's called international revenues, which are, if your credit card charges you a foreign exchange fee, or something to that effect. Any time that a credit card is used outside of its main area, you get a nice, additional, international revenue stream, if it has to deal with currency exchanges or convenience fees, those sorts of things.
Jones: Really, for companies like Visa and MasterCard, volume is where the money is at. The more transactions they process, the more revenue they make. The goal, of course, is to extend their network, especially internationally, which is key. Really, the more banks and partnerships that they're able to sign on board, the better, as well.
With that, Matt, let's actually turn our focus over to Visa. Visa is the largest payment processor in the world. They recently reported earnings for their third quarter. They're on a slightly different fiscal calendar than MasterCard. Matt, what can you tell us about how Visa fared in this last quarter?
Frankel: First of all, just to give you an idea of how big Visa is, Visa has nearly 3.3 billion cards in circulation with its logo on it. That's a lot of cards. That's about one for every two people in the world. So, Visa is the big company here. They're both big, but relatively speaking.
Visa grew its revenue by 15% year over year, grew its earnings by 40% year over year. Most of that was due to tax reform, but like I said, there was some revenue growth, so it was pretty strong on both ends. Tax reform and revenue growth combined to produce some pretty nice profit growth. Their payment volume -- just to name a couple of statistics -- was up 11% year over year. The number of cards, I mentioned it was 3.3 billion, that grew by 4% year over year. And it was equal growth on debit card and credit card products, which was nice to see. Service revenue was up by 13%. Data processing revenues were up by 19%.
Internationally, they grew by 16%. You mentioned a little bit ago that international is a very big growth market for Visa and MasterCard. In a lot of places around the world, credit cards and card payments in general are not like they are in the U.S., where if you go to any merchant, you can expect them to at least accept Visa and MasterCard. In places like a lot of Asia and Central America, especially, there are a lot of places where Visa and MasterCard are not widespread accepted yet. China is a big market that Visa is just tiptoeing into now. So, there's a lot of international room to grow. That's a key number that we want to watch every quarter. 16% international growth is really impressive.
Jones: Yeah, absolutely. A phenomenal quarter for Visa, as expected. Just going back to the international markets, for our listeners who want a little more about that. When you think about it, the U.S. is pretty saturated when it comes to the payment processors. Really, the opportunities are abroad. Especially with the advancement of mobile connectivity, you see a huge opportunity for Visa and MasterCard to really dominate and gain more market share.
Typically, these international retailers, many of them small businesses, just the outlay required to acquire some of these big, expensive credit card processing machines was so detrimental to the business, it really wasn't even worth it. So, cash really is the dominant form of payment internationally -- especially, as Matt mentioned, in Asian markets in particular.
With mobile connectivity, you have, now, many more consumers abroad using their mobile phones for payment. That's a huge opportunity in itself. Some estimates are that the global mobile payments volume will increase from $75 billion this year to over $500 billion by 2020. That's roughly an 88% compound annual growth rate. That's huge. Those are opportunities that Visa and MasterCard are definitely going after.
Frankel: Right. There are a couple of other big catalysts for Visa and MasterCard going forward. The rise of e-commerce. E-commerce sales were up 16% in 2017 year over year. E-commerce is an area where they don't have to compete against things like cash and checks.
Also, cash is going away in mom and pop merchants all around the country, and in some international markets. When you think about how many small merchants have the little Square payment readers, you can't walk through a craft market in North America these days without everyone accepting credit cards. The rise of e-commerce and the ease with which merchants can accept card payments these days have really been big catalysts for these companies.
Jones: Yeah, absolutely. One other thing I will say, one key area that I'll be watching in particular, is China. One thing investors should know is, in China, there is Alipay and Tencent's WeChat app. These were basically created for consumers who didn't have credit and debit cards there. They still wanted their consumers to be able to shop on their online marketplaces, to still be able to participate in e-commerce. Basically, this eliminated the need for the middlemen, the traditional banking system that we have here in the U.S. I've seen Visa and MasterCard executives talk about it a bit, and think about ways to monitor that, and, even more so, defend against that. That'll be one area to watch, because I think it'll be interesting.
Frankel: Yeah, definitely. China, like I said, is a pretty untapped market for credit cards. It was only a couple of years ago where Visa and the others weren't allowed to operate in China. As we know, that's the most populated area in the world. If you think Visa and MasterCard are saturated, in terms of how big they can get, you might be surprised.
Jones: That's right, there's a huge growth opportunity there. Let's talk about Visa's strategy. What really makes Visa unique? What areas are they going after, apart from international?
Frankel: Like I said, Visa and MasterCard are 95% the same business. Having said that, they're emphasizing different areas. Visa is really emphasizing safety and security in payments. Both of them are aggressively investing in fintech, with Visa having an orientation toward safety. Security, especially with all these data breaches that have been going on recently, they want to make the case around the world that it's safe for people to make card payments.
They have the advantage of scale at this point. They have a big head start over MasterCard in many markets because they're such a bigger company. As we'll see in a minute, there are about 50% more Visa cards in existence in the world than MasterCard cards. That in itself is a big competitive advantage that gives them a leg up when it comes to efficiency and things like that.
Jones: Really, in order to stay competitive, you mentioned how both companies are really working with and partnering alongside with fintech companies. It's interesting, Visa is really changing their overall focus. They're attempting to move away from just being known as a card network and really wanting to be seen as a technology platform solutions company.
One thing that they actually recently rolled out is something that they call fintech in a box. Many of these smaller fintech companies that are out there, they are attempting to onboard many of these smaller companies onto their network within about a month, which is pretty fast, and basically giving them the tools, as a developer, to easily integrate on to the Visa network. I think that's something that should help them as an open-source platform moving forward.
Another thing that's been really interesting is their Visa Direct program. Basically, they're attempting to expedite how quickly funds go from, if I'm going to pay for something at a merchant's store, how quickly those funds get from me over to that merchant's bank, and really try to expedite that entire process. Visa Direct is another way that they're doing that. Of course, they're well-positioned with the growth of mobile payments, with Apple Pay, PayPal, Samsung Pay, Android Pay, Microsoft Wallet -- again, not too much different from MasterCard.
They also, too, acquired Visa Europe back in 2016. This was really designed to help accelerate the transition from cash to electronic payments there in Europe. So far, you're just starting to see the fruits of that, but I think that really opened up the door to really give Visa that extra push forward ahead of MasterCard in that regard.
Frankel: Definitely. Visa has done a great job of transforming itself, as you said, from just a payments company into a technology company. The open source is great. Fintech, they're investing very heavily, as is MasterCard. The Visa Checkout button that you'll see on a lot of merchants' websites is one good example. That allows a one-click checkout, to encourage customers to use their Visa card instead of some other company's. MasterCard has a competing feature now, but that was one big Visa innovation a few years ago. It's a great example of how they're trying to transform themselves into more of a technology company than a payments company.
Jones: Absolutely. Matt, let's shift gears and talk about the underdog here. I almost hate to use that term when it comes to MasterCard, but, just in terms of relative size and scope. MasterCard also just reported earnings. How did they fare in their second quarter?
Frankel: You mentioned that MasterCard is about 50% smaller than Visa, in terms of the number of cards that exist with MasterCard logos on them. But, the other way to think about that is, MasterCard has more room for growth. It looks like that's exactly what's happening. You mentioned Visa's numbers. Believe it or not, MasterCard's were actually a little bit better.
They grew revenue by 18% year over year. Because of that combined with the effects of tax reform, their earnings shot up by more than 50% year over year, which is pretty incredible for a company of that size. Payment volume was up by 14%. Just to recap, Visa's was 11%. The number of cards in existence shot up by 5%, as opposed to Visa's 4%. And, they matched Visa in international growth with a 16% growth rate, which is pretty impressive all by itself.
MasterCard has been doing a great job of making acquisitions that add value over the past couple of years. If anything, I would call MasterCard the more aggressive acquirer out of the two. Acquisitions are definitely more of their strategy than Visa's. MasterCard has really been taking advantage of its growth opportunity when it comes to things like e-commerce and the rise of card payments worldwide, and it's really showing in the numbers this quarter.
Jones: Absolutely a phenomenal quarter for MasterCard, as well. Just like you mentioned, Matt, MasterCard is really strategically investing in technology, and you are starting to see that pay off. But, I think the growth runway is much, much longer for them.
In particular, there were a couple of acquisitions that not only expanded MasterCard beyond its core, but also enhanced and will be enhancing its capabilities moving forward. Last year, MasterCard actually bought out VocaLink. This was really to expand MasterCard beyond their traditional retail setup, where you have your person-to-merchant setup, and really gave MasterCard an opportunity to dive in to peer-to-peer and business-to-business payment networks.
Also, you've seen this with MasterCard integrating its network with Zelle and PayPal's Venmo. As a matter of fact, MasterCard is actually behind the new Venmo consumer debit card, which will basically enable Venmo users to cash out their balances and use those funds, either online or in stores wherever MasterCard is accepted. There are so many firsts that MasterCard is going after and have done. Masterpass, that was rolled out not too long ago, was the first network to have a digital payments service across all devices and all channels.
You mentioned security and fraud for Visa. MasterCard is really stepping it up with that. They've been investing in several different things, one of which was artificial intelligence. They'll also be rolling out a biometric card, which will combine the chip technology with fingerprint scans and even iris scanning on a mobile phone to verify online purchases.
What you're seeing is MasterCard invest heavily in technology, investing in its future, and I think it looks pretty bright. I also agree, they are extremely aggressive when it comes to investing in the next big wave, into how to differentiate themselves from Visa. I think, ultimately, MasterCard is really set to dominate that war on cash that's happening right now.
Frankel: MasterCard, like you mentioned, is really doing a good job with the peer-to-peer payments, especially Venmo. Michael would be very proud of me, I finally used Venmo last week for the first time.
Jones: [laughs] Congratulations!
Frankel: Right after he leaves the show. [laughs] He always gave me a hard time about that, because he would bring it up in every discussion. But, MasterCard is doing a great job of integrating technologies into technologies like that, and altogether doing a really good job of adding value to their product that differentiates them from Visa.
Another acquisition I was going to mention is one called APT, Applied Predictive Technologies, that they acquired in 2015. That adds analytical capabilities to their products that really differentiated them. That's the key word here, differentiation. They want to differentiate themselves from Visa, and they're doing it through all of these value-adding acquisitions and investing heavily into the newest financial technology.
Jones: Absolutely. Matt, we've talked about Visa, we've talked about MasterCard, the million-dollar question here -- which one do you think, right now, is a better buy?
Frankel: At first glance, both of these look kind of expensive. For me, they're almost the same business, so it comes down to a question of valuation and growth. Both stocks are up by over 700% over the past decade, just to give you an idea of how incredible this growth story has been. Visa has been up over 40% over the past year alone, MasterCard almost 60%. They trade at pretty high price to earnings multiples. Both are right around 39X as we're speaking.
But, given MasterCard is growing a little bit faster, I think, in my opinion, they're doing a little bit better job of investing in new technology. I would have to go with MasterCard.
By the way, those price to earnings multiples, don't let them scare you. If e-commerce keeps growing like this for another few years, if the rise of card payments worldwide keeps growing as predicted, those multiples could seem very cheap. But, for now, I would have to go with MasterCard, out of the two.
Jones: It's hard to bet against Visa, who's been the dominant market leader for so long. Really, I don't think you can go wrong with investing in both in this regard. The war on cash is really still in its early innings right now. You're going to see growth continue to pick up for both of them. I agree with you, Matt. I think, from the technology perspective, MasterCard, to me, is the better long-term growth opportunity. But, just like Buffett said at his most recent Berkshire Hathaway meeting -- he's a Visa shareholder, but he said, "Looking back, I could have bought MasterCard as well, and I really should have."
That is really the feeling around here, too, at The Fool. When you ask analysts, it's hard for them to choose one or the other, because they're such great, awesome companies. I really don't think you could go wrong with either.
Frankel: I'd go with MasterCard, but it's really tough to over-emphasize how close it is. If MasterCard was a 10, I'd call Visa a 9.9, in terms of attractiveness. It's really, really close. But, like I said, MasterCard, I like how they're growing, I like that they're focusing on the technology aspect of it and international markets. But you won't go wrong with either one of them. Don't sell Visa to buy MasterCard or anything like that.
Jones: You heard it here first, Fools! Both are great, MasterCard certainly doing its fair share to close that gap between it and Visa.
Really, that's it for this week's Financials show. Don't forget, this month, The Motley Fool turned 25. That's right, it's The Fool's 25th anniversary. To celebrate, everything in the podcast swag store is 25% off between now and the end of the month. You just have a few more days to snag some really great deals on your podcast swag.
As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. This show is produced by Austin Morgan. For Matt Frankel, I'm Shannon Jones. Thanks for listening and Fool on!
Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Matthew Frankel owns shares of AAPL, BAC, BRK-B, and SQ. Shannon Jones has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends AAPL, Mastercard, PYPL, and SQ. The Motley Fool owns shares of Visa and has the following options: long January 2020 $150 calls on AAPL and short January 2020 $155 calls on AAPL. The Motley Fool recommends BRK-B. The Motley Fool has a disclosure policy.