Visa (NYSE:V) has consistently earned shareholders market-crushing returns in the decade since it went public, rising an astounding 1,000% in that time -- more than four times the S&P 500's gain. It's easy to see why the stock has been so successful. Visa operates in a virtual payment-processing duopoly with Mastercard (NYSE:MA) in much of the developed world, enjoying a network effect that makes it extremely difficult for other companies to enter the industry. And the market for its services is growing as the huge trend toward the digitization of money continues.
A quick glance at Visa's 2019 first-quarter results, released last week, could easily lead investors to believe that the bull case for the company's stock was still intact. Yet a look under the hood reveals potential signs of trouble for the payments network.
Most troubling? Management indicated that growth in cross-border transactions was slowing. In the first quarter of Visa's fiscal 2019, cross-border growth inched down to 7%, a material slowdown from the company's 10% growth in this key category for all of 2018. During the earnings conference call, company executives said they were seeing the same worrying trend extend into the current quarter. This is important because approximately 27% of Visa's total revenue is driven by its international transaction revenues segment, where cross-border payments are accounted for.
Let's take a closer look at the quarterly earnings and see what might be driving this development.
Trouble across the border
In Visa's annual 10-K filing with the SEC, the company states, "Cross-border transactions arise when the country of origin of the issuer is different from that of the merchant." In other words, if I traveled from my Florida home to Paris and bought an Eiffel Tower souvenir with my Visa card (issued by a domestic bank), that would count as a cross-border transaction. In that case, the issuing bank would be American and the merchant would be French.
Cross-border transactions, along with cash currency conversions, are accounted for in Visa's international transaction revenue segment. In the year's first quarter, international transaction revenue rose to $1.85 billion, an 11% increase year over year. While at first glance that doesn't look bad, it's important to note that cash conversion activity must have grown significantly faster than the 11% rate to help make up for the 7% growth rate of cross-border transactions.
Visa management blamed the cross-border slowdown on a confluence of factors, including the U.S. government shutdown, trade worries with China, and Brexit. CFO Vasant Prabhu called it "a combination of ... some of the uncertainties that are all coming to a head in the next few weeks" as the company headed into its second quarter. These reasons all sound plausible, but there's one small problem.
The Mastercard comparison
The day after Visa reported its earnings, Mastercard, the other half of the payments duopoly, released its earnings results. The two companies almost always report earnings within a day or two of each other and, without fail, see the same economic trends at play. Yet this quarter, Mastercard not only reported 17% growth in cross-border transactions (as measured in local currency), but it also saw double-digit increases in all reporting regions. It expects cross-border growth in the coming year to grow in the mid-teens percentage range. That's a far cry from Visa's relatively tepid 7% growth.
When Mastercard CEO Ajay Banga was asked to compare Mastercard's rosy outlook to Visa's and whether it was a result of his company's growing market share, he replied:
Yes, we have been growing share for the last few years, and that gives us some degree of a better leg to stand on. But remember, we've also been diversifying our revenues with more legs to the revenues tool, so to say, which include services. ... [W]e expect services revenue to grow faster than our core payments revenue. And so they do have a sense in our business, of our numbers. I cannot compare those [to] what competitors feel.
To add insult to injury, Mastercard tried to outbid Visa for Earthport, a financial technology (or fintech) start-up that specializes in -- yep, you guessed it -- cross-border payments. Visa and Mastercard are now in a bidding war for Earthport, with the only clear winner thus far being Earthport's shareholders.
Can Visa right the ship?
This is no reason for Visa shareholders to panic. Yes, it does appear Mastercard is taking market share from Visa now on the back of its heavy investments in its services. This is something Visa can rectify, however, if it takes the problem seriously -- and there is every reason to believe it is. In the conference call, CEO Al Kelly said:
[C]ross-border is important to us. We look at any and all partnerships and any and all technologies that would -- where we can add value and participate in the movement of funds from one geography to another geography. So in short ... it'd be safe to say that we certainly wouldn't leave any rock unturned.
Kelly mentioned that while he couldn't comment on the Earthport bidding war, his company was considering its options, indicating that Visa might at least be open to putting in another bid.
For now, Visa remains a cash-flow machine. Its competitive position is secure, though it's possibly showing the slightest signs of weakening. Still, the company didn't lower full-year guidance and sports an operating margin of 68%. For Visa to compete, however, it might need to invest more and let that margin drop a bit closer to Mastercard's in the low-50 percentage range. Banga has repeatedly said he manages Mastercard based not on its margin, but on its top-line growth. He believes the best way to accomplish this is by investing heavily in the services Mastercard can offer its clients. Visa would do well to take a similar approach.
For investors, it's quite possible Visa could still offer market-beating returns well into the future. Over the trailing three- and one-year periods, however, Mastercard's stock price has appreciated considerably more. I expect this trend to continue as long as Visa management is more focused on its margins than on investing in the company's future -- which is why Mastercard, not Visa, holds a prominent position in my own portfolio.