The War on Cash, Revisited

In this podcast, Motley Fool analyst Jason Moser and Motley Fool contributor Matt Frankel discuss:

• The state of the "War on Cash."
• Embedded finance.
• Two "toll booths" that aren't going away anytime soon.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Dec. 03, 2023.

Jason Moser: War on cash basket of Mastercard, Visa, PayPal, Block in equal weightings. The inception date of July 24, 2017 is worth noting, this basket is still up 130% versus the market's 105%. Even with this pull back specifically, I'd look at companies like Block and PayPal, even with the pullback in companies like those, the basket is still outperforming.

Mary Long: I'm Mary Long and that's Jason Moser, a lead advisor here at The Fool, and our go to guy when we want to talk the war on cash. As we close out the year, we'll be bringing you some industry focus style episodes where a couple analysts get together to discuss standout stocks in a given industry. Today, Jason is joined by Matt Frankel to tackle the world of payments.

Jason Moser: Let's go ahead and just start this show off with, let's call it the big format, the war on cash basket. We get questions about this basket all the time. People are very interested in these companies. It's something we talked about for many years. As a reminder for listeners who may not be as familiar, we're talking about in specific Visa, Mastercard, PayPal, and Block. Those are the four companies that make up the official war on cash basket. Though hey, listen, we encourage all listeners, hey, get creative, make the war on cash basket that's right for you. It doesn't have to be those four. We've even talked about a war on cash basket Part 2 on these shows before. But Matt, we're gonna kick it off with these four specifically. I want to start with the two big toll boosts. Visa and Mastercard, because these are the ones that are always just in your face so obvious and yet some folks will say, these are companies that are headed the way the Dodo bird. Crypto and Web 3.0 they're going to obsolete these networks. But I tell you to this point met, it really doesn't feel that way at all.

Matt Frankel: We haven't revisited the war on cash basket in quite some time. We looked like mad geniuses for the war on cash basket in around 2021 for a while there. Now it's doing OK, but it's come back to Earth a little bit. But you mentioned Visa and Mastercard, and I don't want to get into what I think Crypto is going to do or not do because it's not that long of a show. But my short answer is both of these businesses are not going anywhere. We can cover them in one swoop because I'd say they're like 95% the same company.

Jason Moser: It does feel like this is a lows Home Depot situation. When you cover one, you cover the other. They're a little bit different but they're the two that really ruled the roost.

Matt Frankel: One is 30% bigger than the other, a lows Home Depot situation. The numbers look pretty similar. If I look at the most recent quarter, both of them grew revenue by the exact same amount, up 11%. Earnings were up 22% at Visa and 24% at Mastercard. Payment volume is enormous at these companies. Between the two of them they have, just doing the quick math in my head here, they have $22 trillion of annualized payment volume between the two of them.

Jason Moser: Wow.

Matt Frankel: It's roughly split 50, 50 between the US and international. There are 4.26 billion Visa cards in the world, between credit and debit cards, 3.26 billion Mastercards. These are massive payment networks. They are not going anywhere. What a lot of people don't realize is that the other companies we're going to talk about like PayPal and Block, as well as a lot of these Fintech start-ups and a lot of the Crypto companies, it's not an either or. Visa wants companies Block to do well because guess what? Those little cash cards have a Visa logo on them. They want these companies to do well, these Fintech start-ups, it's a win win situation. I call Visa and Mastercard the ultimate war on cash stocks because whatever Fintechs win the battle, Visa and Mastercard win too.

Jason Moser: Well, they've done a very good job I think through the years of finding new avenues or ways into that payments value chain. I think you make a very good point there in that you've got a lot of these new fangled Fintech companies, they're doing neat things. We'll talk about embedded finance to an extent here in a little bit as well. But they all rely on those rails at one point or another. You're seeing attempts at disruption there, you see things like Fed now and whatnot, trying to basically invent new sets of rails to give more choices, more options, quicker transmission of money finances. But it seems to boil down to the fact that these are two businesses, these rails in Visa and Mastercard are just inexorable parts of the value chain here when it comes to payments, no matter what the company.

Matt Frankel: It's also worth mentioning that Visa and Mastercard don't have their hands in some areas of finance yet especially person to person transfers, which PayPal and Block are both known for. That's a massive opportunity there. But you're right, they are the rails. It's not a complete duopoly, you have American Express and Discover in the US and in a lot of foreign markets, Visa and Mastercard are not the dominant players like they are here. If you go to some parts of the world, credit card acceptance isn't even that widespread yet.

Jason Moser: I've lived in a few of those places. [laughs]

Matt Frankel: You don't want to go backpacking through certain parts of Latin America and not have cash, it doesn't really work out that well in a lot of cases. But they're very mature and profitable businesses, very profitable. They have net margins that would make pretty much any other company jealous, but they're not mature to the point where they don't have any room to grow. There's a lot of international opportunity, I mentioned person to person payments. There's business to business transfers that are very prevalent that no one's really figured out how to make money off of yet. But they are definitely the rails and they're not going anywhere.

Jason Moser: I'm glad you mentioned earlier that, we look maybe a little bit more like geniuses with this war on cash basket, maybe a couple of years back. Obviously the performance was significantly higher than. It is worth noting this war on cash basket of Mastercard, Visa, PayPal, Block in equal weightings. The inception date of July 24th, 2017 is worth noting. This basket is still up 130% versus the market's 105%. Even with this pullback specifically, I mean, I'd look at companies like Block and PayPal, even with the pullback in companies like those, the basket is still outperforming. Let's go to PayPal because I think this is an interesting story from a number of angles. PayPal, you talk about a business with so much potential, but one that's clearly going through some growing pains. There's new leadership, hopefully there's new renewed focus there. But Matt why is the market so glass half empty on PayPal these days?

Matt Frankel: You mentioned the new leadership and that kind of is one of the things that I'm excited to see if their growth strategy is a little bit more like you said, focused. Their growth was very disjointed for a while. I don't know if you remember when they were trying to acquire Pinterest.

Jason Moser: I do. Well, it seems like it goes back to that phrase, everything app. They wanted to be this super app in doing everything for everyone. You know what, culturally, at least on this side of the world, it just doesn't seem like that's what consumers want.

Matt Frankel: I'm a big Pinterest shareholder, so I'll take it. But I was sitting there scratching my head like, what are they going to do with it? They were going to buy them out for $70 a share, it's also worth noting. It was a very disjointed growth strategy. I would call it all over the place. Some of their acquisition certainly made sense, like Honey definitely made sense as an acquisition whether or not they overpaid for is another conversation.

Matt Frankel: A lot of companies overpaid in 2021, 2022 for acquisitions just based on the valuation environment at the time. It's not that management made bad decisions. The other thing is PayPal had these very ambitious growth targets that it looked during the pandemic years like they were going to meet without any issue. For one, they have about 430 million active users right now. Their CEO, this was only a couple of years ago, said we're going to hit 750 million users in just a few years. Clearly that's been walked back a little bit since then. The strategy has definitely shifted from we're going to hit 750 million in a few years, then we're going to go on to one billion and we're just going to go from there. Now it's gone to we have 430 million good users let's figure out how to maximize them. The question is, can PayPal extract any more value out of its current user base. Venmo in particular, has been very slow to monetize, I would say. But the numbers look better than the stock price might lead you to believe. PayPal is growing. Not maybe as the market wants it to, the user base is actually declining a bit but the users that they have, they're doubling down on, they're more engaged. Total payment volume is up 15% year of a year. That's outpacing inflation. This isn't just inflation driven. Revenue is up 8% year every year. Non-transaction expenses, which has been a big focus area, there's down 12% year every year despite higher payment volume. That combination 20% earnings growth year over year, they're really engaging their members better. The average active PayPal account makes 56.6 transactions per quarter. That's 13% higher than a year ago. They're doing a great job of engagement. This is an absolute cash machine, this is a profitable business. A lot of people think of PayPal as a tech company, which in a lot of minds translates to unprofitable. They have roughly $15 million of cash on their balance sheet. They generate over $5 million of free cash flow annually, which right now they're putting it all into buybacks.

Jason Moser: I'm just going to say, we talk about how companies reinvest this capital, this cash flow. I mean, PayPal is really making a big effort here to buy back a lot of these shares right now. I mean, clearly they see at least some value in where the share is right now.

Matt Frankel: Yeah, I mean, they've retired 5% of their shares in the past year. They've spent $5.4 billion in buybacks during that period. Essentially, all their free cash flow is going into buybacks right now. Now my hope is that they find some bolt on acquisitions that could drive value. That's the preference. It's like Warren Buffett says, "Our first priority is figuring out how to maximize our current business then we'll worry about buybacks and things like that." But that tells me that they see a real deep value here if they're not doing anything else with their money. I mean, and I mentioned, they have a lot of cash on their balance sheet, so that gives them a cushion to spend their money on buybacks and still be able to pursue acquisitions or whatever if they arise. But this is a very cheap business. It trades for I think, less than 15 times forward earnings like 12 times for a while there. If you had told me that was going to be PayPal's valuation a couple of years ago, we would have both thought that was kind of a silly statement to make.

Jason Moser: It definitely seems like a bit of an overreaction to the downside there. I'm not saying that the market was necessarily rational in 2022 either. But yeah, it does feel like given, I mean, this is the company in a fundamentally a very good position, good financials, playing into a market where there are clear and obvious tailwinds that are not abating. Then it's going to really just boil down to new leadership. Seems like new leadership is some focus, they're trying to pull back from that super app aspiration. Really just dig down into what they do really well, which could work out very well for the company. I mean, these companies go through growing pains all the time. It's never a straight line up. Speaking of never a straight line up, I mean let's look at block here because this is another really interesting story to follow here. The Fintech formerly known as Square, now it's block and it's got Square, it's got cash app, it's got these crypto aspirations with Bitcoin. It's got title and music streaming. I'm not exactly sure what the focus there, so we talk about PayPal and maybe that we're a little bit relieved that it looks like this company is getting some focus back. I think it's a fair question to ask, at least with block, is this a company that is losing focus?

Matt Frankel: Well, as you know, I've been a block shareholder for the long haul. I bought two days. I'm right, two days after the IPO, I've written block from $9 a share all the way up to $280 a share and back to where it is now. I've been a fan of this company for a long time. The last time I saw you in person, we were interviewing Block co founder Jim Mckelvey.

Jason Moser: Oh yeah, that's right, that was a fun interview.

Matt Frankel: Their growth strategy over the past few years. I could also describe like PayPals, It's like all over the place. But they weren't just talking about making acquisitions that didn't make sense. They actually did a couple. You mentioned title, which I'm not really sure what the point of that was.

Jason Moser: Now that felt like either he was appeasing Jay Z, trying to kind of get tight in that club, or maybe this was just like a gamble on NFT's, which clearly that had worked out so well. But any which way you cut it, I just don't see the logic in that deal. But thankfully, they didn't pay an arm and a leg for Judge.

Matt Frankel: Speaking of paying an arm and a leg, I'm glad you just used it.

Jason Moser: I knew where this was going.

Matt Frankel: They also acquired After Pay which made sense. That is definitely a fit in the business. Not for $29 million.

Jason Moser: That was a lot.

Matt Frankel: It thankfully, it was an all stock deal so as their stock went down, the essential price they paid for the acquisition went down as well. I think it would be something like $6 million if you look at their current stock price, stop doing that, focus. That's kind of my point with with Jack Dorsey. The first line of his recent shareholder letter really made me smile. It said, "We've been quiet lately because we've been focused," and if you think about it, you really haven't heard any news from Block lately. You've heard a lot from PayPal, the new CEO, the management, shake up the strategy shift. You really haven't heard much from Block. They're really focusing their efforts and they're doing a lot of things that are very non Jack Dorsey esque, in the sense that, number 1, they're really focusing on controlling costs. He's generally a growth at all costs type of guy. They capped the number of employees they're going to have. They implemented a $1 million buyback program, which that's the first time I've ever heard the words buyback in block the same sentences. Unlike PayPal, their business is still growing very rapidly. Gross profit was up 21% year over year in the last quarter. Cash app is still growing. The payments ecosystem is still growing. The Afterpay integration actually looks like it's adding significant value to the business, but there is a long way to go when it comes to reaching profitability. Out of the four we've talked about so far, this is the least profitable by a long shot. Now, they could be very profitable today if they would stop pumping so much money into growth run in their expenses. I mentioned that's just now becoming a priority. They're a little late to the party with that.

Matt Frankel: I mentioned they did a $1 billion buyback authorization, that's not even going to cover their stock based compensation for the year. That's just really to offset it. Their share account is not going to go down even if they buy back $1 billion worth of stock. Things like that really need to be brought under control for this to really return to the level it was at before.

Jason Moser: I think that makes a lot of sense. I appreciate you bringing up the buy now, pay later stuff because I think in the very beginning stages of that market, I think we all probably looked at it at least with the healthy dose of skepticism. It seems ultimately like BNPL is more or less just credit card in a different name. But when you look at it, clearly consumers are looking at that more and more as an option, and retailers are looking at that more and more as an option. I said it before, if it's something that enables consumers to spend and it enables retailers to sell, then it's a value. If you look at the Adobe Analytics, they're talking about for Cyber Monday alone, BNPL is going to grow nearly 19% close to $785 million in sales. It's clearly an option that consumers are gravitating more and more toward. So even if block overpaid, which is obviously something that's debatable though, I think we probably would all agree they paid a lot. Maybe that is something that does pay off down the road. You look at the tail ones in that market, maybe it is something that ends up paying off. Matt, I wanted to dig into a few other companies in this space, companies that we like to follow tangentially, ones we don't get to talk as much about, but companies that probably many listeners are very familiar. We wanted to start with Marqeta, and I think it's a nice segue from Block into Marqeta because Marqeta in Block, they're joined at the hip, aren't they?

Matt Frankel: Yeah. Well, Block is their biggest customer, specifically the Cash App by far. Marqeta is a credit card infrastructure or a payment card infrastructure provider is the best way I could describe them. In addition to being the company that provides the technology behind the Cash App card, they also do things like they provide cards for Uber. If you ever do an Instacard grocery order, they're the company that allows your credit card to be used in store without you physically being there with your card. Your shopper can buy groceries on your behalf things like that. They provide the technology behind these things. Cash App makes up a big part of their revenue. It was a huge sigh of relief for investors when Cash App renewed its contract this year. That was up to expire. I think it's now renewed.

Jason Moser: Big deal.

Matt Frankel: That would have been a nail in the coffin. I think that's renewed through 2028, I believe.

Jason Moser: Four additional years, I believe.

Matt Frankel: As a result, the company reset this year. The renewal rates as is rather common when you sign a new contract, the initial rate goes down but you agreed to four more years. You saw their revenue decline by 43% year over year, but that doesn't tell the story about how the business is going. That's just because the Cash App rates went down quite a bit. If you look at the numbers, the payment volume through Marqeta's platform is up 33% year over year. They say, start judging our growth again in the third quarter of 2024. That'll be one year after the Cash App renewal. So you'll see year over year comparisons of revenue, they're really apples to apples comparisons. High gross margin business 67% gross margin. They have up $1.3 billion in cash, so they don't really have to worry about being profitable just yet. It's only a $3 billion market cap company, so that's a lot of cash on hand. On an adjusted basis, they're on the verge of profitability, but their growth has been very impressive. I'd like to see them continue to diversify their revenue away from Cash App. But really impressive business and it's a technology that is very much needed and is going to be increasingly needed as those type of businesses really expand.

Jason Moser: I suspect you're right. I mentioned embedded finance earlier in the show and that really is what Marqeta is. It's embedded finance. It's bringing those finance capabilities into apps that aren't necessarily Fintech companies. You mentioned Uber, DoorDash, companies like that that rely on drivers or delivery drivers going in there and picking up something and needing to charge it to a card then gets charged to the individual consumer buying the product or whatever. That embedded finance market, it's an interesting one. It really is growing as we see the mobile economy, the digital economy, the gig economy, continue to grow. It does feel like there's a lot of opportunity there for Marqeta and it was very good news to see them continuing that relationship with Block because I have a feeling that that should pay off down the road. Matt, Shift4 payments. This is not a business I'm as familiar with, one that you follow. What does Shift4 do and what do you like about them today?

Matt Frankel: They do payment processing and software for businesses. They're specifically concentrated in restaurants and hotels. They're the actual consumer-facing software terminals and things like that that you'll see when you go to pay for a hotel stay or things of that nature. Pretty big and successful company. A little over $5 billion market cap. So bigger than Marqeta and profitable on a gap basis. They have a 6% net profit margin in the past 12 months. It's a really successful business so far, very strong growth, payment processing volume is growing 36% year over year, 23% revenue growth. They get a percentage of transaction volume and some software revenue, things like that. Over the past five years, they've grown at a 48% annualized rate sustained over four years, and including in this slowdown, they're still growing. Their main focus is restaurants and hotels. They've expanded that quite a bit in the past couple of years. Stadiums and sporting venues are a big focus area for them. They recently acquired a company called Appetize that gets them into a lot more sports venues. I believe, if I remember correctly, that you're a golfer, I'm sure you've heard of Pebble Beach Resorts.

Jason Moser: You remember correctly.

Matt Frankel: Pebble Beach Resorts is a recent big winner that added Shift4 as their payment processing partner and non-profit organizations are another big vertical of theirs like habitat for you matter to use the Shift4 as their payment software. Interesting software play on the payments industry.

Jason Moser: Well finally met one that most listeners are probably pretty familiar with. May have heard of this company, Mercado Libre. It's what we talked about on occasion here. [laughs] It's not just a marketplace, this really is a Fintech play as well. How does Mercado Libre continue to gain share because it really feels like they have just got everything going in the right direction?

Matt Frankel: They keep building out their ecosystem and it's really impressive. Their profitability really has gotten much better in the past couple of years too. If I'm looking at some of these growth numbers, I'm thinking, what's the slowdown? On both sides of their business, you have the e-commerce platform, merchandise volumes up almost 60% year over year. It's not just inflation because let's be fair, they operate in some countries where inflation is way, Argentina, inflation is over 100% right now.

Jason Moser: That's such a bad deal what we've got going on here right now. [laughs]

Matt Frankel: It puts ours into perspective. But the number of items sold on the platform is up 26% year over year, so it's not just inflation. On the payment side, total payment volume on the Mercado Pago is up over 120% year over year. What's slowdown? If you look at their numbers, you would have no idea that's going on. Their credit business is doing well, Mercado Credito is doing well. Forgive my terrible Spanish accent.

My high school Spanish teacher would be very upset at me right now. But their credit portfolio is growing and performing to expectations. On the bottom line, they're very profitable. It's really rare you find a company growing revenue at almost 70% year over year with great bottom line profitability. They have an 18% operating margin, so it's a powerhouse business. I'm not surprised, it just recently hit a 52 week high. One of my largest investments and I'm sure a lot of people listening and people at the Fool could say the same. People always throw around this is an early stage Blank but this really is like an early stage Amazon, PayPal all rolled into one.

Jason Moser: Sounds familiar Matt. Well, listen, that's a lot of Fintech in a short amount of time. We're going to leave it there. But hey, thank you for making some time for us this week.

Matt Frankel: Thanks for having me. It's always good to get back together with you for a fun episode.

Mary Long: 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. I'm Mary Long. Thanks for listening. We'll see you tomorrow.