Credit card processing networks Visa (V -0.96%) and Mastercard (MA -1.25%) announced bombshell news last week that could significantly affect their businesses. They agreed to settle a lawsuit with merchants, almost 20 years in the making, to lower their swipe fees, the amount they charge merchants for processing credit and debit card transactions. Let's go through the details to see how it could affect investors.
The details of the deal
Visa and Mastercard agreed to lower all of their swipe fees (or interchange rates) by 0.04 percentage point for three years and lower the average rate by 0.07 percentage point for the next five years. The merchants' legal team said this would save their clients $30 billion over that time. Visa and Mastercard together generated about $58 billion in revenue over the trailing 12 months, and losing those fees could make a substantial dent in sales.
Another part of the settlement allows merchants to help shoppers choose the best or cheapest payment option, getting around previous requirements that merchants had to follow to be able to accept Visa and Mastercard. For example, participating merchants are currently required to honor all cards of each network and can't choose to accept certain ones that could end up being cheaper for the merchant.
This could be just the beginning
This isn't the end of the story. Merchants are still worried about the five-year cap, after which the credit card companies can go back to raising rates.
A federal judge denied Visa's and Mastercard's request to finish the litigation here, allowing further cases against them. Several large retailers, including Target, Foot Locker, and Starbucks, say that Visa and Mastercard collude to keep processing rates high, and the retailers are pursuing a separate case against them.
Should investors be worried?
This comes following the news that Capital One is acquiring Discover, the fourth-largest credit card network after Visa, Mastercard, and American Express. Although regulators are concerned about how that could reduce competition, it could also break down Visa's and Mastercard's duopoly and generate more competition.
Visa and Mastercard enjoy dominant, high-margin businesses that generate rising revenue and increasing profit as shoppers spend more money. This is precisely why investors love these businesses, and Visa and Mastercard stocks have both created tremendous shareholder value. These are the kinds of qualities Warren Buffett looks for in a great stock, and his Berkshire Hathaway owns shares of American Express, Visa, Mastercard, and Capital One.
Neither Visa nor Mastercard gave any insight into how the settlement might affect their performance over the next few years. That might be coming in their next quarterly reports.
Both of these companies are likely to be able to absorb the impact of the settlement, but if it indeed saves merchants $30 billion over five years, that works out to $3 billion per year for each company, which is substantial. None of this changes the networks' model, but it could reset the revenue level lower than it is today and lead to slower growth.
Visa and Mastercard have other revenue streams outside of interchange fees, including small-business solutions. But the bulk of their business is interchange fees.
Some experts predict that the five years of temporary relief for merchants give time for market forces to transform the current payment system in the U.S., and that after the five years are over, the landscape could look completely different.
Investors shouldn't be worried -- yet. But this is a major development that could have near-term and long-term repercussions for Visa's and Mastercard's businesses, and investors should keep tabs on how it plays out.
