Better Investment: Visa or MasterCard?

Warren Buffett often talks about "tollbooth" businesses -- those that charge entrance fees on services we can't live without.

No better example exists than Visa (NYSE:V) and MasterCard (NYSE:MA). The business model these two share is beautifully simple: They extract small fees on credit card and debit card purchases for facilitating transactions. Every time you swipe a card with their logos, they get a small cut of the deal. Banks like JPMorgan Chase (NYSE:JPM) provide the actual money for these transactions, swallowing all the risk. They're the ones out in the cold, dangling from the scaffolding, building the bridge; Visa and MasterCard just sit in a heated tollbooth with their hands out, raking in fees on every vehicle that needs to cross. It's a great way to be in business.

Visa and MasterCard both reported full-year 2009 results last week. So let's weigh 'em in, unpack the numbers, and declare a winner.

Keep it simple
When analyzing a credit card processor, it helps to focus on three major metrics:

• Total payment volume -- the dollar amount of card transactions.
• Payment volume broken out by debit and credit segments.
• Total processed transactions.

Why these three? There are two streams of income in the card processing business: One, called service revenue, is based on the dollar amount of transactions. Another, called data processing revenue, is based on the number of transactions. We also need to know if money came from the credit or debit side in order to size up growth potential.

Looking at full-year 2009 growth, here's what you get:

That's a fairly close race, but there are some important differences here:

• Debit is growing rapidly, while credit is slowly shrinking.
• Visa does proportionally more debit business than MasterCard.
• Visa's racking up more transactions (likely because of the debit bias).

So the crowd's cheering for Visa at this point. It's on the right side of the debit-credit showdown, where all the growth is.

Of course, the market isn't blind to this. Consider the long-term earnings-per-share estimates:

Source: Capital IQ, a division of Standard & Poor's.
CAGR = Compound annual growth rate.

Better buy ... or buy at all?
So here's the big question: Should you buy a 20% grower at 22 times earnings, or a 16% grower at 16 times earnings?

Frankly, neither is an obvious buy at today's prices. People use many wonderful words to describe these companies, but "value" typically isn't one of them. Other companies of equal caliber, like Procter & Gamble (NYSE:PG) and Johnson & Johnson (NYSE:JNJ), could be more worthy of your hard-earned money.

But here's my take on the cards: As the economy moves from a debt-fueled disaster toward a culture of saving and sanity, debit growth is sure to keep running laps around credit. And there's more to it than just a change in spending behavior. Debit growth is also fueled by increased social acceptance of using plastic in lieu of cash.

The banks issuing these cards also tend to pick and favor one processor over the other. Bank of America (NYSE:BAC), for example, is a huge issuer of Visa debit cards, while Citigroup (NYSE:C) is a major issuer of MasterCard credit cards. Distribution is skewed bank by bank. That makes it difficult for card processors to steal market share from one another, especially since the banking industry is so heavily concentrated.

So here's the verdict: Since debit's future is quite clearly brighter than credit's, and Visa reigns supreme in the debit world, Visa is where you want to be.

Just wait for a better price.