Like many Americans who shopped at Target (NYSE:TGT) during the holiday season, I recently received a replacement credit card from my bank as part of an effort to prevent fraud from potentially compromised credit card numbers.
For those of you like me, you may have also noticed that your new card includes a gold or silver security chip prominently displayed on the front of the card. While this may appear new to most of us in the US, these chips are actually an additional security feature that has been common place internationally for well over a decade.
Technically, this chip is part of the EMV standard, named for the three companies, Europay, MasterCard, and Visa who developed the standard. It contains the same personal information found in the strip of a standard credit card, but because it uses modern technology – versus the comparatively ancient magnetic tape technology that has been around since the mid-1900s—the data is encrypted and much harder for ne'er-do-wells to access or duplicate. In many cases the chips also provide an additional layer of security by requiring users to enter a PIN each time they pay with the credit card, in the same manner Americans are familiar with from ATM withdrawals and debit card payments.
If this technology can be used to prevent fraud, why hasn't it been widely adapted in the US? Mainly because to date, merchants and banks have believed that the risk associated with the legacy system was not large enough to justify the costs necessary to upgrade existing infrastructure to accept what are known colloquially as "smart" or "chip and PIN" cards. Historically, losses due to credit card fraud have been manageable — only 5 cents per $100 — but increasingly this doesn't reflect the full story.
Large scale data breaches are intensifying the need for better security
Hacking incidents like those at Target and Neiman Marcus are occurring on such a large scale that they change the playing field. Besides the direct impact of huge numbers of stolen credit cards flooding the black market (in Target's case, upwards of 70 million accounts were compromised), the resulting negative press and brand damage could result in reduced sales that are orders of magnitude larger than the losses from traditional fraud. In Target's case, they have already said that as a result of the breach, they expect same store sales could be negatively affected by 2%-6% -- which in real money terms could be upwards of a billion dollars forgone.
Even before this most recent batch of incidents, MasterCard and Visa recently mandated an adoption timeline for EMV that would require retailers and banks to upgrade by October 2015 or else face increased liability exposure for using older, less secure systems. Taken together with the wake-up call offered by the relentless press coverage of the Target incident, it appears that the impetus to finally push the US companies to adopt modern payment security systems may have arrived.
Verifone and NCR could be Foolish possibilities for your portfolio
How can you position you portfolio to benefit from this coming trend? Look toward companies like VeriFone (NYSE:PAY) and NCR (NYSE:NCR). They provide the point-of-sale (POS) and ATM systems used at the vast majority of retailers and banks that currently accept plastic. For the time being, most "smart" cards that include the "new" EMV chip still also include a magnetic strip that works with existing equipment. However, for the new standard to be truly effective the strip will need to be eliminated and this means that point of sale (POS) terminals used to read the cards must be upgraded to new ones. New POS systems can offer other benefits as well, like being able to accept contactless payment via NFC devices such as many modern mobile phones.
VeriFone in particular may be a good way to play this trend over the next 12-18 months. The stock has showed signs of a technical breakout over the last few weeks after underperforming in 2013. Expectations are still low after several years of issues concerning historical accounting errors and questionable acquisitions. However, with new management in place that is focused on recapturing lost device market share, there could be room to the upside on the stock, as noted by JPMorgan who on Tuesday upgraded the stock from neutral to overweight.