Mastercard (MA) is pushing insurer ACE Ltd. out of the S&P 500 and pushing General Motors out of the S&P 100.
Yowza.
Showing posts with label Ticker:MA. Show all posts
Showing posts with label Ticker:MA. Show all posts
Thursday, July 10, 2008
Tuesday, July 8, 2008
Cream of the Cards
I've posted on the markets' mispricing of ACAS, and I thought it might be worth looking at a few other companies whose prospects I think are solid and asking whether they may have become bargains during the apparent panic underway in the markets. So here we address Mastercard (MA).
The Payment Industry
Mastercard is in an interesting industry. Financial services are reaching into more countries and are accessible to people on continents where they traditionally have been unavailable. With increases in access to banking will come increased access to payment card products (debit or credit), so there will be enormous growth in non-US cardholders (and users). As cardholding grows, the value of being a participating merchant grows. As users and merchants increase the demand on the card system, the value of having a big fast processing network improves, and the number of transactions one can tax in exchange for the use of the big, fast data centers that make this all work grow. Growth need not all come from abroad, though: trends in the developed world toward online transactions put pressure on vendors to accept convenient payment, and lots of folks have payment cards.
The Payment Industry
Mastercard is in an interesting industry. Financial services are reaching into more countries and are accessible to people on continents where they traditionally have been unavailable. With increases in access to banking will come increased access to payment card products (debit or credit), so there will be enormous growth in non-US cardholders (and users). As cardholding grows, the value of being a participating merchant grows. As users and merchants increase the demand on the card system, the value of having a big fast processing network improves, and the number of transactions one can tax in exchange for the use of the big, fast data centers that make this all work grow. Growth need not all come from abroad, though: trends in the developed world toward online transactions put pressure on vendors to accept convenient payment, and lots of folks have payment cards.
And since revenue is growing faster than expenses, profits will grow faster than revenues. Nice, eh?
Risks Are Opportunities
Mastercard attracted me for several reasons, not the least of which was the simplicity with which its operations can be analyzed. One might look at American Express (AXP) and wonder whether its desire to be a widely-held brand (i.e., pressure for acceptance by vendors) might lead it to unacceptable credit risks, and before the Ameriprise spinoff, L scoffed at investment in AXP under a Peter Lynch thesis.[1] Mastercard is so simple that one need only examine one kind of transaction to understand its business, and one never need worry whether different parts of the business might lead the company off a cliff. (Recent examples of this are easy to think of: Countrywide preferring deals to due diligence, Merrill Lynch preferring investment banking fees to even slight thought to home value risk exposure magnification, and so on.)
So, what's the story with Mastercard?
Mastercard: A Pure Play in Cashless Payment
Mastercard just wants people to swipe cards. (OK, they are branching out: you can now put your card near a non-swipe reader -- oooOOOooo!) Mastercard may acquire transaction processors, but it's just part of the game to increase the portion of per-transaction card fees actually captured by Mastercard. It's silly to say it, but all these things you see Mastercard doing that don't seem to involve pushing cards into your pocket (buying processors, buying technology integrators, etc.) are all designed to achieve performance in a single business: making money off card use. Card use is thus all you need to think about to evaluate Mastercard's business.
If you are a fan of Collins' Good to Great, you will recognize this focused area of specialization as Mastercard's hedgehog concept. Mastercard gets paid by making payment easy. Understanding this is understanding Mastercard.
(You might think about whether Mastercard is in a position to be squeezed out of the market, but since Mastercard is settling antitrust claims with plaintiffs as big as AXP, you are probably safe to conclude Mastercard isn't on the very brink of being crushed. On this topic, though, this article wins "best headline".)
Mastercard isn't a creditor. Mastercard licenses creditors (and folks who want to let you carry gift cards, and folks who want you to debit existing accounts, and whomever else wants a license) the use of the Mastercard logo and, with it, the promise that where the logo appears their customers can make payments hassle-free. If you can't pay your bill, Mastercard doesn't care particularly. The next creditor issuing you a card will pay Mastercard a fee to do so, and if your interest rate is high (or too low) Mastercard knows nothing about it and can't be helped or hurt by it.
Developing Countries?
What's Mastercard doing in China? In China, banking hasn't got the history it enjoys in Korea or Japan -- after all, China was technically communist until the country's constitution was amended in 2004 to recognize a right to private property -- so folks can't, for example, expect a check to be processed, and therefore have no realistic alternative to pay by check. And neither Mastercard nor anyone else sees a stack of greenbacks waiting for the person who makes check processing easy in China. Mastercard is working to make it easy for banks to issue Mastercard products, easy for merchants to accept and get paid through Mastercard products, and easy for users to handle Mastercard products. As financial services reach more and more Chinese, and as Chinese increase their income as the country industrializes, the demand for payment systems and the utility of offering cashless payment will make payment cards an explosive hit.
Explosive? Why?
Mastercard is often cast as an antagonist of merchants trying to get paid -- as are Visa and AmEx and other payment card vendors. To the extent the parties argue how much Mastercard should be paid for processing payments, this is true. But the big picture is exactly the opposite. Card companies want people paying with cards in merchants' stores because they get fees. Merchants want people paying with cards because people who pay with cards are willing to spend more (though there is an argument this isn't generalizeable and that its appearance may be more a "definite maybe" than a fact).
Vendors may grumble about interchange fees, but they want customers and they even more like customers whose ability and willingness to spend money has been enhanced beyond the cash in their pockets. Folks who take off for an ATM don't always come back, and willingness to pay is impacted by the effort to make the payment. Making payment easy is very good for merchants. One easily imagines a reinforcing feedback loop involving increased merchant acceptance and increased customer expectation that cards will be accepted. Since Mastercard's infrastructure costs don't escalate with anything like linearity with card use, an explosion in card use in the developing world can be expected to yield a hurricane of money at Mastercard's headquarters in Purchase, NY.
With built-in inflation protection and currency-protection, and the entirety of China into which to grow,[2] Mastercard is set to make money almost regardless what happens, merely because it's riding a trend -- cashless payments -- that is heading to the moon. It's Mastercard's game to lose. Of course, as AmEx has proved, you can be #3 and still make good, solid money. This isn't a winner-take-all game. In fact, Mastercard-owned transaction processors probably handle quite a bit of non-Mastercard payment processing volume, and definitely keep some processing fees from those transactions. Nice, eh?
Worldwide transaction growth will drive Mastercard results regardless what happens to the US currency, the rise of foreign powers, credit dislocations, or the like. Developing countries, improved communications, online commerce, and the like will all drive payment card use. Mastercard trades at about $240 after previously reaching past $320 in June of 2007. I've bought January 2009 calls with a strike price of 250, and 350. The 350s are a trade idea -- a whim -- but the 250s recently became long-term gains, and as summer spending's effect on Mastercard becomes evident in future quarterly reports I will begin making an orderly exit from both the call positions.
So, is Mastercard underpriced? Mastercard seems to be gaining share and improving its return on its infrastructure while building its brand and gaining plum cardholders ... the likelihood that Mastercard's profit potential is fully appreciated by the markets in this time of apparent panic seems about zilch. The P/E ratio -- that is, the price paid for the earnings delivered -- has tightened from 35 to 25 while Mastercard's business has only improved. The outlook for the future makes one's face screw up trying to estimate forward P/E (that is, the price paid now for the earnings MA will deliver over the next year, as opposed to the earnings you know MA delivered over the last four quarters). Given the growth I expect in Mastercard, and the strong reasons for the growth and the absence of credible threats to that growth, I think investing at a trailing P/E of 25 is a good deal.
I expect to sit on my Mastercard shares ... forever.
======
[1] Peter Lynch's "invest what you have seen works" theory articulated in One Up On Wall Street is a pretty good way to weed out investments you don't understand. It does lead to funny results, though, like mine with Microsoft. AmEx is another example: American Express Bank had to L's knowledge mis-processed so many different checks -- into the wrong account, lost, sent to the wrong AmEx subsidiary, you name it ... some of them six-figure retirement checks L had AmEx process for relatives looking to control their own retirements, and the loss of those checks at the very time they were willing to make investment decisions was a terribly confidence-undermining failure in a financial institution -- that the whole of AmEx was subject to the suspicion it was rife with incompetence and about to rot from within, leading to a customer rebellion. L concluded the only people who'd invest in AXP were those who avoided its services enough to be unaware of their quality. Now that AMP has been spun off, presumably L might consider AXP safe hunting grounds again.
[2] Banking in China is in such condition that one can't expect checks to be processed at all in many places, and I've seen stories about online sales consummated by runners coming to buyers' doors, though virtual currency has also hit the news as a factor in some Chinese commerce. Will travelers trust virtual currency in lieu of trusted payment brands? Who will help Chinese banks connect to vendors who want to accept payment cards? Mastercard's expertise in transactions processing and facilitating card issuance should make card issuance much easier than home-grown solutions likely to be incompatible with the expectations of world travelers.
Risks Are Opportunities
- Suppose inflation devalues money? Transaction sizes promise to swell, and with them size-based fees. Mastercard is a global inflation hedge.
- Suppose a worldwide recession crushes consumers? Transaction size declines in this event, but frequency promises to grow, driving per-transaction charges.
- Suppose the US dollar collapses? The US-dollar value of non-US transaction fees paid to Mastercard in local currencies soars. Mastercard's growing foreign business offers protection against US currency risk.
- Suppose people can't pay their fat card bills? Ahh, that's the beauty of Mastercard -- who cares?
Mastercard attracted me for several reasons, not the least of which was the simplicity with which its operations can be analyzed. One might look at American Express (AXP) and wonder whether its desire to be a widely-held brand (i.e., pressure for acceptance by vendors) might lead it to unacceptable credit risks, and before the Ameriprise spinoff, L scoffed at investment in AXP under a Peter Lynch thesis.[1] Mastercard is so simple that one need only examine one kind of transaction to understand its business, and one never need worry whether different parts of the business might lead the company off a cliff. (Recent examples of this are easy to think of: Countrywide preferring deals to due diligence, Merrill Lynch preferring investment banking fees to even slight thought to home value risk exposure magnification, and so on.)
So, what's the story with Mastercard?
Mastercard: A Pure Play in Cashless Payment
Mastercard just wants people to swipe cards. (OK, they are branching out: you can now put your card near a non-swipe reader -- oooOOOooo!) Mastercard may acquire transaction processors, but it's just part of the game to increase the portion of per-transaction card fees actually captured by Mastercard. It's silly to say it, but all these things you see Mastercard doing that don't seem to involve pushing cards into your pocket (buying processors, buying technology integrators, etc.) are all designed to achieve performance in a single business: making money off card use. Card use is thus all you need to think about to evaluate Mastercard's business.
If you are a fan of Collins' Good to Great, you will recognize this focused area of specialization as Mastercard's hedgehog concept. Mastercard gets paid by making payment easy. Understanding this is understanding Mastercard.
(You might think about whether Mastercard is in a position to be squeezed out of the market, but since Mastercard is settling antitrust claims with plaintiffs as big as AXP, you are probably safe to conclude Mastercard isn't on the very brink of being crushed. On this topic, though, this article wins "best headline".)
Mastercard isn't a creditor. Mastercard licenses creditors (and folks who want to let you carry gift cards, and folks who want you to debit existing accounts, and whomever else wants a license) the use of the Mastercard logo and, with it, the promise that where the logo appears their customers can make payments hassle-free. If you can't pay your bill, Mastercard doesn't care particularly. The next creditor issuing you a card will pay Mastercard a fee to do so, and if your interest rate is high (or too low) Mastercard knows nothing about it and can't be helped or hurt by it.
Developing Countries?
What's Mastercard doing in China? In China, banking hasn't got the history it enjoys in Korea or Japan -- after all, China was technically communist until the country's constitution was amended in 2004 to recognize a right to private property -- so folks can't, for example, expect a check to be processed, and therefore have no realistic alternative to pay by check. And neither Mastercard nor anyone else sees a stack of greenbacks waiting for the person who makes check processing easy in China. Mastercard is working to make it easy for banks to issue Mastercard products, easy for merchants to accept and get paid through Mastercard products, and easy for users to handle Mastercard products. As financial services reach more and more Chinese, and as Chinese increase their income as the country industrializes, the demand for payment systems and the utility of offering cashless payment will make payment cards an explosive hit.
Explosive? Why?
Mastercard is often cast as an antagonist of merchants trying to get paid -- as are Visa and AmEx and other payment card vendors. To the extent the parties argue how much Mastercard should be paid for processing payments, this is true. But the big picture is exactly the opposite. Card companies want people paying with cards in merchants' stores because they get fees. Merchants want people paying with cards because people who pay with cards are willing to spend more (though there is an argument this isn't generalizeable and that its appearance may be more a "definite maybe" than a fact).
Vendors may grumble about interchange fees, but they want customers and they even more like customers whose ability and willingness to spend money has been enhanced beyond the cash in their pockets. Folks who take off for an ATM don't always come back, and willingness to pay is impacted by the effort to make the payment. Making payment easy is very good for merchants. One easily imagines a reinforcing feedback loop involving increased merchant acceptance and increased customer expectation that cards will be accepted. Since Mastercard's infrastructure costs don't escalate with anything like linearity with card use, an explosion in card use in the developing world can be expected to yield a hurricane of money at Mastercard's headquarters in Purchase, NY.
With built-in inflation protection and currency-protection, and the entirety of China into which to grow,[2] Mastercard is set to make money almost regardless what happens, merely because it's riding a trend -- cashless payments -- that is heading to the moon. It's Mastercard's game to lose. Of course, as AmEx has proved, you can be #3 and still make good, solid money. This isn't a winner-take-all game. In fact, Mastercard-owned transaction processors probably handle quite a bit of non-Mastercard payment processing volume, and definitely keep some processing fees from those transactions. Nice, eh?
Worldwide transaction growth will drive Mastercard results regardless what happens to the US currency, the rise of foreign powers, credit dislocations, or the like. Developing countries, improved communications, online commerce, and the like will all drive payment card use. Mastercard trades at about $240 after previously reaching past $320 in June of 2007. I've bought January 2009 calls with a strike price of 250, and 350. The 350s are a trade idea -- a whim -- but the 250s recently became long-term gains, and as summer spending's effect on Mastercard becomes evident in future quarterly reports I will begin making an orderly exit from both the call positions.
So, is Mastercard underpriced? Mastercard seems to be gaining share and improving its return on its infrastructure while building its brand and gaining plum cardholders ... the likelihood that Mastercard's profit potential is fully appreciated by the markets in this time of apparent panic seems about zilch. The P/E ratio -- that is, the price paid for the earnings delivered -- has tightened from 35 to 25 while Mastercard's business has only improved. The outlook for the future makes one's face screw up trying to estimate forward P/E (that is, the price paid now for the earnings MA will deliver over the next year, as opposed to the earnings you know MA delivered over the last four quarters). Given the growth I expect in Mastercard, and the strong reasons for the growth and the absence of credible threats to that growth, I think investing at a trailing P/E of 25 is a good deal.
I expect to sit on my Mastercard shares ... forever.
======
[1] Peter Lynch's "invest what you have seen works" theory articulated in One Up On Wall Street is a pretty good way to weed out investments you don't understand. It does lead to funny results, though, like mine with Microsoft. AmEx is another example: American Express Bank had to L's knowledge mis-processed so many different checks -- into the wrong account, lost, sent to the wrong AmEx subsidiary, you name it ... some of them six-figure retirement checks L had AmEx process for relatives looking to control their own retirements, and the loss of those checks at the very time they were willing to make investment decisions was a terribly confidence-undermining failure in a financial institution -- that the whole of AmEx was subject to the suspicion it was rife with incompetence and about to rot from within, leading to a customer rebellion. L concluded the only people who'd invest in AXP were those who avoided its services enough to be unaware of their quality. Now that AMP has been spun off, presumably L might consider AXP safe hunting grounds again.
[2] Banking in China is in such condition that one can't expect checks to be processed at all in many places, and I've seen stories about online sales consummated by runners coming to buyers' doors, though virtual currency has also hit the news as a factor in some Chinese commerce. Will travelers trust virtual currency in lieu of trusted payment brands? Who will help Chinese banks connect to vendors who want to accept payment cards? Mastercard's expertise in transactions processing and facilitating card issuance should make card issuance much easier than home-grown solutions likely to be incompatible with the expectations of world travelers.
Wednesday, June 25, 2008
Master of Cards
This morning when I read Mastercard (MA) had made a $1.8 billion settlement with American Express (AXP), I assumed that such a big hit would surprise the shortsighted folks who have been looking at MA's quarterly numbers and expecting a trajectory to continue to the moon. (When investors come to expect surprises, there's something seriously amiss. Their behavior stops seeming the rational activity of investors and begins to mirror the folks in line to buy lottery tickets.) The settlement is payable in twelve quarterly installments of $250m each, beginning later this year (the third quarter). Mastercard is taking a current $1b accounting charge.
Both assets and earnings will take a nasty hit, starting soon. Yet, Mastercard as I write is up something like $14 per share in the wake of the settlement announcement. Why?
Let me back up to my original thinking on Mastercard. Mastercard, like Visa (V), does not issue cards. These guys license brands. The organizations -- MA and V -- were not created as publicly-traded corporations. Rather, they were organized by banks to facilitate a bank-run card-issuing scheme that would (a) create a small number of standards adoptable by a large number of banks, so that (b) the banks -- who actually controlled the cooperatives -- would be able to lower costs and increase card issuance and elevate acceptance of their credit products. Remember, banks make their money by lending deposits at higher interest than they pay depositors. Credit cards are a way to help make sure folks are borrowing, and the rates offered on credit cards -- because the loans are unsecured -- are some of the most oppressive rates a person can lawfully be charged. (Talk to me about "payday loan" firms and pawnbrokers, if you like; they play some legal games to seem not to violate laws against illegally high interest, and they make crazy returns doing it.)
The upshot? Banks banded together into cooperatives -- Mastercard and Visa -- to make iteasier to market credit card products, and they did it so that as credit cards became an increasingly significant part of worldwide commerce, the banks would be receiving rather than paying the middleman fees these card networks would support. Not until many years later, after folks had seen what a cash cow American Express' card business was, did folks think about demutualizing a card syndicate (combining under one tradeable entity's roof the brand, the contracts, the processing infrastructure, the personnel with the relevant expertise, and the expected flow of fees from the various licensing and processing operations), and getting the public to bid the value of the resulting assets toward the moon. Rising share prices would lead to benefit to banks who formerly ran the cooperatives: they could sell out and take the cash, or they could show a fattening asset on the books. Without the public offering, the asset would be illiquid, hard to value, and sure to be criticized if touted as a major balance-sheet booster. With folks excited about the valuations found in American Express, there's no question why banks wanted to show the true value of their card brands and processing networks by creating a liquid market for their ownership.[1]
In MA, though, the business isn't credit card debt. When American Express issues a card, it extends credit as it sends out the branded card -- and American Express benefits from interest payments or suffers from defaults. By contrast, MA's business depends only on the cards being issued (ka-ching: issuance fees) and used (ka-ching, ka-ching, and maybe also another ka-ching: per-transaction fees, percentage-of-charge fees, and maybe even fees for acting as the transaction's processor). MA is not a bank. MA was designed not to compete with or control the bank member-owners and thus has no say at all in credit limits, credit decisions, payment terms, etc. MA leaves all that up to banks, who pay MA fees. MA is thus not limited by its lending power or its risk tolerance in its power to issue cards. Personal bankruptcies and slow payment and the like isn't MA's problem -- it's the problem of the bank that issued the card.
If you fear consumer credit problems just don't invest in banks that make consumer loans like credit cards. That's still no reason to avoid MA.
When MA went public and quickly sailed into the high 40s, I had some quick thinking to do. I was, after all, about to leave for a month on business and would have crummy Internet access. First, I thought, the planet only has a few really enormous credit card brands -- cards consumers and merchants will easily recognize, trust, and use. Second, American Express may have superior average credit risks, but (a) growth is limited to American Express' power to find and seduce more good credit risks to its brand, and (b) the network benefit of the Visa/MA credit processing systems worldwide ubiquity makes it easier to sell consumers on a Mastercard than on AmEx. (Eat your heart out, Discover.) Third, you couldn't yet buy Visa so nobody but MA was a pure card play: they were mixes that involve credit risk and the like, and suffered from a smaller base of supporting merchants. (If you can't use the card where you are shopping, you can't use the card.) Fourth -- and this one was the clincher -- the planet is getting more electronically connected, the availability of banking services is increasing worldwide, more commerce is being conducted at distances and at speeds that make cash and checks impractical, and the standard of living for the world is increasing ... which all lead to a major global trend toward electronic payments, the primary beneficiary of which will be established players with the most-available processing networks.
So I bought at 47 early June following Mastercard's public offering.
One of the overhanging risks when I did that was ongoing litigation with American Express. American Express said that Visa and Mastercard colluded with member banks and with each other to exclude American Express from offering cards through the member banks, and damaged American Express' business. Folks were wary of the huge money flowing through Mastercard becoming a potential input in a damages calculation. I had some personal doubt that (a) the US would really hand a big award to an antitrust plaintiff after essentially giving Microsoft a free pass despite obviously violating the law on purpose for essentially the whole of its presence in the operating system market and for sure its whole participation in the browser market, and (b) that American Express, which keeps the whole profit from every transaction by dealing directly with each merchant and each customer, could really articulate a damages model anyone would believe that depended on Visa or Mastercard preventing third-party banks from issuing American Express cards. The only thing I could imagine was that if Visa or Mastercard managed to make merchants not accept American Express, AmEx could successfully describe that the value of its merchant network had been impaired in ways that caused more demand for Mastercard products. However, I never heard a merchant say "I don't take AmEx because Mastercard threatened to pull out" -- I only ever heard them say "I don't take it for orders less than $750 because AmEx charges merchants too damned much." I hadn't been a fan of the bank cartels' handling of the merchants or of small banks or the like, and I sure liked American Express, but I didn't think American Express was really in a position to clobber Mastercard on the damages theory in the news.
Uncertainty, however, is a killer. Folks didn't know how the antitrust litigation with AXP was going to work out, and folks worried about MA's exposure to a whopping verdict. As MA approached its public offering, folks expressed worry that MA's accounting reserves for pending litigation might be inadequate.
The upshot: the lifting of the cloud of antitrust litigation risk from Mastercard, though it is going to eat $1.8 billion in future cash flow, is so reassuring that the public is willing to pay more for the shares knowing the size of Mastercard's loss than it was willing to pay while it could still speculate that the loss might turn out to be trivially small.
My big regret: I oughta have bought more MA at 47!
[1] To understand the importance to financial companies of having not just revenues or accounting profits but demonstrable liquid assets, let me compare the banks after the Mastercard IPO to Amercan Capital Strategies (ACAS). ACAS' valuation of illiquid assets continues to attract derision and scorn even though the company has proven repeatedly, through sales of whole portfolio companies and through fractional shares of its entire portfolio, that its valuations really stand up to scrutiny by third parties negotiating in an arm's-length transaction. The fact that ACAS pulls in significant operating revenues from its illiquid and hard-to-separate business operations hasn't helped the shares resist getting clobbered with the collapse of the financial stocks in the last year -- a collapse from which ACAS, unlike Mastercard, seems to be struggling to shrug off. Not that ACAS is having trouble getting credit (its credit is great), and not that ACAS isn't getting payments from those who own it money (ACAS seems to be great at picking risks, as they're paying like champs), and not that ACAS isn't able to continue its fat dividend (the dividend is rising, and ACAS is making so much money it's still having to accumulate undistributed profits and will probably end up rolling those profits forward in a way that will force ACAS to pay larger dividends down the road in order to maintain its tax status) ... ACAS just has a balance sheet full of illiquid securities and observers just don't believe anything ACAS says about them even when ACAS demonstrates folks pay what ACAS says the stuff is worth by actually making a sale.
Both assets and earnings will take a nasty hit, starting soon. Yet, Mastercard as I write is up something like $14 per share in the wake of the settlement announcement. Why?
Let me back up to my original thinking on Mastercard. Mastercard, like Visa (V), does not issue cards. These guys license brands. The organizations -- MA and V -- were not created as publicly-traded corporations. Rather, they were organized by banks to facilitate a bank-run card-issuing scheme that would (a) create a small number of standards adoptable by a large number of banks, so that (b) the banks -- who actually controlled the cooperatives -- would be able to lower costs and increase card issuance and elevate acceptance of their credit products. Remember, banks make their money by lending deposits at higher interest than they pay depositors. Credit cards are a way to help make sure folks are borrowing, and the rates offered on credit cards -- because the loans are unsecured -- are some of the most oppressive rates a person can lawfully be charged. (Talk to me about "payday loan" firms and pawnbrokers, if you like; they play some legal games to seem not to violate laws against illegally high interest, and they make crazy returns doing it.)
The upshot? Banks banded together into cooperatives -- Mastercard and Visa -- to make iteasier to market credit card products, and they did it so that as credit cards became an increasingly significant part of worldwide commerce, the banks would be receiving rather than paying the middleman fees these card networks would support. Not until many years later, after folks had seen what a cash cow American Express' card business was, did folks think about demutualizing a card syndicate (combining under one tradeable entity's roof the brand, the contracts, the processing infrastructure, the personnel with the relevant expertise, and the expected flow of fees from the various licensing and processing operations), and getting the public to bid the value of the resulting assets toward the moon. Rising share prices would lead to benefit to banks who formerly ran the cooperatives: they could sell out and take the cash, or they could show a fattening asset on the books. Without the public offering, the asset would be illiquid, hard to value, and sure to be criticized if touted as a major balance-sheet booster. With folks excited about the valuations found in American Express, there's no question why banks wanted to show the true value of their card brands and processing networks by creating a liquid market for their ownership.[1]
In MA, though, the business isn't credit card debt. When American Express issues a card, it extends credit as it sends out the branded card -- and American Express benefits from interest payments or suffers from defaults. By contrast, MA's business depends only on the cards being issued (ka-ching: issuance fees) and used (ka-ching, ka-ching, and maybe also another ka-ching: per-transaction fees, percentage-of-charge fees, and maybe even fees for acting as the transaction's processor). MA is not a bank. MA was designed not to compete with or control the bank member-owners and thus has no say at all in credit limits, credit decisions, payment terms, etc. MA leaves all that up to banks, who pay MA fees. MA is thus not limited by its lending power or its risk tolerance in its power to issue cards. Personal bankruptcies and slow payment and the like isn't MA's problem -- it's the problem of the bank that issued the card.
If you fear consumer credit problems just don't invest in banks that make consumer loans like credit cards. That's still no reason to avoid MA.
When MA went public and quickly sailed into the high 40s, I had some quick thinking to do. I was, after all, about to leave for a month on business and would have crummy Internet access. First, I thought, the planet only has a few really enormous credit card brands -- cards consumers and merchants will easily recognize, trust, and use. Second, American Express may have superior average credit risks, but (a) growth is limited to American Express' power to find and seduce more good credit risks to its brand, and (b) the network benefit of the Visa/MA credit processing systems worldwide ubiquity makes it easier to sell consumers on a Mastercard than on AmEx. (Eat your heart out, Discover.) Third, you couldn't yet buy Visa so nobody but MA was a pure card play: they were mixes that involve credit risk and the like, and suffered from a smaller base of supporting merchants. (If you can't use the card where you are shopping, you can't use the card.) Fourth -- and this one was the clincher -- the planet is getting more electronically connected, the availability of banking services is increasing worldwide, more commerce is being conducted at distances and at speeds that make cash and checks impractical, and the standard of living for the world is increasing ... which all lead to a major global trend toward electronic payments, the primary beneficiary of which will be established players with the most-available processing networks.
So I bought at 47 early June following Mastercard's public offering.
One of the overhanging risks when I did that was ongoing litigation with American Express. American Express said that Visa and Mastercard colluded with member banks and with each other to exclude American Express from offering cards through the member banks, and damaged American Express' business. Folks were wary of the huge money flowing through Mastercard becoming a potential input in a damages calculation. I had some personal doubt that (a) the US would really hand a big award to an antitrust plaintiff after essentially giving Microsoft a free pass despite obviously violating the law on purpose for essentially the whole of its presence in the operating system market and for sure its whole participation in the browser market, and (b) that American Express, which keeps the whole profit from every transaction by dealing directly with each merchant and each customer, could really articulate a damages model anyone would believe that depended on Visa or Mastercard preventing third-party banks from issuing American Express cards. The only thing I could imagine was that if Visa or Mastercard managed to make merchants not accept American Express, AmEx could successfully describe that the value of its merchant network had been impaired in ways that caused more demand for Mastercard products. However, I never heard a merchant say "I don't take AmEx because Mastercard threatened to pull out" -- I only ever heard them say "I don't take it for orders less than $750 because AmEx charges merchants too damned much." I hadn't been a fan of the bank cartels' handling of the merchants or of small banks or the like, and I sure liked American Express, but I didn't think American Express was really in a position to clobber Mastercard on the damages theory in the news.
Uncertainty, however, is a killer. Folks didn't know how the antitrust litigation with AXP was going to work out, and folks worried about MA's exposure to a whopping verdict. As MA approached its public offering, folks expressed worry that MA's accounting reserves for pending litigation might be inadequate.
The upshot: the lifting of the cloud of antitrust litigation risk from Mastercard, though it is going to eat $1.8 billion in future cash flow, is so reassuring that the public is willing to pay more for the shares knowing the size of Mastercard's loss than it was willing to pay while it could still speculate that the loss might turn out to be trivially small.
My big regret: I oughta have bought more MA at 47!
[1] To understand the importance to financial companies of having not just revenues or accounting profits but demonstrable liquid assets, let me compare the banks after the Mastercard IPO to Amercan Capital Strategies (ACAS). ACAS' valuation of illiquid assets continues to attract derision and scorn even though the company has proven repeatedly, through sales of whole portfolio companies and through fractional shares of its entire portfolio, that its valuations really stand up to scrutiny by third parties negotiating in an arm's-length transaction. The fact that ACAS pulls in significant operating revenues from its illiquid and hard-to-separate business operations hasn't helped the shares resist getting clobbered with the collapse of the financial stocks in the last year -- a collapse from which ACAS, unlike Mastercard, seems to be struggling to shrug off. Not that ACAS is having trouble getting credit (its credit is great), and not that ACAS isn't getting payments from those who own it money (ACAS seems to be great at picking risks, as they're paying like champs), and not that ACAS isn't able to continue its fat dividend (the dividend is rising, and ACAS is making so much money it's still having to accumulate undistributed profits and will probably end up rolling those profits forward in a way that will force ACAS to pay larger dividends down the road in order to maintain its tax status) ... ACAS just has a balance sheet full of illiquid securities and observers just don't believe anything ACAS says about them even when ACAS demonstrates folks pay what ACAS says the stuff is worth by actually making a sale.
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