An ‘amazing opportunity’ that you ‘can’t really acquire on the Australian market’. That’s how Magellan’s Dom Giuliano introduced Visa and Mastercard in what I thought was the best presentation of our Melbourne and Sydney roadshows.
There are two companies set to benefit enormously from ‘a fundamental secular change that is occurring around the world’, Dom explained, and those two companies are Visa (NYSE:V) and Mastercard (NYSE:MA).
The way that we spend money has transitioned over the last couple of decades, and will continue to transition over the next couple of decades, from cash and cheque towards electronic payments. We increasingly pull pieces of plastic to conduct our lives.
The tailwinds are indeed irrefutable and the consistent direction of those winds unalterable. Cash is on the way out, electronic is on the way in. Even my own life, new technologies such as Paywave and PayPass mean less and less cash withdrawals. And there really are decades of growth ahead. ‘Even in developed economies like Germany, Japan and Italy,’ Dom told us, ‘almost 70-80% of transactions are still cash and cheque.’ ‘In emerging markets, 95% of transactions are cash and cheque.’
Industry growth doesn’t mean shareholder growth, of course. Just ask any renewable energy investor over the past decade. But there are only a few companies at the centre of the global electronic payments system, their moats are extremely deep and wide and they are all profiting handsomely. Both Visa and Mastercard have more than doubled earnings per share in the past four years. Imagine what might happen if the world economy grows?
The network effects in this industry have been insurmountable for new competitors. I can hand a piece of plastic to a Zambian fishing camp operator, the system checks you have enough cash or credit in an Australian bank account and then enables the transfer of cash from an Australian bank to a Zambian bank. It’s a nifty piece of technology. There is no point the fishing camp having a system that doesn’t accept Australian credit cards. And there’s no use to me of a card that I can’t use in Zambia.
The more potential customers that are on a network, the more useful it is to merchants. The more merchants are on a network, the more appealing that network is for consumers. This circularity naturally leads to a few dominant global players. In fact, if it weren’t for competition concerns around the world, there would likely only be one.
There is, however, one small corner of the world that wants to upset this cosy oligopoly. And assisting their cause is that other inexorable trend taking place in the world: the rise and rise of the internet.
Silicon Valley catches Bitcoin fever was the headline in last weekend’s Financial Times. And whilst nominally about the one virtual currency that is currently flavour of the month, the most interesting part of the article referrenced the general Silicon Valley excitement about the potential for a completely new financial system:
Prominent investors who have been drawn to the field include Jim Breyer, a partner at Accel and early backer of Facebook, as well as Google’s venture capital arm, which has invested in Ripple and Buttercoin, a Bitcoin exchange.
Bitcoin’s tech industry backers argue that the shared protocols and common technology standards on which it is based echo the open technologies that lie at the heart of the internet. That could make it the foundation for a low-cost, standards-based financial system independent of the traditional banking industry.
“It reminds me of the internet protocols in the mid-1990s,” said Mr Breyer, who is also a director of retailer Walmart. Bitcoin was an “enormous ecommerce opportunity” for merchants, because it could greatly reduce transactions costs and make it easier to buy online, said Mr Breyer, who contributed to a $9m investment in Circle – the biggest first-round financing for a payments start-up, according to the company.” [Emphasis added]
A low-cost financial system independent of the traditional banking industry. That’s not something you want to hear if you are an owner of Visa or Mastercard. If Silicon Valley succeeds, it’s going to be at a dramatic cost to these two companies.
It is a big if, of course. The opportunity is so lucrative and sought after precisely because the existing infrastructure is so difficult to replicate.
But think about this for a moment. Payment system infrastructure is so difficult to replicate because all of the merchants, all of the banks and all of the customers are already connected to it. Know any other piece of infrastructure that all of these players are already connected to?
Of course. And that’s why the opportunity is so exciting. The internet provides all of the building blocks you need to bypass the existing payment networks. The more we are connected to that network every second of our lives, the more powerful that network becomes.
The first battleground is going to be for online payments but with mobile smart phones proliferating, there is no reason a successful online system can migrate to bricks and mortar retailing as well. You won’t hear us (or any other merchants) complaining. Intelligent Investor pays more than $30k per annum in merchant fees – any innovation that reduces it will be encouraged.
What about the impact on the existing payment network providers? Don’t expect an overnight revolution, I expect they will still be major players in 10 and 15 years time. But both stocks trade on price-earnings multiples in excess of 25 times. Any innovation that just impedes their growth is going to harm today’s investor. And there’s the smaller but real risk of a dramatic upheaval.
The internet was included in Guiliano factors driving the secular shift to a cashless society: “It is being encouraged and supported …. by the internet and ecommerce which, by definition, you have to use electronic means of payments”. No argument there. I’m just not sure you’ll have to use Visa and Mastercard.
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