V and MA: Quantifying Concentration and Disintermediation Risk

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SEE LAST PAGE OF THIS REPORT Howard Mason

FOR IMPORTANT DISCLOSURES 203.901.1635

hmason@ssrllc.com

February 2, 2014

V and MA: Quantifying Concentration and Disintermediation Risk

  • Conversion of the Chase consumer credit portfolio to V, which apparently had not begun in 2013, will represent a 2%+ headwind to global growth for MA in 2014 (and 6-7% headwind to US growth) assuming 80% of the portfolio migrates during the year. In 2013, Chase’s ~$90bn of credit volumes represented 8% of MA’s branded purchase volume of $1.05tn in the US and 3% of the global figure of ~$3tn (see Exhibit below).
  • The Chase conversion means 2014 purchase volume growth for MA will likely be low-single digits in the US and ~10% globally; this can leverage to 11% net revenue growth (as guided) assuming a modest lift from pricing and less-than-10% growth in rebates/incentives. With a 32% tax rate and 3% reduction in stock count, EPS growth of 20% will require expense growth of 3% or less.
  • Network economics are sensitive to large issuers. MA’s other large issuers are C and COF accounting respectively (across credit and debit) for 20% and 11% of US purchase volume; large issuers for V, other than Chase, are BAC and WFC accounting for 18% and 11% of US purchase volume.
  • We separate Chase because its private-processing arrangement with Visa means that some (and, in due course, possibly substantially all) of its volume will not count towards branded purchase totals; this is important because V and MA generate 10-12% more revenues from service fees (based on branded volume) than transaction processing (based on processed volume).
  • We see risk that other issuers (particularly those with large acquiring businesses such as BAC, WFC, and USB) follow Chase’s move towards private-processing; V and MA can be disintermediated even by issuers who do not have large acquiring businesses through BIN routing (where an issuer partners with a merchant-processor, merchant, or merchant consortium such as MCX so that transactions are routed directly based on a Bank Identification Number).
  • BIN-routed transactions cannot benefit from network-level services, such as the detection and prevention of fraud. However, large issuers have fraud risk management to rival the networks; furthermore, if fraud risk is reduced through chip-and-PIN and (for online activity) tokenization, network-level risk management becomes less compelling even for smaller issuers.

Exhibit: 2012 Purchase Volumes by Network and Large Issuer – $bn

Overview

We believe MA stock reacted not so much to an 8 cent EPS miss in Friday’s Q4 report (of which 5-6 cents was due to litigation expense), or even the higher-than-expected figure for client incentives (up 23% over FQ42012), but to guidance for 2014 net revenue growth at the low-end of the long-term performance objective of 11-13% in constant-currency. The reason is the expected migration to Visa of Chase’s credit portfolio which, in 2012, accounted for ~$90bn of branded purchase volumes at MA.

Assuming 2013 growth in purchase volume approximately offset commercial credit volumes (which are not being converted) and based on MA comments that the migration had not yet begun in 2013, Chase’s consumer credit portfolio represented ~8% of MA’s US branded purchase volume of $1.05tn in 2013 and 3% of the global amount of $3.0tn (see Exhibit 1). The timing of the portfolio conversion is uncertain but if 80% of the volumes shift over 2014, MA will report purchase volume growth in the US in the low single-digits and ~10% growth in global purchase volumes. With a “modest contribution” to revenue growth from pricing built into long-term performance objectives (of 11-13% growth in constant-currency net revenues from 2013-2015 and at least 20% EPS growth off a tax-normalized base of $2.14 in 2012), net revenues can grow at 11% in constant-currency (at the low-end of the long-term range as per Q4 guidance) assuming growth in client rebates and incentives is held below 10%.

Exhibit 1: Branded Purchase Volume at MasterCard by Region and Funding Account

Source: Company Reports

If we further assume stock buyback reduces the stock count by near-3% and adopt guidance for a 32% tax-rate (versus 30% in 2013), MA can then deliver 20% growth in EPS to $3.08 by keeping growth in operating expenses to 3% (see Appendix); we ignore the couple of pennies dilution in 2014 from the acquisitions of Provus and Homesend. Revenue growth at the 13% high-end of the long-term performance objective (if, for example, the Chase migration proceeds more slowly than we model) allows 20% EPS growth with an increase in operating expenses of near 9% (the upper bound from Q4 guidance).

Appendix: MasterCard Model

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