The Collateral Plays on EMV – FIS, VNTV, NCR, NXPI
“It is very clear that card issuers like Capital One need to have our US customer base by the latter part of 2015 on a chip basis ….. but I have a feeling by the time we have all invested in chip and PIN it may have passed its prime” Richard Fairbank, CEO of Capital One, May 29th 2014
We believe investors are under-estimating the pace of EMV adoption and that, instead of the “gradual grind” reflected in consensus and based on guidance from small issuers and providers such as NXPI, large issuers will have migrated customers to chip cards by end-2015. The reason is that fraud tends to concentrate around weak-spots, and issuers will not risk being disadvantaged by high fraud costs as the last mag-stripe swiping.
- While, under network rules, fraud risk on EMV-transactions will be borne by merchants if they are not EMV-compliant by October 2015, most large merchants already are. Furthermore, re-terminalization will accelerate ahead of the October deadline so that total penetration of EMV-compliant hardware, currently 20-30% of the base of ~12mm terminals, increases to 50%+.
Rapid EMV adoption will create upside surprise at: third-party card issuers (such as FIS and VNTV); suppliers of EMV-compliant chips (such as NXPI); and acquirers (such as VNTV) able to take advantage of the retailer focus on payments security (following the Target breach last November) to sell an integrated solution including not only EMV but also tokenization and encryption of card credentials. The scale of card reissuance is large: there are presently only ~8 million US chip-cards in circulation vs. 550mm total credit cards and 590mm total debit cards.
- In addition, the transition to EMV will catalyze a share-shift from debit running over signature networks to debit running either over PIN networks or directly routed from acquiring-processor to issuer based on the bank identification number or BIN. Obviously this is true for PIN-authenticated transactions (on chip-and-PIN cards) but is also true for PINless transactions (i.e. those transactions below the threshold, often $50 and even on a signature-card, where no authentication is required). FIS and VNTV will benefit through their ownership of the NYCE and Jeannie PIN debit networks respectively, and because the access to funding accounts arising from their issuer-processing businesses enables direct BIN routing.
While there is potential upside for PAY on the terminal side, particularly in the hospitality segment where there are ~3 million terminals and where EMV will require the replacement of existing infrastructure with customer-facing terminals, we prefer NCR as a play on the EMV-related ATM upgrade cycle. We are early since the deadline for fraud liability-shift on ATMs is October 2016 (vs. October 2015 for POS terminals). However, we expect the ATM refresh-cycle to anticipate this given bank initiatives to cut teller-staffing through “smart” (and, to NCR, high-margin) ATMs providing functionality above cash withdrawal (including deposit acceptance, check-cashing, bill-exchange and remote-teller access) and integrating with digital and mobile services via a single platform to capture customer activity.