WHAT VISA DOES
Visa sits at the center of more than half of the world’s credit card transactions, connecting cardholders (and their banks) on one side, with merchants (and their banks) on the other. Because there are thousands of banks, millions of merchants, and billions of consumers, it would be far too complex for every entity to have a direct relationship with every other entity. So Visa acts as a centralized operator, developing technology, maintaining infrastructure, and setting operating standards for all parties.
Consider a small merchant bank in Thailand that wants to enable their clients (i.e., merchants) to accept credit cards from tourists. For a transaction to take place, the Thai bank must have a way of communicating with each tourist’s bank so that the transaction can be approved, and money can be transferred. That means developing software that integrates with every single one of the tourist banks, and every single one of the merchant point of sale systems. There has to be support for hundreds of languages and currencies, all while ensuring compliance with thousands of local laws and regulations. Operating standards must be established so that the banks can settle merchandise returns, cardholder disputes, and fraudulent transactions. And the entire process has to be automatic, real-time, and operate with zero failure or downtime. The truth is, most banks simply don’t have the resources to do this with more than a few other banks—let alone thousands. So Visa does it for them.
Visa’s value proposition is simple: integrate with us, and gain instant access to a network of 3 billion cards, 16,000 banks, and 44 million merchants in 200+ countries and territories.
HOW VISA MAKES MONEY
The beauty of Visa’s business model is that they get paid every time one of their cards are used—a flat fee of $.07, plus 0.11% of the transaction amount (and more for international transactions). So the more dollars that flow through Visa’s network, and the more transactions that they process, the more money they make.
Visa makes money three ways: service fees, data processing fees, and—if the transaction involves banks in two different countries—cross-border fees.
1. SERVICE FEES – To participate in the Visa network (i.e., accept/issue Visa cards), banks pay Visa a small percentage of the total dollar amount of every transaction. So the more a product costs, the more money Visa makes. That makes payment volume—which is the total dollar amount spent on Visa’s network—the primary driver of this revenue source. What’s great about this type of revenue is that it’s a built-in hedge against inflation; if the cost of goods rises, Visa’s revenue automatically rises with it.
In 2018, Visa’s services revenue was $8.9 billion on $8.1 trillion of network spend. That means Visa pockets about 0.11% of every transaction, which is known as the service fee yield.
2. DATA PROCESSING FEES – Visa also earns a fixed/flat fee per transaction for settling transactions and transferring funds between banks. These revenues are based on the total number of transactions made on Visa’s network, regardless of the dollar amount. What’s great about this type of revenue is that it costs Visa about the same to process one million transactions as it does one hundred billion; so each incremental transaction is close to 100% profit.
In 2018, Visa’s data processing revenue was $9 billion, on 124 billion transactions. That works out to $0.07 per transaction.
3. CROSS-BORDER FEES – Visa earns additional revenue for processing cross-border transactions; that is, when the merchant’s bank and cardholder’s bank are in different countries. Because these types of transactions are more complex, require currency conversion, and tend to have a higher rate of fraud, the fees are much higher than those on domestic transactions. The primary driver of this revenue source is the total cross-border dollar amount; however, Visa does not break this number out.
In 2018, Visa’s cross-border revenue was $7.2 billion. The yield is estimated to be around 1%, making it Visa’s highest-yielding and most profitable product—by far.
WHAT MAKES VISA SPECIAL
VISA’S BUSINESS IS A VIRTUOUS CYCLE. As more cardholders spend more money on their Visa cards, more merchants will accept Visa in order to capture those sales. And as the number of merchants who accept Visa grows, consumers are more likely to use it. That translates into an ever-growing amount of dollars and transactions flowing over Visa’s network; and thus, an ever-growing stream of service, data processing, and cross-border revenue.
HIGH OPERATING LEVERAGE. Visa’s business is all about scale. That’s because the company’s fixed costs are high, but the cost of processing a transaction is essentially zero. Said more simply, it takes a big upfront investment in computers, servers, personnel, marketing, and legal fees to run Visa. But those costs don’t increase as volume increases; i.e., they’re “fixed”. So as Visa processes more transactions through their network, profit swells. As a result, the company’s operating margin has increased from 40% to 65%:
And the total expense per transaction has dropped from a dime to a nickel; of which only half of a penny goes to the processing cost. Both trends are likely to continue.
NEW ENTRANTS RELY ON VISA. (and Mastercard) A few years ago, many predicted the payment industry would soon be “disrupted” to the detriment of Visa (and Mastercard). They were half right. Companies like Apple, Google, Amazon, Stripe, Square, PayPal (and PayPal-owned Venmo) did invent novel new ways to make and process payments. But rather than compete head-to-head with Visa and Mastercard, these companies chose to partner instead. Why? Because any would-be competitor would have to invest billions of dollars in networking infrastructure so that transactions can be processed in real-time and with practically zero failures. They would need to establish relationships—one by one—with 16,000 banks worldwide. They’d need to write complex software that works with each of those banks, as well as millions of payment terminals. And they would need to ensure compliance with thousands of financial laws and regulations from over 200 countries. Or they could just partner with Visa.
DOESN’T NEED CAPITAL TO GROW. Since 2010, Visa’s revenue, earnings, and cash flows have grown 11%, 17%, and 22% per year, respectively. What’s remarkable about this growth is that it has been achieved with minimal investment—equity has only increased by about 4% per year, and CapEx (as a percent of revenue) has been flat. So what has Visa done with all that excess cash? They’ve returned it to shareholders. Of the $51 billion Visa has earned since 2010, $49 billion has been paid to shareholders in the form of buybacks and dividends.
HOW VISA CAN KEEP GROWING
After growing payment and transaction volume 10%+ per year (and FCF/S 20%+) for over a decade, it’s hard to imagine Visa has much growth left. But the company is likely to sustain—or even accelerate—their already-high growth rate thanks to five tailwinds:
1. INCREASE IN WORLDWIDE ECONOMIC GROWTH & INFLATION. Visa’s fees are like a royalty on economic growth and spend. So as the economy grows, so does Visa. For most businesses, the downside to economic growth is inflation, which means higher input costs. If the company can’t pass on price increases to its customers, volume (and profitability) shrink. Visa doesn’t have this problem. That’s because they earn a percentage of every transaction—so as things become more expensive, Visa makes more money.
2. CONVERSION OF CASH/CHECK TO CARD/ELECTRONIC. Consumers increasingly prefer using credit cards, debit cards, and electronic forms of payment over cash and check. That’s good news for Visa, since the less cash is used, the more money they make. But even as digital forms of payment have begun to supplant cash, there is still a long way to go. 80% of worldwide transactions and 42% of payment volume (i.e., total dollar spend) are still done in cash. By Visa’s estimate, $17 trillion is still spent on cash and check each year. That’s a big opportunity.
3. GROWTH OF E-COMMERCE. E-commerce spend is growing at 4x the rate of physical retail. This is more good news for Visa because the company captures $0.43 of every dollar spent online versus $0.15 for physical. The reason is simple—you can’t use cash online. So the more purchasing that moves online, the more Visa benefits.
But even though e-commerce has been growing 20% per year (versus 5% for physical retail), there is still a long way to go. Today, only around 13% ($3.4 trillion) of total retail sales occur online, providing Visa another long runway for growth.
4. NEW MARKET SEGMENTS. Visa’s primary segment has always been consumer-to-business (i.e., C2B). But Visa is expanding into new segments (e.g., B2B, P2P, G2C, C2G) where payments have traditionally not been electronic. For example: payments from businesses to suppliers (i.e., B2B) often rely on checks, bank transfers, and invoicing; sending money to a friend (i.e., P2P) is usually done with cash or check; and when governments need to disburse money to citizens (i.e., G2C) for things like disaster relief, medical subsidies, and tax refunds, check or wire transfers are used. Visa believes $30 trillion is spent in these segments, so if they are successful in converting even a tiny fraction of it, it would be a huge boon for the company.
5. VISA EUROPE PRICE INCREASES. In 2016, Visa acquired Visa Europe for $23 billion. Though the two companies shared branding, research, and some operational resources, Visa Europe was a separate company that was collectively owned by its member banks. That meant it wasn’t run as a for-profit business. But it will be now that Visa owns it.
The acquisition of Visa Europe explains the recent dip in the service fee yield and the data processing fee per transaction. Before the acquisition, Visa’s data processing fee per transaction was $.078; following it, it dropped to $.07. And service fee yield—that is the percent of total payment volume that Visa keeps—dropped from 0.13% to 0.11%. If Visa can bring Visa Europe pricing on par with the rest of the company—as is expected—service revenues would increase by about $1.6 billion, and data processing revenues would increase by $900 million. Both would flow straight to operating income.
Here’s what it looks like when we add it all up: 2 – 4% for natural economic growth and inflation; a $17 trillion opportunity for converting cash and check; $3.5 billion annual e-commerce spend (which is growing 20%/yr); a $30 trillion opportunity in new payment segments; and an increase to service fee yield and per transaction data processing fees.
With so many tailwinds, it would not be surprising for Visa’s payment and transaction volume to continue growing around 10% per year.
Visa is a great business. The company has, in effect, a royalty on global economic expansion and consumption. Would-be competitors have chosen to partner with Visa rather than compete head-to-head. And Visa is poised to keep growing double digits thanks to several tailwinds, like the digitization of money, the growth of e-commerce, new market segments, and Visa Europe price increases. And because the business requires very little capital and benefits from high operating leverage, all growth should fall straight to the bottom line.
These are the hallmarks of one of the best businesses on the planet. What that business is worth comes down to assumptions made about payment and transaction volume growth, yields/processing fees, the sustainability of the company’s competitive position, and long-term operating margins.
You can model those assumptions here:
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Source: Vintage Value Investing