I don't usually write about the topic of investing, but it is something I enjoy, so I decided to take the jump by sharing some thoughts on MasterCard, one of my favorite companies. Although it's not an obvious technology disruptor, MasterCard is a successful technology company. When it comes to investing, boring can be beautiful. Mastercard is relevant in the context of my blog, where I often write about the digitization of the world.

An investor who invested $10,000 in MasterCard around the time of its IPO in 2006 would have seen that investment grow to $200,000 today. MasterCard has significantly outperformed the S&P 500, since a $10,000 investment in the S&P 500 would have returned less than $20,000 over the same 9.5 year time frame. I was not fortunate enough to buy at the IPO; I only got into MasterCard 18 months ago.

MasterCard, along with its rival Visa, has one of the most lucrative business models I've seen. MasterCard and Visa enjoy a virtual duopoly in payment transaction processing. Unlike other credit card companies like American Express, MasterCard and Visa don't assume any of the credit risk; the customer's bank takes on the risk of its customer not being able to pay the bill, and either the merchant or their bank takes the risk for charges that are fraudulent or unrecoverable. What makes MasterCard and Visa so lucrative is that they simply act as "digital tollbooths" that take a small interchange or "swipe fee" on every credit or debit card transaction that goes through their network, without assuming any of the risk.

When you pay $100 with your MasterCard, MasterCard takes about $2.60 in interchange fees and the retailer collects the remaining $97.40. MasterCard has a net profit margin of an astounding 52%. So of that $2.60, MasterCard gets to keep $1.30. Now consider that MasterCard processes many billions of credit card "swipes" each year, and you start to see the beauty of their business model. Because MasterCard has minimal capital expenses, it is able to generate enormous free cash flows and maintain a pristine balance sheet with virtually no debt. It can then invest the retained profits toward new technology, advertisements, share buybacks, dividends, etc.

Growth opportunity

As someone living in the United States, I take my credit cards for granted and use them to pay for almost everything; at the grocery store, at Starbucks, my utility bills, train and plane tickets, etc. I almost never use cash.

But that is far from the norm; MasterCard cites a global credit card penetration of just 15%. Cash usage has declined to 59.4% in developed markets, while it is still 92.7% in emerging markets. This means that MasterCard is likely to have years of growth ahead, as 85% of global transactions are still cash-based. For example, at present, the Chinese market is dominated by state-backed UnionPay, but China recently opened its domestic transactions to foreign companies like MasterCard. The company claims it is already seeing double-digit annual growth in cross-border credit card transaction volume in China, primarily fueled by e-commerce. Beyond China, the ecommerce market is growing 25% year-over-year globally, opening up even more opportunity. All things considered, I believe MasterCard is poised to continue to see tremendous revenue growth. In addition, MasterCard continues to buy back stock (3-5% of the float per year) which further adds to their earnings-per-share growth.

Possible risks

Technology disruption seems like the biggest risk to MasterCard. While MasterCard and Visa currently play prominent roles in both Apple and Google's digital wallet as the processing "middlemen", that could change. If Apple or Google creates a more secure payment infrastructure, there might be no need for a MasterCard or Visa. Furthermore, technologies like the Blockchain could render companies like MasterCard and other middlemen in the payments value chain obsolete. Merchants are more likely to adopt new technologies if they get some sort of benefit in the form of reduced interchange fees or risk. What better way to reduce fees than cutting out the middleman?

While emerging markets do represent the largest areas for growth for a company like MasterCard, in some countries, it will be extremely difficult to set up the same level of banking infrastructure that the US or Europe has. That is why we're seeing mobile payment technologies like M-PESA take off in Kenya, enabling the easy transfer of cash over an alternative to credit card rails. There is a chance that technologies like M-PESA could leapfrog traditional credit card infrastructure entirely.

There are also some big legal and regulatory risks. Since Visa and MasterCard operate a near-duopoly, they have a lot of government eyes watching them on behalf of merchants. For example, in 2010, the US passed the Durbin Amendment, which forced Visa and MasterCard to lower interchange fees on credit card transactions. Also, both Visa and MasterCard are being investigated for price-fixing and possible collusion in a near $6 billion settlement lawsuit with merchants. Each of these legal and regulatory hurdles could become a significant hit to MasterCard's bottom-line.


Despite these risks, MasterCard isn't going anywhere anytime soon. The strong growth drivers, the relative lack of immediate competitive threats, and their profitable business model make me believe that MasterCard will keep outperforming the market. There are a few things to dislike about MasterCard; at 0.65% the dividend is low and at 30 the price-to-earnings ratio is high. The high price-to-earnings ratio makes MasterCard somewhat risky, as stocks with a premium valuation are more vulnerable to a steep corrections. I think MasterCard is a buy-and-hold, as long you buy into it at the right price point ...

Disclaimer: I'm long MasterCard with a cost basis of $90 per share. Before making an investment in any of the companies mentioned, you should do your own proper due diligence. Any material in this article should be considered general information, and not a formal investment recommendation.


Jacob Redding (not verified):

I agree that Mastercard and Visa aren't going anywhere soon at least not for the next 10-15 years, but unless they innovate they are a dying business model post 15yrs from now. While the 2.5% is easy money now, it's not money a merchant wants to give up and the CC companies are less and less seen as a nice-to-have, but rather as a mandatory or, more appropriately stated, as a commodity in the established markets (U.S, Europe, etc.). Two years ago U.S laws were modified to allow merchants to disclose to customers the fees they pay and to pass them on to customers primarily pushed for by merchants that want more transparency to push those fees down and/or shift others to alternative payment methods. This leads me to believe that electronic currencies are simply commodities in these markets and whichever one has the most penetration with consumers will win (hence all the ads for points, cashback rewards, etc.). However, it will only take an level of market penetration to dethrone them, which Apple Pay and Square are starting to gain traction on (and companies like Level Up are going after).

In the markets that are new to credit card companies very few of these markets truly want to see 2.5% of the currency spent in their country siphoned off to a foreign country and current terms are unfavorable to merchants relative to other options. You're right though in that banking infrastructure is extremely difficult to setup so Mastercard/Visa have an advantage. Mastercard may be seeing double digit growth in China, but that's not hard to do when you have near-zero market penetration (go online in China and try using your mastercard, then try again use your emoji filled cutesy chat application and tell me which one is easier). I suspect we'll see the largest of these alternative payment systems emerging from China and other Asian economies and Africa before they arrive in Europe and the States as those markets are already used to payments method such as squid cards, WeChat, etc. and the States is still trying to figure out what the weird metal chip thing is on their piece of plastic.

In approximately 10-15 years, which is about the length of time it takes to introduce a replacement payment(it took roughly 7 years to introduce the CC chip into American economy) the value proposition of a CC will dwindle as Apple Pay and other competitors begin to make payments easier (level up, square, etc. etc.) and gain the market penetration they need to shift merchants away. The only thing keeping this whole thing alive is the need for an immense amount of capital to truly compete, because it is simply not enough to introduce a new payment method. You have to wait the decade or more for consumer and merchant adoption. Heck, Paypal tried and they have yet to make any true headway into the Visa/Mastercard market. I suspect we'll see more competitors trying to fill in the gap that Paypal could never fill in the next 5ish years and many will be Apple-pay like and driven by devices like Coin, phone, and, potentially, wear-ables.

Then again... maybe it's just too difficult and the CC companies will continue to ride the wave of the infrastructure they built decades ago. After all Paypal couldn't do it, NFC couldn't do it, and Apple pay is struggling for adoption. It's an interesting space to think about and I do think very ripe for true disruption (which to me is going after the 2.5% merchant fee and chopping it down to near 0%)

pilu (not verified):

Many of the transactions that needed credit cards are no longer needed. For example:

- cash on delivery for many, many goods
- purchase of "food cards" where the full money can be utilized to buy or gift foods
- similar "cards" for jewelry, clothes etc
- most importantly many hotels in our part of the world will want "account transfer" - my money from my bank account to their bank account (from desktop or laptop or mobile via net banking)