I recently took a look at payment processor Visa (V, Financial), as I think the stock is starting to look cheap after recent declines. Following this discussion, I thought it might be interesting to compare the company with Mastercard (MA, Financial), its main competitor in the U.S. market.
Visa and Mastercard are both fighting the same headwinds. The pandemic has had a significant impact on highly lucrative cross-border payment transaction fees, which are three times higher than non-cross-border payments. However, Mastercard is more richly valued than Visa. Is this a sign of more attractive business conditions at Mastercard, or is Visa just as good at a lower price?
Multiple headwinds
As the pandemic continues to affect the world, it is unclear when the critical revenue stream of cross-border transactions will return to growth. Another challenge both Mastercard and Visa face right now is the challenge of competition, particularly with the rise of alternative payment options such as payment apps and site-specific payment platforms. There's also blockchain, which has the potential to cut out the middleman in the payment process.
Competitors like the U.K.-listed cross-border payment processor Wise (LSE:WISE, Financial) are edging in on traditional finance institutions' turf. The company has slashed payment fees for consumers sending payments overseas, lowering fees as volumes increase.
Visa and Mastercard report profit margins of between 60% and 70%, so it is easy to see why competitors might want to gain a share of their market. The thing protecting them right now is, both companies have a scale advantage. Their global footprints would be very difficult to replicate. It would take years and tens of billions of dollars of investment to disrupt the international payment processing market, even if new alternatives are more convenient on a smaller scale.
In many ways, increased competition in the market is a blessing as well as a curse. Competitors may be taking market share away from these incumbents, but they're also fighting each other. As competition in the market increases, companies will have to spend more and more money to market to consumers.
This could work in Mastercard's favor as the group already has an established brand, and it has the scale required to fund ever-increasing marketing spending. Mastercard is also investing heavily in diversifying its business model. It has been quite aggressive in expanding into the cryptocurrency space and recently acquired CipherTrace, a cryptocurrency intelligence company that helps prevent fraud and protect digital assets.
It is also launching a buy now pay later service, offering interest-free consumer financing on behalf of lenders. Put simply, competitors are attacking the company's market share, but the group is fighting back and it has the resources to do so.
Mixed outlook
All in all, I think Mastercard's outlook is mixed. The company is facing more competition, and lucrative cross-border payments have taken a hit. On the other hand, it is expanding into new sectors, and the total volume of cashless payments around the world is rising.
Put all of the above together and I think the company still has a runway for growth in front of it, albeit at the right price. However, I think there needs to be a margin of safety in place before buying this company considering the challenges the business may face over the next couple of years. I don't see anything to meaninfully differentiate it from Visa and earn a higher valuation than its close peer.
Using GuruFocus' discounted cash flow (DCF) calculator, the stock does not look particularly cheap at current levels. Setting a terminal growth rate of 10% per annum, compared to the 10-year average of 17.6%, and a discount rate of 4%, the calculator provides a fair value of $297 per share. That is around 14% below current levels. I used the same terminal growth rate and discount rate for Visa, and this model showed that Visa does have a margin of safety, unlike Mastercard.
Considering the current interest rate environment, one could argue that a lower discount rate is more applicable. Using a discount rate of 3% generates a fair value estimate of $335 per share. That is around the current share price. One could also adjust the terminal growth rate, although this is risky considering the headwinds outlined above. Using a growth rate of 12% and a discount rate of 3% would generate a fair value of $423 per share, but I think that is overly optimistic.
