Invest at your own risk; this is not financial advice! This is not a recommendation to buy or sell any securities discussed in the article.
Intro
Disclaimer: Mastercard will release its earnings tomorrow, the 29th of January.
This company is no unknown company to you. I am sure about it. I am also sure that you are either a user or you will know many people who are users of Mastercards.
Together with Visa and American Express, Mastercard forms the triumvirate of transaction processing. companies A short history lesson: A triumvirate is a political institution ruled or dominated by three individuals, known as triumvirs. Some famous ones include the first Roman triumvirate of Julius Caesar, Pompey the Great, and Marcus Licinius Crassus, and the second Roman triumvirate of Octavian (you know him as Caesar Augustus), Mark Antony, and Lepidus.
Talking about American Express: I published my deep dive in August 2023 when American Express was trading at $165. Today we are at $362, a nice +120%. I hope you were part of the journey and enjoyed the nice gains. You will find the original deep dive here:
Don’t forget to read my recent articles on what is going on with software stocks
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and my very popular Adobe article
What does it do?
A very simple way to describe Mastercard is a digital toll booth for payment transactions. Companies pay Mastercard a lot of money to use its payment network. And just like any good toll booth, there is no proper way around it. So you just pay your fee and move on.
That’s how Mastercard describes itself in the annual report:
Mastercard is a technology company in the global payments industry. We connect consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide by enabling electronic payments and making those payment transactions secure, simple, smart and accessible. We make payments easier and more efficient by providing a wide range of payment solutions and services using our family of well-known and trusted brands, including Mastercard®, Maestro® and Cirrus®. We operate a payments network that provides choice and flexibility for consumers, merchants and our customers. Through our unique and proprietary global payments network, we switch (authorize, clear and settle) payment transactions. We have additional payments capabilities that include automated clearing house (“ACH”) transactions (both batch and real-time account-based payments). Using these capabilities, we offer consumer and commercial payment products, capture new payment flows and provide services and solutions. These services and solutions include, among others, security solutions, consumer acquisition and engagement services, and business and market insights, all of which draw on our principled and responsible use of secure data. Our capabilities strengthen, reinforce and complement each other and are fundamentally interdependent.
Mastercard provides the infrastructure to facilitate the switching of transactions and permit account holders to use the products at more than 150 million acceptance locations and 250 million digital access points. More than 150 currencies and 220 countries and territories are supported. Fun fact: According to the UN, there are 193 countries. Mastercard is literally everywhere, and on top of that, a bit more.
The payment network consists of four players: The account holder (the person that holds a card), the issuer (that is, the account holder’s financial institution, a bank), the merchant (e.g., a shop), and the acquirer (the merchant’s financial institution).
Very important: Mastercard itself does not issue any cards. That is purely done by the issuer, hence the name. Mastercard states this also very clearly in their annual report:
Mastercard is not a financial institution. We do not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers (the account holders’ financial institutions), or establish the rates charged by acquirers (the merchants’ financial institutions) in connection with merchants’ acceptance of our products. In most cases, account holder relationships belong to, and are managed by, our customers.
This also means that Mastercard does not bear any credit risk. The credit risk lies fully with the issuers.
A typical transaction could be you buying flowers for your partner (since you are a very attentive fellow) and paying with your Mastercard. Your issuer authorizes the transaction, and the issuer then pays the acquirer (the flower’s shop bank) the amount minus any fees. Your funds then get transferred to the merchant.
The payment architecture of Mastercard is global and enables cross-border transactions just as it does local transactions. It is based on a peer to peer strucutre and, via intelligent routing plus services such as fraud scoring and tokeniaztion it is able to complete transactions in real time. Needless to say, it works 24/7. With a multi layerd appraoch, Mastercard does everything to protect its global payment system and prevent cyber attacks and
What are the products?
Mastercard splits its business into Payment Network and Value-Added Services & Solutions. While the revenues from the Payment Network Segment are larger in absolute terms, the Value-Added Services & Solutions are growing at a faster rate.
Let’s have a look at both segments in more detail:
Payment Network
The payment network is where it all began and the engine of the business. Without the payment network, there is no Mastercard. The beauty of the network: The larger it gets, the more benefits it offers. It is a self-reinforcing mechanism. Mastercard makes money based on network transaction fees. The more money that flows through the network, the higher the fees for Mastercard. This metric is called Gross Dollar Volume (GDV).
In the 3rd quarter alone, Mastercard did $2,747 billion (!) in Gross Dollar Volume. The split between credit and debit/prepaid cards is almost even (46% vs 54%), while the split between pure domestic US (30%) and the rest of the world (70%) is more unevenly distributed. The great thing about cross-border business is that it entails higher fees for Mastercard.
The number of switched transactions reached 45.4 billion (!) in the third quarter alone, and 3,637 million cards were outstanding. With the world's population being around 8 billion people, that means that statistically, one in two people would have a Mastercard Card.
Value-Added Services & Solutions
The second segment delves further into a software- and data-driven model. Products in this segment include fraud and risk platforms, tokenization and authentication tools, loyalty and engagement products, data analytics and consulting, as well as digital and authentication tools for banks and merchants.
All of these solutions build upon the payment network and make the payment network stronger and better. This segment is also less cyclical than the payment network.
The Value-Added Services & Solutions fall into four main categories:
Risk, Identity, and Fraud Solutions: As the name indicates, these are all based around protecting the network. Key points are decision intelligence with the help of an AI-based fraud scoring system, behavioral biometrics, identity checks, cyber risk scoring, and data breach services.
Data & Services (D&S): The data analytics and consulting arm of Mastercard. Merchants get access to benchmarks, insights into consumer spending, geography, and sector forecasting. Another important part is the loyalty and engagement platform.
Open Banking & Account-to-Account (A2A) Services: This is the whole non-card business. Mastercard built this up to become more independent from the pure card business and offers products like open banking connectivity APIs and payment initiation services.
Processing & Managed Services Beyond Cards: Mastercard made the smart move to tackle adjacent businesses. These include real-time payment systems, government disbursement systems, transit and mobility solutions
What about competitors?
Visa is the archenemy of Mastercard and the by far biggest competitor. The business models are strikingly similar. Needless to say, Visa is also a fantastic company. Just look at their close alignment in terms of revenue development.
American Express is the follow-up to these two giants, but American Express differs in the fact that it is both the network but aso the bank. American Express focuses more on high spending customers, whereas Visa and Mastercard are almost universally accepted.
How is the business going?
Mastercard is boring. Boring in the sense that business almost always goes great. There is no big surprise. And that is exactly what makes Mastercard a fantastic company. It just marches along without any obstacles. There are just not that many competitors out there, and Mastercard is deeply entrenched with banks and merchants. A company that does so well can also afford to have some of the most boring slides of any quarterly presentations. See below:
An additional benefit of skimming the top of the total transaction is the built-in inflation protection. If inflation rises, so does the dollar amount of cleared transactions and therefore the take of Mastercard. Fantastic indeed.
Are there any risks? Isn’t crypto a major threat?
Well, that is what many crypto die-hard fans want you to believe. So far crpyto has relatively little (read close to nothing) to show in terms of an alternative to the big boys. The idea of DeFi (Decentralized Finance) was great, but so far the results have been bleak.
Until there is a major breakthrough, change in customer behavior, or any other sort of miracle happening, Mastercard, Visa, and American Express will dominate the payment processing industry. Period.
Regulatory is the largest risk, as you can see in the countless court cases that Visa and Mastercard face. So far, regulators have not dared to tighten the screws on these two giants. I also doubt that the US government would seriously threaten two of its crown jewels in terms of businesses.
In terms of FinTechs, we should not forget Apple and Google Play. Both companies are partners today and build up their solutions on top of the Mastercard network. Knowing them, it is not a far-fetched thought that they might eventually introduce their own network.
Lastly, if we all went back to paying in cash or with pebbles and seashells, Mastercard would face serious trouble. I’m just kidding; more and more transactions will move to the digital realm.
What about the Financials?
The financials of Mastercard are a beauty. Revenue has been growing at a CAGR of 12.9% per year since 2015.
Operating Profit has grown even faster at a CAGR of 13.8% since 2015. The revenues keep growing faster than the operating expenses. A sign of a fantastic network in effect. Each additional transaction in the network comes at close to no cost.
The third chart I want to highlight: Net income (this is what is left over for the owner = potentially you). The largest deductions from operating profit are taxes, interest expenses, and legal settlements. Legal settlements, you might wonder: Yes, Mastercard paid every single year except 2019 multi-million dollar legal settlements.
These arise from antitrust cases and the network rules that Mastercard enforces. These legal settlements show that the business practice of Visa and Mastercard are fantastic for themself but awful for new competitors. This is fantastic news for all shareholders.
Net income is growing as well, and the CAGR is yet again even higher at 14.5%. To illustrate the beauty of compounding: 14.5% does not sound that much, but it turns a net income of $3,808 million into $14,250 in just 10 years.
And here comes the icing on the cake: Earnings per share grew even faster than net income at 17.1% vs 14.5%. The reason is not magic; it is share buybacks
Mastercard keeps buying back shares. The number of outstanding shares declined from 1,137 million in 2015 to 912 million. This reduction of 20% fuels the increase in earnings per share (EPS).
Regarding the balance sheet, Cash and cash equivalents stand at $10.6 billion vs debt of $19 billion, resulting in net debt of $8.4 billion. Given the large net income of $14.2 billion, I do not worry about the net debt one bit.
Free Cash flow is almost the same as operating cash flow, since Mastercard operates a very asset-light business. The capex is almost negligible compared to the high cash flows.
Now that we all agree that Mastercard is one of the very best companies, we come to the second part of investing: Buying great companies at the right price.
Would you buy it now?
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