Credit Card Processing Services For Small Business – Currently Berkshire Hathaway (BRK.B) (BRK.A), in other words Warren Buffett, holds Mastercard (MA), Visa (V) and American Express (AXP) in his portfolio. What is so tempting for companies to seek these payouts that the best investor alive keeps three companies in the sector? To answer that question, we first need to understand how the entire industry works.
Many companies often misinterpret payment requests as banks or financial institutions. However, these salary-seeking companies are more like technology companies than financial companies.
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“Visa is a global payments technology company that connects consumers and merchants … (providing) secure and reliable electronic payments. We enable global commerce by transferring value and information between these participants.” (Visa 10-K).
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As Visa states in its annual report, credit card processing companies act as conduits between consumers, merchants and financial companies. They generate revenue by charging various parties in the transaction a small fee for providing processing services and payment-related products. This unique business model allows credit card companies to earn recurring income without bearing credit risk.
Service Revenue Earnings for services provided to support customers in using the company’s products. Data processing revenue Earnings for authorization, removal, settlement and other maintenance services that facilitate the processing of transactions and information between customers. International Transaction Revenue Somewhere to process cross-border transactions and currency conversion activities. Other income License fees, account holder services, etc. Click to enlarge
In other words, when we pay a card with our credit card, the card processing company earns a small amount of money with no risk.
The industry still has huge potential for growth. The world is now moving towards a cashless society. More and more countries like India are withdrawing their higher denomination notes in an effort to fight corruption and make transactions easier. As technology continues to improve, with the increasing acceptance of electronic payments and the increase in online transactions, the card payment system will become ubiquitous and therefore increase the pie for the credit card processing industry as a whole.
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The sector itself has a strong advantage because the costs of entry into the industry are very high and it is unlikely that a new leading player will emerge or dominate the market. There are currently six major players in the market according to Visa’s annual report, namely Visa Inc., Mastercard, American Express, JCB, Discover / Diners Club (DFS) and UnionPay.
Visa Inc. MasterCard American Express JCB Discovery / Diner Club Club Payment volume ($ b) 6,843 $ 3,360 $ 1,028 $ 200 $ 144 Total volume ($ b) 9,905 $ 4,564 $ 1,040 $ 154 Total transactions (B) 148.2. 69.2 expenditures. Click to enlarge
* UnionPay is not included in this table because it primarily operates in China and is not listed. So we are not sure about his knowledge. (Visa 10-K)
Not all card processing companies have the same sources of income. If we take a closer look at each company’s annual report, we see that Visa and Mastercard’s revenue is 100% risk-free, these companies generate all of their revenue from interest-free sources and do not rely on credit card interest income. users, earn all of their revenue as a payment service provider. On the other hand, American Express and Discover Financial are also card issuers or card processing companies. Both earn interest income. In 2016, 82% of American Express’s revenue came from risk-free processing sources, while Discover Financial generated only 21% of its net revenue from non-interest income. Although dependence on interest income seems insignificant in a prosperous period, such a difference in income structure can have a big impact when a black swan appears and reduces liquidity. Companies that rely heavily on interest payments may have difficulty receiving interest payments and suffer a large drop in revenue, which in itself represents a liquidity risk. As Benjamin Graham said: “An investment operation is one that promises security of principal and a corresponding return” (The Intelligent Investor). Therefore, we believe that Discover Financial is not a good investment because its business model does not give the company a moat in a bear market.
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In the long run, the entire industry will prosper, but we, as small investors, do not have billions of dollars to buy shares of all of them. Therefore, we need to distinguish which companies give us the best opportunity for investment and security of principal while giving us sufficient returns in the long run. Of the five companies mentioned above, Visa, Mastercard and American Express are considered a safe bet for the diligent investor when the market is in turmoil.
As mentioned above, the credit card processing industry itself already has a moat with a high barrier to entry and provides a unique service that cannot be easily replicated. Of the total transactions, Visa and Mastercard process 91.2% of all transactions (excluding UnionPay as their information) with 100% risk-free revenue, providing additional support to the two companies within an already strong industry. Since American Express has a unique business model and market position, we will write an additional article about the company itself, but it will not be included in the following comparison.
As shown in the charts above, both companies’ revenues have grown steadily over the past four years, with Visa consistently ahead of Mastercard. Both have shown healthy revenue growth (Mastercard’s revenue grew just 2% in 2015 due to currency fluctuations. It would have been 8% currency-adjusted) while maintaining competitive gross margins. Although Mastercard is growing faster than Visa in terms of revenue, the gap between the two companies is widening as Visa appears to be more efficient at converting its revenue into gross profit. (Gross profit margin of Visa decreased in 2016 due to the acquisition of Visa Europe *)
Both companies spent a huge amount of money on incentives to attract and retain customers in 2016. Visa spent ~$3.4 billion while Mastercard spent ~$4.8 billion. This shows increasing competition within the industry to retain and attract customers, but it is also beneficial as it increases the entry barrier for other companies.
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Increased global regulation of the payment industry may affect the profitability of card companies. Visa and Mastercard are the first to list regulatory risks in their risk segment. For example, both companies mentioned that foreign exchange rates are subject to regulatory activity and thus limited the companies’ ability to set these rates. (MA 10-K)
Other risks cited by both companies include increased competition within the industry for clients and technology and information security.
The credit card payment industry is a profitable industry with a strong moat, strong pricing power, great potential and a high barrier to entry. These qualities make it a perfect industry for long-term investment. Of the big 5 companies, we see that Visa, Mastercard and American Express have the best investment potential. We will write a separate report for each of the three companies. However, investing in the industry is not exactly watertight. Within the industry, competition among companies to acquire and retain customers is increasingly fierce, and increased regulation could disrupt the highly profitable industry.
Our goal here is to see through the facade of stories and understand how the world really works and invest in fact-based information
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