Visa (NYSE: V) and Mastercard (NYSE: MA), the two biggest U.S. payment processors in that order, saw their stocks struggle for much of the year’s first nine months.
Investors were concerned that consumer spending would slow, thanks to inflation, lessening the digital transactions that provide the companies’ revenue. And there was worry that artificial intelligence could lessen or eliminate the need for their processing networks. Also on the AI side, there was talk that AI systems could perpetrate tremendous fraud in the networks.
Before examining those issues, it’s useful to know how the processors make their money. There are several revenue sources. Merchants’ banks pay a processing fee to Visa and Mastercard for each transaction (the banks end transfer those fees to their merchants).
Merchants’ banks also get charged based on the volume for their transactions for utilizing the network (again the banks charge that payment to their merchants).
When a card issued in one country is used in another, Visa and Mastercard receive fees from merchants and consumers. Also, the companies sell value-added services. That includes technology, data, security, and consulting solutions — to financial institutions, merchants, and governments.
Client incentive payments bite
One big negative for the companies is client incentives. That includes financial payouts, cash rewards, or fee discounts for to banks, fintechs, and large merchants to secure their business and drive transactions.
Visa’s client incentives soared 21% in quarter ended Sept. 30 to $5.1 billion. Mastercard’s incentives jumped 18% to $6.4 billion.
Getting back to the investor concerns mentioned above, consumer spending hasn’t sagged. While lower-income Americans have indeed suffered from rising prices, the wealthy have continued to buy, especially as the value of their stock holdings has risen. U.S. consumer spending climbed at a 2.5% annualized rate in both the second and third quarters.
Turning to AI, the fears seem overblown, just as they do in many other industries. Visa and Mastercard’s processing systems can’t easily be replaced. Visa has operations in more than 220 countries, handling more than 250 billion transactions every year. Mastercard has about the same country number and more than 175 billion transactions.
Decades of brand recognition and trust have helped the companies thrive around the world. “Replicating a heavily regulated, two‑sided payments network of that scale is extraordinarily difficult, which is why no credible challenger has displaced (Visa and Mastercard), despite decades of attempts,” Mike Smith, head of Allspring’s Growth Equity team, told Barron’s.
Displacement is a tall task
To displace Visa and Mastercard, AI would have to create a network where every player has confidence that their money won’t “disappear into the online ether,” notes Barron’s Teresa Rivas.
And the companies aren’t just sitting around. As you’d expect, they are developing AI capabilities of their own: systems to allow shopping bots to safely use their networks and systems to combat potential fraud from AI platforms.
“It’s amazing how you have a decent business and people assume that the company’s not going to do anything to improve or maintain their competitiveness,” David Ellison, portfolio manager at Hennessy Funds, told Barron’s, speaking specifically about Visa. “Of course they’re going to do that.”
Not surprisingly, Visa and Mastercard posted strong earnings for the Sept. 30 quarter, with Visa’s net revenue up 13% and Mastercard’s up 14%. Both stocks have surged 21% over the past month.
So Mastercard and Visa seem to have good credit at the stock market now.
The author owns Visa and Mastercard shares.
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