Of the Monday morning sessions at ATM, Debit & Prepaid Forum 2009, I was particularly interested in the analysts’ views of the payments sector. The session included perspectives on transaction volumes, impact of consolidation and potential for new M&A activity, and areas the analysts are watching for investment and regulatory changes. On the panel were representatives of Morgan Stanley, J.P.Morgan, Keefe, Bruyette & Woods and the moderator was from Oliver Wyman.
[Editors note: it goes without saying that Glenbrook Partners, LLC is not a licensed investment adviser!]
Generally the panel was positive in terms of expectations of transaction volumes and revenue growth as we move into 2010. Although the US consumer has a higher saving rate, the increase in income projected by economists is expected to drive improvements in payments volumes. Improvements in payments volumes are already being reflected in MasterCard and Visa volumes and foot-traffic in stores. The headwinds the industry has been facing in gas prices and foreign exchange are also expected to normalize. Unemployment is still a key concern.
In terms of investments, banks have been increasing reserves and there are even more requirements to hold reserves going into effect with FAS 166/167. While this may be difficult for banks to increase reserves in the short term (takes affect at the end of this fiscal year) it is a one-time event. As banks relax and draw reserves down this should be reflected in a stronger bottom line.
Examples of areas to watch:
- Prepaid program managers – Investors like the free cash flows generated by these businesses
- Processing – Looking for businesses effectively transforming through platform consolidation and emerging with lower costs and innovative offerings
- Mobile Players – While the analysts are watching these businesses, they still consider them up-starts and niche when it comes to payments
- Card Issuing – despite the ride, credit card assets are lucrative. Watch for capitalization structures and reserves. As the market reaches an inflection point of a strengthening financial position and economy, there may be M&A activity.
- Micro payments and International processors were also mentioned
In the wake of the Credit Card Accountability, Responsibility, and Disclosure Act, Issuers are getting ahead of the changes. The Private label and sub-prime categories are relatively more affected due to risk based re-pricing. The problem will come in the next market downturn where issuers will be unable to reflect the increased risk of default through pricing. The analysts are watching for possible fee income regulation; it has been proposed that fees be “reasonable and proportional to the actual cost to the financial institution.” Just today Senator Chris Dodd proposed legislation targeting overdraft fees (See Payments News).
Those most affected will be issuers using teaser rates as a customer acquisition strategy. American Express Charge card is expected to benefit and increase in attractiveness to frugal consumers and those looking for good rewards. The public attention over overdraft fees may also turn consumers to charge card or prepaid models. Card issuers have many levers to pull to offset any expected lost revenue including product bundling, annual fees, and merchant funding of rewards.
Alternative payments and mobile…
The investment advisers were not concerned about alternative payments as a disruptive technology but rather a compliment to the main players. Their rationale is that it is hard to change consumer behavior and hard to change the merchant point of sale. If a new payment scheme does not have ubiquity, it is hard to compete. Current networks work extremely well for consumers ease of use and for merchants getting paid. The large networks are able to under-price or acquire any serious contenders.
In addition, many alternative payments are using ACH. The ACH system may not be designed with these alternatives in mind. Some niche products have small tickets, no authentication, no rules for chargebacks etc. – growth and scale will push these issues to a point at which they can no longer be ignored. It is worth watching what PayPal can continue to do off eBay.
Mobile phone enhances current payments and can be seen as a new channel and not a disruption. Interestingly in the US the mobile network operators seem not to want to enter mobile payments as processors or underwriters of risk. This may change but it differentiates the mobile payments dynamics in the US market from other countries.
“Why Visa trades at a premium over MasterCard”.
In June 2009 J.P. Morgan North American Equity research put out an analyst report on the Top 10 reasons why Visa trades at a premium to MasterCard. In summary it suggests that the difference comes down to Visa’s escrow fund that provides a fence around corporate litigation risk and the US market debit mix. In addition, Visa has a high mix of issuers with a focus on deposit taking which is also reflected in their debit success. Should, at a future date, there be stronger growth in Europe than the Rest of the World, that might skew valuations back towards MasterCard as Visa Inc. corporate structure excludes Visa Europe.