Major credit card providers Visa Inc. of San Francisco and MasterCard Inc. of Purchase, N.Y., have a stranglehold on the global payments business that is unlikely to be loosened in the foreseeable future. In fact, both firms should see their earnings and share prices continue to rise at a fast clip.
That’s because the two companies control the digital payments business globally and, as long as they continue to be in the vanguard of innovation, their position is virtually unassailable.

In fact, both the cost and time needed to build the required infrastructure and gain the trust of merchants and card issuers, such as banks, are effective barriers to entry into the credit card business, says Yassen Dimitrov, portfolio manager with GCIC Ltd. in Toronto. In addition, a new entrant would have much higher costs for a considerable time because this is a “very scalable business,” in which costs per transaction drop as volumes rise.

“The beauty of [Visa and MasterCard] is their resilient growth, high operating margins and that they don’t take on credit risk,” says Chris Wain-Lowe, portfolio manager with Portland Investment Counsel Inc. in Burlington, Ont. Rather, the banks that issue the credit cards are the entities that extend the credit.

Visa and MasterCard sailed through the credit crisis with no problem. While there was a reining in of consumer spending in the industrialized world, explains Wain-Lowe, this was more than offset by the shift toward card-based payments from cash and cheques.

That trend is expected to continue. There are more than 30 point-of-sale terminals for every 1,000 people in the U.S. and 15 to 20 in Canada and Britain. However, Germany has only 10, and emerging economies such as Mexico, China, India and Russia have two to four — so there’s lots of potential growth.

Wain-Lowe cites a recent issue of The Nilson Report, a payment-card industry newsletter published in Carpinteria, Calif., which projects that the share of card-based consumer payments in the U.S. will rise to more than 60% of transactions by 2015 from 49% in 2010.

Furthermore, analysts don’t think there’s much risk of Visa or MasterCard being left behind by technological advances; the firms are already working on “contactless” transactions, done either through cards or mobile phones by waving them at terminals.

Contactless cards were introduced in 2005 but are just now “gaining traction,” says Dimitrov, who points to their use in New York City taxis and London’s public-transit system. So far, the cards can be loaded with only relatively small sums of money because of security issues. MasterCard was the first out of the gate with this technology, Dimitrov says, but Visa is catching up.

Mobile-phone transactions were pioneered by telecommunications companies in Africa, says Charles Burbeck, head of global equities with Barclays Bank PLC’s private wealth-management division in London. More Africans, he adds, have a telecom account than have a bank account.

The technology gained further acceptance in September 2011, when Mountain View, Calif.-based Google Inc. launched Google Wallet, which was developed in partnership with MasterCard. Google Wallet enables users to store credit cards, loyalty cards and gift cards on a mobile phone. (Visa now is allowing its contactless card to be loaded into Google Wallet.)

In the meantime, says Dimitrov, Visa is working with leading banks and telecom companies in 20 countries on pilot projects for payments by mobile phone.

But there are other risks. One is merchants offering discounts if customers use debit cards rather than credit cards. This is similar to the discounts already offered for cash payments — and the trend could slow revenue growth significantly for Visa and MasterCard, as fees received from debit payments are lower.

Increasing regulation also could cause problems. The U.S. now is regulating debit card fees. Initially, it was assumed that this move would reduce Visa’s and MasterCard’s revenue. But in the end, says Dimitrov, the drop in overall fees didn’t affect what these firms charge per transaction.

Furthermore, both firms are vulnerable to litigation. MasterCard took an after-tax charge of $495 million in the three months ended Dec. 31, 2011, in anticipation of settling a long-standing case brought by merchants who say high fees violate U.S. anti-trust laws. (All figures are in U.S. dollars.)

Visa also is a plaintiff in this case; but, Dimitrov explains, when Visa went public in 2008, the banks that were the previous owners had agreed to bear any costs from this litigation.

A closer look at the two firms:

> Mastercard Inc.’s European operations could be a drag on revenue, given the recession in Europe’s southern countries and sluggish growth in the northern countries. But the firm will benefit in the longer term, as card usage, especially in Germany, increases.

Of the analysts surveyed by Thomson Reuters Corp.’s First Call, 26 of 35 have a “buy” rating on MasterCard’s stock, with nine rating it a “hold.”

Net income for the year ended Dec. 31, 2011, in which the firm took the litigation charge, was $1.9 billion on revenue of $6.7 billion. Remarkably, that was up from net income of $1.8 billion on revenue of $5.5 billion for the year prior.

> Visa Inc. is a bigger company than its competitor, but it isn’t as global. When Visa went public, its European business wasn’t included, and that segment remains owned by banks. The resulting concentration in the U.S. means Visa will benefit from the expected 2%-2.5% economic growth in the U.S. this year.

Of the 35 analysts surveyed by First Call, 28 gave Visa’s stock a “buy” rating, with the other seven rating it a “hold.”

The only caveat, says Burbeck, is that once investors feel more confident about economic recovery in the U.S. and Europe in the next year, they may see banks as better bets, given the lows to which their share prices have dropped relative to their book values.

Net income was $5.8 billion on revenue of $11.5 billion for the year ended Dec. 31, 2011, vs $5.1 billion on $10.4 billion for the previous year. IE