We all know Visa. Many of us use it as consumers. But is it an attractive business for investors? Is the company growing? Is it adapting to new technology? We believe it is – particularly now. As always, our thesis revolves around the quality of the business and our quality criteria boils down to four things – what the Trimark Global Equities team calls our FORS approach.
What does Visa do?
With more than 40% of global purchases1 occurring on the Visa network, the company operates the largest consumer payment network in the world. In comparison, Mastercard, its next-largest competitor, holds a 27% market share1. Visa generates revenue by charging fees to its customers (the issuers and merchants) based on transaction amounts and the number of transactions.
The network is “open loop”, which means it licenses the Visa brand to financial institutions that issue and market credit and debit cards. Visa does not underwrite any consumer credit and does not bear the resulting risk. It also offers debit cards, Internet payment systems, value-storing smart cards and traveller’s cheques.
FORS: Is it a high-quality company?
To answer this question, we focus on the four key criteria below, which is our FORS approach:
Free cash flow
Over the past ten years, Visa’s free cash flow conversion rates averaged close to 90%.2 The shortfall in free cash flow relative to earnings is attributable to periodic changes in Visa’s networking capital. Specifically, in years when Visa acquires new issuer accounts or signs up new merchants (such as the 2013 deal with JP Morgan), the company’s receivables and other current assets often increase relative to payables, creating a temporary shortfall in cash flow versus earnings.
Visa’s organic revenue growth has averaged more than 10% per year since 20082, and the growth has been accompanied by operating margin expansion. Revenue growth is driven by a combination of:
- Consumer transaction volumes
- New customer wins
- Increases in cross border transactions among developed countries
There is also scope for Visa to improve its profitability further. The company announced plans to purchase Visa Europe from a consortium of European banks. Visa Europe became independent of Visa in 2007 – the European division had been operated as a cost centre by its previous owners and through the integration of IT systems and back office processes, the profitability gap between Visa and Visa Europe is expected to narrow after the purchase.
In addition, structural long-term growth drivers include:
- Increase in e-commerce transactions
- Rising mobile payments
- Electronic payment penetration in emerging markets (where a majority of transactions are still settled in cash)3
Returns on capital
Over the past ten years, Visa has generated returns on tangible invested capital in excess of 20%.4 The company’s high operating margins were partially offset by the need to invest in network infrastructure and business systems, and by working capital fluctuations from new customer acquisitions. The 20% plus returns on tangible capital remain protected by the firm’s sustainable competitive advantage, as outlined below.
Sustainable competitive advantage
The competitive “moat” around Visa is its dominant position in the payment industry. It is the most widely accepted payment network by merchants and cardholders. As mentioned, payments through the Visa network account for nearly 40% of global transactions1 and the broad adoption of its authorization, processing and settlement services creates a network effect, attracting more cardholders and issuers to the platform.
Visa has signed agreements with thousands of issuing banks and merchants operating in over 200 countries around the world, and each agreement has been negotiated individually in accordance with local regulatory frameworks.2 Contracts range in length from three to 10+ years. In essence, it would be difficult for a disruptor to dislodge Visa’s incumbency in any reasonable time frame.
In addition, Visa is able to exercise pricing power because the base of financial institutions and merchants around the world is so fragmented. This is particularly true given the rise in B2B and B2C cross-border transactions.
Finally, Visa’s brand name is trusted by cardholders and merchants, which allows the company to negotiate attractive fees, in particular within emerging markets where many consumers are starting to use digital payment platforms.
These advantages allow Visa to enjoy the highest operating margins in the payments industry5, thereby supporting increased marketing activities, which produce higher incremental margins as the marketing expenditures are distributed across a larger revenue base. The company’s strong profitability also allows it to provide attractive incentives (i.e., fee rebates) for new customers to entice them to join Visa’s established network, further strengthening the network effect.
Overall, we are looking for companies that can compound their value over time, and Visa has proven it can, and does – with its market capitalization increasing in excess of 30% annually over the last five years. Along with examining the quality of the business itself, we evaluate the quality and track record of the management team at the helm to ensure its priorities are aligned with ours as shareholders. From there, and from there only can be begin to determine our view of the intrinsic value of the company and at what price we’d be willing to invest. This is the disciplined approach that our team, led by Michael Hatcher, uses for every investment in the funds.
1 Source: Nilson 2014 Global Payments Report.
2 Source: Visa Inc. 10-K filings for the U.S. Securities and Exchange Commission.
3 Capgemini World Payments Report 2013
4 Source: Visa Inc. 10-K filings for the U.S. Securities and Exchange Commission, Invesco Canada estimates.)
5 Source: Invesco Canada, as at December 31, 2015.
The company listed above is for illustrative purposes only and is not intended as specific investment advice.
Free cash flow is a measure of financial performance calculated by subtracting capital expenditures from operating cash flow. It represents the cash that a company is able to generate after spending the money required to maintain or expand its asset base.