The No. 2 Credit Card Issuer Is Banking On Big Expansion Plans

January 10, 2007

Call it the David and Goliath of the card payment industry.

No. 2 MasterCard holds half the market share of the industry giant, Visa. Yet the little guy beat its chief rival to the markets in going public in May at 39.

Since then, MasterCard's shares have risen to more than 100. They soared 15% Nov. 1 when the firm reported $1.42 a share in third quarter earnings, beating by 35 cents Wall Street estimates for its first full quarter as a public company.

Analysts expect MasterCard to log double-digit earnings growth through 2010, with 2007 earnings expected to rise 19% to $3.88 a share.

"We have a very leverable business," Chris McWilton, chief financial officer, said of the firm's $3 billion card business.

Still, MasterCard's share of the worldwide card market has barely budged. Visa still enjoys more than 60% of the market vs. less than 30% for MasterCard.

Visa To Go Public

This year, Visa plans to join MasterCard as a publicly traded company, eroding some of MasterCard's advantage in that aspect.

The field will probably get even more competitive with Morgan Stanley's planned spinoff of its Discover-card business, probably into a stand-alone public company.

Because it won the legal right in 2004 to sign on bank card issuers to its network, card issuer American Express has been encroaching on MasterCard's turf as well, not to mention Visa's.
"Competition is strong today and it will continue to get stronger," McWilton said.

When Visa does charge into the public market, MasterCard doesn't intend to let its house of cards fall.

"Our three- to five-year plan is to grow revenue 8% to 10% a year, improve operating margins by 2 percentage points and achieve return on equity of 20%-plus," McWilton said.

Founded in 1966 by a band of banks to compete with BankAmericard (now Visa), MasterCard makes most of its money from processing transactions made on its credit and debit card brands MasterCard, Maestro and Cirrus.

"The history of both companies is a history of two competitors who really didn't come out slugging, headed for a knockout, because the same banks owned both brands," said David Robertson, publisher of the Nilson Report.

When MasterCard went public, its bank owners dropped in ranking to minority investors.

When Visa joins MasterCard as a publicly traded company, it too will answer not to banks but to shareholders, and it too will come under closer regulatory scrutiny.

Meanwhile, MasterCard and Visa face the same dark clouds hovering in the distance: lawsuits. On one side: civil damages related to a long-running American Express and Discover antitrust case. On the other side: merchants' suits over interchange fees.

"It's still potentially a big issue," said analyst Robert Dodd of Morgan Keegan & Co. "But the timing on when these issues go to court and get settled is very much up in the air."

All has been quiet on the litigation front lately, but the first new noise is expected this spring when "fact discovery" papers are presented on the American Express-Discovery case. New information on the merchant interchange fight isn't likely to surface for at least another year.

"If you look at legal statistics, these cases rarely if ever go to trial," McWilton said. He says MasterCard will more than likely settle. "It boils down to the timing and amount," he said.

Analyst Sanjay Sakhrani of Keefe, Bruyette & Woods estimates MasterCard will incur damages of $7 per share, or about $1 billion, with $3 per share pegged to the American Express/Discover lawsuit and $4 for the merchants' lawsuit.

He figures that the first lawsuit will be settled at the end of this year and that the merchants' suit will be settled in 2010.

In the meantime, MasterCard plans to chase "profitable market share," McWilton said, by working with its many bank customers on new brand initiatives to prod card carriers to use MasterCard cards more often. MasterCard's largest bank customers include JPMorgan Chase, Citibank, HSBC and Bank of America.

A $1 billion ad and marketing budget probably won't hurt.

One MasterCard initiative that's had some success is its PayPass program. PayPass users can make "micro" purchases for such things as highway tolls and fast food.

Big Mac purchases at McDonald's might not sound like much. But it's all about volume.

Increased cardholder spending on a growing number of MasterCard cards drove worldwide purchase volume up 17.2% in the third quarter. Volume, after all, begets fees, which beget revenue and profit.

Plenty of volume is up for grabs. While use of credit and debit cards in the U.S. is becoming ubiquitous, many places in the world are still largely cash-and-go societies.

Overseas Business

More than half MasterCard's gross dollar volume comes from overseas with the fastest growing regions being Latin America and Asia-Pacific.

The U.S. is far from a done deal. Industry watchers see card volume growth there rising from the high single digits to 12% annually over five years, with debit card growth outpacing credit card growth.

MasterCard has a small debit card business in the U.S., especially compared with Visa, which got into the debit card market earlier. But MasterCard scored a bit of a coup last year when it landed debit card business from Washington Mutual, which switched from Visa.

In Europe, the tables were turned. Enlisting German banks, Visa stole debit card business away from MasterCard's Maestro, with conversion set for later this year.

New opportunities loom on the Continent as the European Union spearheads a drive for a single, integrated euro-zone payment system.