Mastercard is one of the most recognisable brands in the world. You may know Mastercard as the card in your wallet that can be used at merchants globally, or perhaps it’s from their memorable multi-decade ‘priceless’ marketing campaign. The network’s global penetration of nearly 100m merchants and 3.1 billion cards creates a seamless and ubiquitous payments experience that is ‘priceless’ to network participants, which makes it extremely valuable to shareholders.
Since Mastercard was formed in 1966 the network has been part of the payments revolution. Mastercard along with peers Visa, American Express and, more recently, PayPal have been transforming payments, and commerce more broadly. We’ve moved from the confines of paying in cash and cheque and signing to having ready access to credit and digital cash (debit) to swiping to tapping, e-commerce, mobile payments, digital wallets and real-time payments. The innovation has been remarkable, and beneficial, to consumers, merchants, governments, and shareholders.
Over the last decade Mastercard’s payment volumes, merchant network and card reach have more than doubled. This growth has generated attractive 15% annual compounded returns for shareholders.
The consistency and strength of the business are due to several layers:
- Business quality – Payment companies enjoy the strong protections of the network effect that links consumers, merchants and banks – where each additional user boosts the benefits of the network for all users. It is extraordinarily difficult to launch and grow to scale a global network, creating high barriers to entry, and therefore making the businesses of Mastercard and its three peers resilient to aspiring competitors. These network characteristics allow Mastercard to generate high-quality, consistent earnings that continue to compound for shareholders.
- Structural tailwinds – Mastercard benefits from multi- pronged structural growth tailwinds over several decades. First was the convenience and security of using cards over cash and cheque. This physical convenience then morphed into digital payments convenience on desktop computers and mobile. Digital convenience was turbocharged by the necessity of fast and secure digital payments that underpin the e-commerce revolution. These tailwinds persist globally and are further supported by nascent tailwinds from growth in business and government digital payment processes. All of these tailwinds have been supported by ongoing innovation from Mastercard, their peers, and technology companies.
- Strength in strategic capital allocation – Mastercard has been a master capital allocator over the past decades. The business in 2012 generated ~90% of revenue from payments and 10% from related services. In FY22, Mastercard generated 20% of its revenue from related services. The transition in revenue mix is due to organic investment and thoughtful acquisitions and is critical to the long-term sustainability of Mastercard’s revenues, and to maintaining its strengths in business quality. The acquisition of the company ‘Dynamic Yield’ is a great example of how Mastercard acquired capabilities in AI and deployed them within its suite of loyalty capabilities across its network.
- Business model – The bulk of Mastercard’s revenue is earned as a percentage of the payment dollars or number of transactions made across its network. These dollars and transactions are mostly related to personal consumption expenditures. Importantly, these revenues are not directly dependent on credit quality for credit card transactions or interest rates on loans. However, the business model does experience cyclicality, with a strong consumer beneficial to revenues and a weaker consumer leading to slower growth. In the post-covid era, this business model proved highly favourable since a large portion of revenue is earned on the value of goods and services transacted, and therefore benefits from higher rates of inflation. This very attractive revenue model is complemented by an expense base that consistently increases at a lower rate than revenues, leading to steady increases in margins over time.
- Financial inclusion – Mastercard is a socially aware company, prioritising financial inclusion for underbanked members of societies. To date, Mastercard, across 94 countries, has brought more than 675 million people into the digital economy, 18 million female-led businesses and more than 10 million small and medium-sized enterprises. Mastercard has achieved this through investment in communities, non-traditional partners and industry groups, assisting with technology and new solutions. This investment is valuable for the poor and unbanked, lifting them from a dangerous and rapacious informal financial system and into the modern, efficient, and safeguarded financial system. Importantly, this investment grows Mastercard’s end market for decades to come.
The attractive dynamics of the payments industry continue to attract investment from competitors. However, to take market share from the four incumbents, any newcomer to the global payments business would need consumers and merchants to simultaneously accept its card, have banks/financial institutions to issue the cards and be connected to the merchant’s bank/financial institution. To achieve that, the entrant would need to achieve mass awareness, offer a simple means of payment, have ubiquitous technology, have positive consumer appeal (for example, fraud protections or associated rewards programs), be trusted (even though the issuing bank bears the risk of theft and fraud), meet regulatory requirements in every country in which it wished to operate, and fulfil arduous customer and merchant servicing needs. With these elevated barriers to entry, we’ve seen mixed attempts to drive competition:
- Thus far the barriers to entry have been too challenging for many well-funded fintech and technology companies outside of China. Apple, Meta, Alphabet and Samsung have all stepped into payments, but they are leveraging the payment companies’ infrastructure. Likewise, buy- now-pay-later and remittance companies rely on the incumbents. Cryptocurrencies are no threat either because payments this way are, so far, too slow and insecure to take market share and they face major regulatory impediments. Their volatile prices are another risk to adoption.
- Central banks, however, have different motivations. Their policy goals typically include safeguarding their domestic payments system, competition and efficiency (i.e., lower cost) in payment mechanisms. They have recognised the possible threats posed by American-owned payments networks on their policy goals. This has led many of them to support domestically owned real-time payment systems, which enable transfer of funds from one bank account to another within seconds at very low cost. These could pose competitive threats to Mastercard, particularly its debit business. However, while investment in real-time payments isn’t new, it is extremely complex to develop and drive adoption. As a result, there has been mixed success globally. This year is somewhat of a milestone, with the U.S. Federal Reserve launching FedNow, its real- time payments network that has been more than five years in the making. While this is a milestone, in its initial form it is not targeting consumer payments. It will take many years for the Fed to be connected to the thousands of U.S. banking institutions, to have a comparable consumer offering and have a comparable proposition for financial institutions. Connecting FedNow to payments globally will be an even bigger hurdle. With less than 10% of Mastercard’s revenue estimated to be linked to domestic debit transactions, this risk is likely to be manageable in the near term.
Mastercard faces risks beyond that of consumer spending levels and government investment in payments infrastructure. One risk is excessive regulation as governments move to protect privacy and competition. Evidence of this includes ongoing investigations from the Department of Justice into anti-competitive practices, regulation of interchange rates and developing countries regulating how banks interact with global networks.
But let’s not forget, these watchful eyes from regulators and competitors are driven by the strength in business quality and the necessity of an efficient payments system. Mastercard’s relentless focus on its network reach and capabilities has been priceless for consumers in its network, and extremely valuable to shareholders. While Mastercard will need to continue to invest in its network, we’re confident that shareholders will continue to benefit from Mastercard’s high-quality business model.
By Elisa Di Marco, Portfolio Manager
Source: Mastercard website