Where Are We Now
Updated on: 11/1/2021
MasterCard is a business that will only gain relevance as the world goes cashless and payments are simplified across many new platforms. MasterCard has also remained innovative by partnering with the hottest fintech providers out there. Despite many disruption risks, we don’t see these as near-term risks and think shares offer great value.
We believe BNPL, cryptocurrencies, and mobile payments apps largely expand the total addressable market for MasterCard as opposed to hindering it. MasterCard should continue to grow as these alternatives hit the market.
Cross-border revenues have bounced back with force to 72% of 2019 levels. We think investor concerns about cross-border revenues offer a good “buy” entry point into MasterCard.
MasterCard hosts one of the most powerful network effects in the world. As merchants and consumers increasingly shift towards cashless means of payments, more merchants and consumers adopt MasterCard-branded products.
MasterCard does not issue debit or credit cards or credit to individuals and businesses. The company operates a payment network on which global transactions flow and change hands. The business model is extremely lean, generating high margins and massive profits.
Around 80% of the world’s transactions are still conducted with traditional payments methods like cash and cheque. Emerging markets use the most cash – growth in these regions and MasterCard’s efforts in these areas will bring cash usage way down and cashless methods way up.
Financial technology (“fintech”) is advancing at a rapid pace and may pose a threat to MasterCard. However, MasterCard’s mind-blowingly large and flexible open-loop network is too strong for disruptors to disrupt. Instead, many of these firms are partnering with or getting acquired by MasterCard to grow and succeed.
Despite this, new innovators still use and rely on the payments "rails" networks that MasterCard and Visa have built.
MasterCard is one of the most important businesses in the world.
It is a technology company that connects payers with payees by enabling the electronic transfer of payments between consumers, financial institutions, merchants, governments, digital partners, businesses, and other organizations.
MasterCard allows money to flow from one person or entity to another by hosting an incredibly large global payments network. MasterCard is the intermediary that “switches” transactions between two parties. “Switching” refers to the authorization, clearing, and settlement of payment transactions.
While the MasterCard and Visa logos are found on credit and debit cards all around the world, neither company:
issues debit or credit cards;
holds consumer or business credit;
makes money on interest payments or other account fees; nor
establishes an acquirer’s rates.
There is a common misconception that MasterCard and Visa are “credit card companies”. Although they provide services to customers – primarily banks and merchants – who extend or accept credit, Visa and MasterCard are only involved in the operating of global payments networks that allow money to transfer digitally between bank accounts.
While it may seem that MasterCard’s business is entirely consumers paying for goods and services, MasterCard is a multi-rail network that runs several payments flows on its network. On top of C2B (i.e., consumer to business) payment flows, MasterCard also enables the flow of:
B2B (i.e., business to business)
P2P (i.e., person to person)
B2C (i.e., business to consumer)
A2A (i.e., account to account)
For a payment to successfully transfer from the payer to the payee’s bank account, MasterCard’s core network engages four separate parties:
Account holder (payer)
Issuer (account holder’s bank)
Acquirer (merchant’s bank)
What appears to be just a transaction between the account holder and the merchant, say, at a restaurant or a grocery store, is a transaction between the account holder and merchant’s banks in real time.
When a person or business consumer purchases a good or service using a MasterCard-branded payment product, the issuer must first authorize the transaction. Once authorized, the issuer transfers the payment amount to the acquirer, the merchant’s bank. After the acquirer receives the cash, it pays the merchant by depositing the funds into the merchant’s bank account.
There are three types of processing fees that are charged in a typical transaction, two of which are not revenue to MasterCard:
Merchant discount rates
MasterCard generates revenue from assessment fees, while interchange fees and merchant discount rates are the issuer’s and acquirer’s “cut” of the transaction simply flow through the MasterCard network. All these fees are “paid” by the merchant. Processing fees on the MasterCard network generally range from 1.55% to 2.6% but typically land at or around 2%.
Using a 2% processing fee example, only about 14 cents is collected by MasterCard for every $100 of gross dollar volume (“GDV”, or simply the sum of transactions between payers and payees).
On the other hand, the issuer and acquirer banks take up most of the 2% processing fee, the majority of which is paid to the issuer in the form of an interchange fee.
Assessment fees are MasterCard’s primary source of revenue, made up of:
Cross-border volume fees
Domestic assessments refer to assessment fees charged when a card issued in a country is used in the same country as the merchant at which the card was used. Cross-border volume fees are the same in principle but refer to a situation where a card issued in one country is used to transact in another country.
MasterCard’s last two revenue sources include:
Transaction processing revenues are generated from authorizing, clearing, and settling transactions, as well as from the collection of connectivity and other processing fees. The “other revenues” segment is the “catch-all” revenue source for all other services, including data analytics and consulting, loyalty and rewards solutions, and cyber and intelligence fees, among many others.
MasterCard Revenue Sources (Q3 2021)
Source: MasterCard Investor Relations
MasterCard has an outstanding financial profile, generating loads of cash and consistently growing as the world trends towards an ever-expanding cashless society.
The behemoth payment rails operator has been able to grow revenues at high single-digit rates, and free cash flow (“FCF”) at even higher rates (low double digits) throughout the last decade.
MasterCard Historical Free Cash Flow ($M) (Q3 2021)
MasterCard Historical Revenue ($M) (Q3 2021)
Despite the size of the business and the amount of transaction volumes processed on its network, MasterCard boasts high operating and net margins above 50% and 40%, respectively.
MasterCard also historically retains over 40% of revenues in the form of free cash flow, which can be used to fund growth investments, mergers and acquisitions (“M&A”), share repurchases, dividends, and debt repayments, among others.
These are astonishingly high numbers few businesses will ever achieve, attesting to the exceptional quality of each dollar of revenue MasterCard makes.
MasterCard Transaction Volume ($T) (Q3 2021)
Source: MasterCard Investor Relations
MasterCard Transactions Processed (B) (Q3 2021)
Source: MasterCard Investor Relations
The Interbank Card
Mastercard’s history dates back to the 1940s when certain US banks offered customers credit-like papers that could be used like cash in stores. Over time, certain merchants would partner with local banks in a city to accept cards as a form of payment.
In 1966, a group of several bank associations worked closely together to form the Interbank Card Association (“ICA”). Each of these banks had representatives that would run the ICA – they created rules for authorization, clearing, and settlement of transactions and also handled general operations.
The ICA created the Interbank card, a payment card developed to compete against BankAmericard, which is now known today as Visa. In 1969, the ICA changed the card’s name to “Master Charge”, a name that closely resembles the company as we know it today. Shortly thereafter in the 1970s, the ICA organization changed its name to MasterCard International to reflect its growing international scale.
Once the ICA became “MasterCard”, it went on an innovative and acquisitive rampage. The Cirrus ATM network and Maestro, a point-of-sale debit network, were acquired in the late 1980s and early 1990s and still operate today.
In 2006, MasterCard prepared and released its initial public offering (i.e. “IPO”). From 2009 to 2012, MasterCard went on to make a few important acquisitions, including Orbiscom, DataCash, Trevica, and Truaxis. Each of these firms were strategic acquisitions to help MasterCard stay competitive against Visa and other fintech disruptors, and innovate more effectively on a large, global scale.
Today, MasterCard reaches over 210 countries and territories around the world and continues to grow in a world that is still dominated by cash. The company believes the future is cashless and it continually makes strides in this direction. It's possible that a few decades from now, we all forget what cash is.
Two-Sided Network Effect
As the second largest global payments network fueling the cashless economy alongside Visa, MasterCard benefits from similar two-sided network effects to its larger peer.
Merchants and consumers alike benefit from MasterCard’s open-loop network, a network that supports general-purpose payment methods like debit and credit cards. This powerful concept, in unison with MasterCard’s trusted and globally recognized brand name, spurred mass consumer uptake of MasterCard payment methods.
As MasterCard users grow, this prompts more and more merchants to find ways to accept MasterCard payment methods to enable these consumers to pay with their MasterCard products and buy their goods and services. This works inversely as well – as more merchants accept MasterCard, consumers are enticed to snap up MasterCard-branded products to pay for things.
In contrast, a closed-loop payments network generally allows a consumer to deal with an individual merchant or select group of merchants. Closed-loop networks generally limit a broad, global network effect from ensuing in the first place due to its local focus.
MasterCard’s open-loop network has high switching costs – for consumers and merchants to leave the MasterCard network for other services such as Buy Now, Pay Later (“BNPL”), those alternative payment services would have to convince enough consumers and merchants to scale down usage of their MasterCard-branded products. When shopping in-store and online is made so easy with MasterCard, it would take a substantial amount of time and effort for merchants to overhaul their systems and processes, and consumers would have to forego the simplicity inherent in using MasterCard products and seeing all their transactions in one place.
They would also have to beat the unit economics of MasterCard (and Visa) to make that happen, which is no easy feat. Merchants may be unwilling to adopt some of these services as they would be much smaller in size and provide services at a higher cost than MasterCard.
As a result, new innovators in the fintech space usually choose to leverage the MasterCard (or Visa) network as opposed to trying to fix a massive open-loop network that is far from broken or ripe for disruption in our view.
The Payment Rails Duopoly
Visa and MasterCard own about virtually the entire market (excluding UnionPay in China) together as measured by purchase transaction amounts made on network cards. MasterCard owns about a third of the market itself.
Global Network Cards 2020 Market Share Ex-UnionPay
Source: Nilson Report
This duopoly position allows MasterCard to reap the benefits of pricing power stemming from high barriers to entry. Smaller players have a tough time competing with the monstrous unit economics of MasterCard. As a result, many of these smaller players partner with MasterCard or get acquired by it rather than try to overpower a business deeply entrenched in the flow of money all over the world.
MasterCard has incredible unit economics that are a direct result of its globally recognized name, high switching costs, and powerful network effects. Free cash flow margins consistently above 40% are unbelievably high, and this allows MasterCard to conduct business in ways that many businesses could only dream of.
These margins and resulting cash flows allow MasterCard to easily pivot into new verticals, reinvest into its business, and innovate in the payments space organically and through M&A.
The Journey to Cashless
Take a look around — the world is becoming cashless. The world has already been trending in this direction and the COVID-19 pandemic simply accelerated it further. Both consumers and merchants opted for digital forms of payment and e-commerce usage drastically increased as well, forcing many individuals and businesses to use MasterCard products or become customers of MasterCard for the first time.
Global non-cash transaction volume is expected to surpass 1 trillion total transactions by 2023. Consumers and merchants are abandoning cheques and cash for more efficient electronic methods of payments online and in-store.
Global Non-Cash Transaction Volume (Billions)
As penetration of cashless payment methods running on the MasterCard global payments network increases alongside growing non-cash transaction volumes and GDV, MasterCard will directly benefit.
The secular cashless trend is young and has legs. MasterCard, as the second-largest payments network in the world, will leverage its strong global reputation to drive this shift and will continue to innovate to make experiences better, more efficient, and more convenient for all consumers and merchants.
Consequently, and perhaps unsurprisingly, we believe MasterCard can sustain high levels of growth throughout this decade as cash usage declines and non-cash transaction volumes shoot up towards the sky.
MasterCard Total Card Credentials (B) (Q3 2021)
Source: MasterCard Investor Relations
Emerging Tech in Emerging Markets
Mature economies like the US and Sweden have largely dropped cash usage in favour of digital methods. Emerging markets, however, still have relatively high cash usage. Emerging markets make up about 85% of the global population and almost 90% of people under 30 around the world live in emerging regions.
Cash Usage by Region for Emerging Markets (% of cash used in total transactions by volume)
Source: Global Payments Map by McKinsey
Cash Usage by Region for Mature Markets (% of cash used in total transactions by volume)
Source: Global Payments Map by McKinsey
MasterCard has been making strides in emerging markets as part of the company’s long-term focus established in the early 2010s. Recognizing that these regions are oftentimes underbanked, MasterCard has a tremendous amount of opportunity to establish the technologies customers and merchants need to go digital.
Ultimately, this would benefit everyone. Electronic payments could help the underbanked gain access to mainstream financial services. Merchants and businesses could keep track of payments accurately and efficiently to have better oversight over their operations and improve access to loans and investors to grow their businesses.
MasterCard is more diversified internationally than Visa, pointing to MasterCard’s focus on international growth to a greater extent than Visa. We expect this to bode well for MasterCard going forward as the duopoly player that has a larger focus on markets outside of North America, many of which use lots of cash and have room to grow their cashless infrastructure.
MasterCard Geographic Revenue Mix (Q3 2021)
Source: MasterCard Investor Relations
Visa Geographic Revenue Mix (Q4 2021)
Source: Visa Investor Relations
Partnering to Prosperity
MasterCard has the payment rails that financial technology firms wish they could build. Because of the MasterCard network’s sheer size and open-loop capabilities, many fintechs choose to operate on or with MasterCard rather than try to get around its network.
The fundamental idea behind MasterCard (and Visa) is that they enable the flow of money and will enable this flow in ways that merchants and consumers both appreciate.
Therefore, MasterCard believes the fintechs that partner with or get acquired by MasterCard will generally see more success by leveraging a global open-loop and multi-rail network, multiple decades worth of payments prowess, and MasterCard’s bulletproof balance sheet to get their technologies to market.
Both partners benefit – the partnering fintech can scale using the MasterCard platform, further widening MasterCard’s moat in return. Even when MasterCard does innovate in an area itself, innovation still finds its way onto the MasterCard network.
On a net basis, we believe new financial technologies emerging today, at least for the time being, present an opportunity for MasterCard to expand further rather than experience disruption and an imminent collapse. MasterCard has been partnering or acquiring with many fintechs to stay on top of the most up-to-date financial technologies to make it more convenient and efficient for consumers and businesses to move money.
A non-exhaustive list of important partnerships and acquisitions MasterCard has made include:
The 2020 partnership with Spotii to expand its BNPL services from 600 current merchants in the Middle East to many more using MasterCard’s extensive merchant network;
The 2020 partnership with TSYS, a global payments company, to complement MasterCard’s BNPL installment capabilities;
The 2020 partnership between TSYS, Extend, and MasterCard to launch a mobile virtual card solution for business clients;
The 2017 acquisition of VocaLink and its mobile payments app that leverages ultra-fast ACH (i.e., Automated Clearing House) technology. This acquisition added to MasterCard’s electronic payments and payments flows capabilities, improving the experience for merchants and consumers, while also gaining a strategic advantage in VocaLink’s home UK market;
The 2020 and 2021 acquisitions of Finicity and Aiia, respectively, to expand on MasterCard’s open banking reach in North America and Europe; and
The 2021 partnership with Paxos and Circle to help consumers convert cryptocurrencies to stablecoins and enable them to spend money in dollars.
MasterCard is on top of all payments trends with its partnerships — namely BNPL and cryptocurrencies — to succeed and further widen its moat. It also runs MasterCard Start Path, a global start-up engagement program designed to help build the “best & brightest later stage start-ups” under the MasterCard ecosystem and maximize chances of success.
We believe MasterCard’s partnership and acquisition strategy that targets proven fintech companies with capabilities to accelerate the cashless revolution will bode well for MasterCard over the next 5 – 10 years.
All while MasterCard is investing for growth, whether that is organically or through partnerships and acquisitions, management is encouraged to return capital to shareholders. With free cash flow margins above 40%, MasterCard has tons of cash it can distribute to shareholders or perform incredible acquisitions that further shield the company from competition.
As potential fintech disruptors continue to emerge, we expect MasterCard to continue acquiring new technologies and partner with established and agile fintechs.
We also expect dividends and share buybacks to be part of the capital allocation equation, growing at rates similar to the past. MasterCard is a high-quality company, and its capital allocation breakdown exemplifies just how big of a beast it truly is.
MasterCard Historical Capital Allocation ($M) (Q3 2021)
FCF per diluted share has been increasing just under 15% for the past decade. Although revenues grew at about 10% per year, FCF per diluted share grew faster due to buybacks, operating leverage, and low capital expenditure requirements. We are encouraged by MasterCard’s historical picture and believe it can continue this strong trend into the future, ultimately benefitting shareholders.
The fintech and payments industries are seeing a plethora of new entrants that appear to be disrupting traditional banks and possibly the payments rails. Although we believe these risks are overblown, concepts like BNPL, cryptocurrencies, and decentralized finance may ultimately develop and scale to a size large enough to allow consumers and merchants to circumvent the payments rails. These technologies are still relatively nascent, so we view this risk as a potential “terminal risk” (i.e., a large risk that may materialize but after a long period) that we will closely monitor, especially if these alternative technologies can compete on price.
MasterCard’s business model is effectively being a “taxman” on global cashless transactions. The main driver for revenues and growth are the number of transactions hosted on its payment network. Economic recessions, closures, lower cross-border travelling, and any other events that could possibly harm any region’s aggregate spending appetite will hinder MasterCard’s growth.
Although MasterCard does not make money through interchange fees, MasterCard sets these fees in compliance with local governments. Several governments and merchant groups have pushed MasterCard to lower interchange rates. Lower interchange rates may impact a local issuer’s willingness to promote MasterCard-branded products, ultimately harming MasterCard’s business.
Fintechs, governments, and other technology companies pose a competitive risk that may affect pricing or how MasterCard competes against them. Protective regulation, such as PSD2 in Europe, enables smaller players to create disruptive payment models that banks can adapt to and roll out to the public. These sorts of regulations can route payment transactions away from the MasterCard network or foster an extremely competitive environment in which MasterCard may be able to compete in a fashion that will sustain its growth and profits.
MasterCard is a massive player in a duopoly. The company faces antitrust risks that may block solid strategic acquisitions or partnerships that regions or governments perceive as predatory. They may also block certain internal initiatives that attract additional market share to it. With the shift to cashless, we believe risks in this regard will only increase as MasterCard and Visa grow larger.
MasterCard is deeply entrenched in our lives (and wallets) as it continues to grow and destroy the usage of cash worldwide. It hosts a massive global payments network that allows people, businesses, and other organizations to transfer cash safely, securely, and efficiently to peers, merchants, and other receivers around the world.
The payment rails boast many competitive advantages that result in a strong moat for MasterCard. The open-loop nature of the network poses huge switching costs to merchants and consumers, its duopoly power leads more disruptors to partner with MasterCard rather than fight it, and the network effects are likely one of the most powerful on the planet. Combine all these factors and you get a few-billion-dollar payments company – MasterCard.
From our perspective, both Visa and MasterCard are incredible companies and we like them equally. We prefer to own both of them equally weighted and consider them as one position.
This is a duopoly benefitting from secular growth in digital payments and a margin profile that generates huge profits.