Where Are We Now
Updated on: 11/1/2021
Visa is the world’s largest global payments network, enabling trillions of digital transactions to happen from almost any place in the world. The world is shifting away from cash towards digital methods, and Visa is currently the leader that will benefit most from this trend even as solutions like BNPL and mobile payments apps grow in popularity. We think Visa is trading at a cheap valuation relative to itself and its history.
Despite noise around BNPL disrupting debit and credit cards, Visa is bringing scale to these payments disruptors through the global deployment of the network-based Visa Installments.
Cross-border volumes recently increased to 86% of 2019 levels, showing signs of life as the world reopens and international travel picks up.
Visa possesses one of the most durable two-sided network effects in the world. If new payment networks were to be introduced, they have to convince both consumers and merchants to start using the platform creating a lot of friction for new businesses to enter the industry making Visa’s position vey difficult to disrupt.
Visa does not lend money, thus not taking on credit risk. Visa generates revenue for what are called Assessment Fees on credit card and debit transactions. The business is a tax on cashless payments worldwide.
It is no secret that cash is being disrupted across the globe as payments go digital. In addition to the percent of digital spend that is done online, more payments are being done on the credit card networks. Visa benefits greatly from the long term disruption of cash. Globally, there is still a long runway as the trend to cashless continues.
Visa simply provides the technology to facilitate transactions with their network yielding incredibly high margins. Visa has an average free cash flow margins of 45%. These are unit economics most businesses could only dream of.
Visa leads the market in payment volume, number of transactions and cards in circulation.
By facilitating digital payments across consumers, merchants, banks and more on VisaNet. The processing network makes digital payments seamless by connecting all parties involved in the transaction instantly.
By creating the payment network rails, Visa and MasterCard have secured their spot as the businesses to facilitate payments.
Visa-branded credit cards, debit cards and prepaid cards are accepted all over much of the world. There is still a long runway of growth for Visa’s offering to disrupt cash and cheque across the globe.
Visa Does Not Lend any Money
Visa generates revenue for what are called Assessment Fees on credit card transactions. This is a small fraction of the total processing fee. So before digging into how Visa does make money and the credit card business works, lets clear up the most common misconception.
Although Visa and MasterCard own such a large market share in the credit card business, neither business actually lends any credit! The issuing bank that is associated with the credit card is the business that lends money and takes on the credit risk.
To compensate this issuing bank, they collect the largest portion of the processing fee in what are called interchange fees. Visa does not lend consumers money with their branded credit cards.
The Credit Card Business
Visa has built a powerful payment network to allow the seamless transaction and connect consumers, merchants, the bank that issued the card and the bank used by the merchant.
Now that we have understood that the payment networks do not actually lend any money, and rather that Visa is the rails that connects parties involved in the transaction, how much revenue does each party make in a typical transaction?
Let’s use a 2% total fee for our example.
Visa only collects about 0.14% or 14 cents on a $100 purchase on Assessment Fees. The rest is given to the banks on both sides of the transaction between the credit card issuer and the acquiring bank (of the merchant).
Because Visa is simply the technology allowing the transaction to take place and providing the payments infrastructure across the globe both for physical in-store purchases and ecommerce payment processors, the business has incredibly high margins.
Visa consistently has gross margins over 80% and pre-tax income margins over 60%. These are stellar numbers for any business, let alone one that does the kind of volume Visa does.
Visa has an average free cash flow margin of 45%.
This means Visa converts 45 cents of every dollar in revenue to cash they can reinvest in the business, make acquisitions, pay out shareholders in dividends or buy back stock.
In September 1958, Bank of America launched the BankAmericard in Fresno, California.
Bank of America delivered the card unsolicited to residents in the area and began working with merchants to accept the card.
Later in 1965, in response to Master Charge (now MasterCard), Bank of America started licensing agreements with other banks to use the card system. It became a joint venture across the banks for this spreading payments system.
This joint venture named National BankAmericard was renamed Visa in 1976. The business has been so successful that its market cap has exceeded any bank that was involved in the original partnership including Bank of America.
The Two-Sided Network Effect
Strong business moats have high switching costs and are difficult to replace and achieve the same result.
Visa is a perfect example of a business that has an extremely difficult to disrupt business model due to the fact they have what is called a two-sided network effect.
Since the business has such strong market share with consumers and merchants, both parties have agreed to use this method of payment. If new payment networks were to be introduced, they have to convince both consumers and merchants to start using the platform creating a lot of friction for new businesses to enter the industry.
This is why financial technology innovation continues to be built on top of the payment rails. The existing infrastructure is already incredibly reliable, fast, secure and accepted everywhere.
Visa Earnings Per Share ($) (Q4 2021)
Visa Revenue ($M) (Q4 2021)
The Payment Rails Duopoly
Visa and MasterCard own about 95% of the market together, excluding UnionPay in China, as measured by purchase transaction amounts made on network cards. Visa owns over half of the market itself.
Global Network Cards 2020 Market Share Ex-UnionPay
Source: Nilson Report
This duopoly position allows Visa 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 Visa.
This is yet another reason why new innovators struggle to get around Visa and instead choose to build on top of its payment network.
High Margins for Growth
Visa 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. Combined with a clean balance sheet, Visa has the ability to exercise opportunities in tons of verticals, namely cryptocurrencies and Buy Now, Pay Later ("BNPL"), and many others that exist today and those that will exist in the future.
These margins and resulting cash flows allow Visa to remain agile, even as a company worth almost half a trillion dollars. High margins = growth for Visa.
Digital Payments Secular Growth
It is no secret that cash is being disrupted across the globe as payments go digital. In addition to the percent of digital spend that is done online, more payments are being done on the credit card networks.
Global Non-Cash Transaction Volume (Billions)
The total addressable market continues to grow for the sector and new innovators continue to operate on top of the payment rails that Visa and MasterCard has a strong position in.
While the total addressable market expands, Visa benefits from a two-sided network effect.
A significant driver of revenue is from cross-border transactions when cardholders make transactions in other countries than where the card was issued. These transactions incur higher Assessment Fees driving a higher take rate for the payment networks like Visa.
Although COVID-19 provides some accelerated growth in digital payments, cross-border transactions were significantly down. As travel picks up after the pandemic, this segment of the business will increase dramatically.
We are already seeing increased reason to believe Visa will hit record payment volume both domestically and cross-border in the near future.
Visa has one of the strongest moats and brands of any business in the world. It is incredibly difficult to disrupt the network and infrastructure the company has built around the globe.
However, one of the leading risks in the terminal value of the payment networks continues to be decentralized finance primarily from cryptocurrency.
These transactions would happen a decentralized protocol, where businesses like Visa would entirely be left out. In addition, in capturing the removal of cash in emerging markets where payments systems can be built without the payment rails the rest of the world uses.
Any business has risk, but Visa is one of the highest quality business models that exists today.
Visa is an incredibly durable business benefitting from a two-sided network effect across the globe. The business can continue to see sustained growth from a secular trend in digital payments while financial technology innovators operate on top of the rails that the card networks have built.
Providing the technology to facilitate payments, Visa has one of the most impressive growth stories and posts fantastic unit economics yielding 45% free cash flow margins.
Even at its size, Visa provides significant upside long-term and remains one of the highest quality businesses in the world.