MasterCard Targets Debit Business – Analyst Blog

According to Reuters, MasterCard Incorporated (MA) is planning to take hold of the debit processing business of its rival Visa Inc. (V), on the feared impact of the financial reform law.

 

MasterCard and other card companies expect the financial reform law of July 2010 to widely restrict the interchange fees that merchants are charged, which banks and networks receive for processing debit card transactions. These fees are significant revenue drivers for card companies such as MasterCard and Visa. With the passing of the bill, credit card companies will not be allowed to set their own fees.

 

The law may also prohibit exclusive debit processing contracts of banks with card networks, and will allow banks to do business with other networks.

 

MasterCard is thus looking forward to gain its U.S. debit share within one to two years, increasing its leadership position and accelerating growth in the debit category. Switching to another revenue stream other than credit cards is important for MasterCard’s long-term viability.

 

The credit card market has not been doing well recently, as consumers are turning away from credit cards, with rising interest rates and uncertainty of future income attributable to rising unemployment rates. MasterCard has also lowered its credit card limits for many of its consumers to lower banks’ defaults, which has further promoted debit card use.

 

Besides, the Credit Card Accountability, Responsibility and Disclosure (CARD) Act of May 2009 has imposed restrictions on card companies to advance less credit to customers. Less credit likely means fewer transactions and transaction amounts, negatively impacting earnings.

 

The CARD Act requires MasterCard and other card companies to follow the guidelines of interest rates increases, a 45-day notice before changing interest rates, restrictions on fees that can be charged, increases in the use of annual fees for cards, requirements for more disclosure, and limits on the usage of those under the age of 21 to obtain cards, which has ultimately made obtaining credit cards difficult.

 

Last week, MasterCard authorized a stock buy-back program worth $1 billion Class A shares through open market operations. The decision for the stock repurchase came in with the company’s share performance in the market, where card companies such as MasterCard and Visa have been experiencing price declines on account of the passage of the financial reform law.

 

While Visa has already estimated that about 16% or less of its revenues will be affected from the adverse impact of these regulations, MasterCard has yet to assess its share of loss from the operation of the Act.

 

Though the actual effect of these regulations will not be witnessed before mid-2011, MasterCard and other card companies expect the law to impinge on profits.

 

MasterCard benefits from strong secular demand growth, meaningful international exposure, high barriers, excellent pricing power, risk-free balance sheet and impressive operating leverage. Also, the above-average earnings growth, strong competitive position and leverage to an eventual economic recovery will result in a relative valuation premium. However, we are concerned about MasterCard’s resilience and ability to raise prices, the detrimental after-effects of the financial overhaul legislation and the scope for increasing cash flows.