TIVP020: Visa (V): Is Visa still the Card to Hold? w/ Daniel Mahncke & Shawn O’Malley

27:50And this was not a credit card in the usual sense. It was more of a charge card, meaning that the full balance had to be paid at the end of the month. so there was no revolving credit which is kind of what we associate with the credit card today. In 1958 Bank of America then created this revolutionary product the so-called Bank AmeriCard which would become the foundational visa and this was the first general purpose credit card so not a charge card but actually one that allowed for revolving credit and users could carry a balance and pay interest over time. The launch happened in Fresno California where Bank of America, they just sent out 60 ,000 unsolicited cards to their customers in what is now referred to as a drop.

28:37It's important to know that these were sent out completely random. No one demanded this card. No one wanted this card. And Bank of America just sent them to their customers in the hope that it would work out. And as you can imagine, if you just send 60 ,000 credit cards to people, especially at a time when no one had an idea what that actually is or what a credit card can do, there will be chaos. So there was a huge amount of fraud, there were credit losses, and it was all just a huge mess. But it also created a blueprint for how credit cards could potentially scale in the future. After the initial chaos and after severe losses in the early years, especially for Bank of America, the business model developed and other banks kind of wanted a piece of the pie.

29:23And in response, Bank of America started licensing these Bank of America programs to other banks nationwide. So they expanded from just California to the entire US. And meanwhile, other banks had also formed their own competing network. One of them was the Interbank Card Association, which later became known as Master Charge, and not far from that today MasterCard. As the program has grown, Bank of America recognized it couldn't manage the system alone. It was just huge and was growing year by year. So it was just too much for them to handle. And then in 1970, it relinquished control of this entire program and turned it into a consortium of member banks.

30:08Essentially like a cooperative owned by the banks that issued the cards, which were dozens, if not even hundreds, throughout the entire states. Then that new entity allowed for shared governance and more rapid international expansion. So we started in California, then we went to these states, the entire states, and now they're starting to go international. Just a couple of years later, in 1976, the Bank of America program was rebranded as Visa, kind of as part of their international branding. A name that was chosen because it was short, recognizable, and also globally accepted. Visa just kind of evokes this universality and trust like a passport that gives you the option to go wherever you want and buy whatever you want.

30:52So I know this has been a long story, but to cut the short, after decades as a bank or network, Visa then actually restructured and went public in 2008. Probably not the best year for a bank or anything like that to go public. and it still ended up being the largest IPO in US history, at least at that point, valuing the company at almost$40 billion. And today, I think the rest is history. Visa facilitates over 300 billion transactions annually across more than 200 countries, connecting billions of cards to over 150 million merchants. I think that's one of the better corporate history stories we've told on this podcast, that's pretty hard to beat.

31:35And if you look at how important credit cards have been for consumption trends in the US over the last 50 years, as you kind of talked about the psychology of it's just so much easier to swipe a card than it is to hand over cash, where it feels like you're actually giving up something in a different way. I think it's not an overstatement at all to say that Bank of AmeriCard and obviously later Visa shaped the countries and then really the world's spending habits and honestly the structure of how our global economy works today absolutely and i know i kind of threw a lot at you but trust me if i say we are time constrained and that's why i had to cut the story short there are many more interesting details actually our friends from the acquired podcast have a fantastic episode on visa which is like three and a half hours long and it's solely focused on its history so i will link to that in the show notes for everyone wanting a deep dive.

32:29The question for us as investors is whether the status quo around Visa's business can't remain intact and keep growing too. I'm not sure, for example, how the rest of the world feels about having their payments infrastructure running through an American company and whether there's anything they could really do about it either. But if we look at the estimates for Visa, it doesn't look like growth is slowing down, even from some huge baseline numbers to be growing off of. So my question for you, Daniel, is where is that growth continuing to come from? Well, the short answer is that growth is coming from everywhere.

33:09And we will kind of get to that. But yeah, usually you would think that the market opportunity should get smaller over time, especially if like the baseline for where to grow at. It's just getting bigger and bigger. And as you mentioned, there are some concerns about other countries having all their sensitive payment data with an American company. And we'll probably get to that when we talk more about the risks and also some competition. But right now, growth doesn't seem to stop. I mean, about$11 trillion of consumer spending still happens in cash or checks. And that's about the size of Visa's current consumer spending business.

33:44So according to Visa's management, because of that, they still see the quote, largest and most immediate addressable opportunity in consumer spending. And that opportunity is not only focused on the less penetrated markets, as you would probably think like emerging market, it remains a global opportunity. Visa divides the world into five regions, which is what most do. North America, Europe, Asia Pacific, Latin America and the Caribbean, as well as Central Europe, the Middle East and Africa. Most companies do that, but for Visa, it's especially important just because of the structural differences between those regions and also how Visa starts thinking about their business over there.

34:27I think you discussed Spotify on the podcast once before, and every now and then we mentioned Netflix, and they also have those regions, but they mostly matter because of their different RPUs, so the average revenue per user. For Visa, the difference is much larger. Some countries have fully developed financial infrastructure, then some others still work mostly on cash, like 70 % cash of the entire volume of payment, for example. Then depending on that, Visa kind of has to choose what to focus on in each region. And they do so by categorizing these regions into four buckets. The first one is called cash rich.

35:06Those are mostly emerging markets who just have lots of people and a lot of cash runway left and then in emerging card infrastructure. So there's no established player over there at the current time. Then you have high potential markets. Those are established markets with also established infrastructure but there's still room for growth especially digital payment growth. Then you have high potential challengers. The main thing about those is they're not only an opportunity to grow in, those are kind of where the competitors of tomorrow come from. So those are scaled non-card RTPs or A-to-A alternatives, which basically means account to account.

35:44So one payment goes from the bank account of person A immediately to the bank account of person B without ever seeing any visa infrastructure. The Caribbean and Central America are regions that belong to the first bucket, so the cash-rich bucket. And for Visa, that means that they have to focus on the consumer payments, so their core business, and then how to grow their market share in that region. And then building the foundation and the customer base for future new flows and value-added services, so everything they build on top of their core business. For regions in the second bucket, it's about accelerating consumer payments.

36:26So leveraging the existing infrastructure to then accelerate their market share, the volume they can create, and then on top of that are the new flows and the value-added services. A great example for that is Japan. Japan is a country where digitalization is already very far, but at the same time, they still use a lot of cash. I think only 35 % of the total addressable consumer spend is done by card, and the majority is still done by cash. However, compared to emerging market countries, the great infrastructure that Japan undoubtedly has also allows for expansion into all the new flow and value-added services at the same time while pushing for more card payment.

37:14it's funny that japan is so high tech and in many ways that they're kind of a laggard in moving away from cash well i thought it would be kind of similarly surprising that europe has extremely high share of cash as well but then thinking back well i don't think that many people think of europe as high tech anyway so maybe it's not that surprising after all but what is important in europe is that it's just a huge market it's about five times the size of japan and just as in Japan, there are multiple growth drivers for Visa within that region. So specific to Europe is that there are many domestic networks.

37:51One that I personally use, and I kind of mentioned it before, is so-called GiroCard. And the GiroCard is a unique concept in Germany. It's basically a debit card, but kind of with limited domestic use. Now you might ask, okay, why would you use a dump-down version of a debit card which is less convenient and I couldn't even give you an argument for that. It's just kind of true. The only thing is that as we've mentioned countries like Brazil and India they kind of skip intermediate steps. They just go from cash to paying with their phone and for many of these European countries we've had intermediate steps like the Jiro card and all of that and it's kind of hard to get rid of it.

38:31For Visa these networks are competitors in the European region. My GiroCard, for example, is technically also a Visa card, but it's part of a specific European Visa product. And it's kind of weird because if I pay with it at the local grocery store and it works on a GiroCard and the terminal that they use works on the GiroCard network, then Visa is actually not getting a single cent out of that entire transaction. The good news for Visa is that it's pushing its cards out to the market slowly, but very surely. In Germany, for example, in just 2023, Visa's payment volume growth has been four times that of the addressable consumer span.

39:12And overall in Europe in the last three years, Visa has gained six points of market share against all other players in the European market. And maybe just to clarify, when I talk about the European market now, it's about the continental European market, not the Nordic stage, which is kind of a thing for themselves because countries like Sweden, Norway, and Denmark, well, they belong to what Visa calls the digitally mature bucket. Over 60 % of consumer spend is by card and cash makes up, in some countries, less than 10%. I think Sweden is kind of called the world champion and spending the least amount of money through cash.

39:50In those markets, Visa's primary goal is to increase market share, which is obvious, and then just beyond that, really focus on the new flows and all the value-added services. What about the emerging markets? I'm thinking about maybe Brazil or India, for example. I would imagine these are massive markets for Visa. Now that you mentioned it, I think we kind of skipped the third bucket, which is the high potential challenger category. And that is also the one that features Brazil and India. And you're right, those are huge markets. I think the addressable consumer spend in Brazil alone is 1.4 trillion dollars.

40:27It might be a bit surprising at first that Brazil or India seem to be in a higher bucket than let's say Japan or Germany but as I said before many of those emerging market economies have the advantage of skipping intermediate steps. So they would never get a dual card in their hands. They would strayed from cash to paying with their phones and Brazil is actually Visa's second largest tap to phone market. Another opportunity in those markets is that the majority of adults still have no credit cards. And the more wealth they gain in the coming years, at least the average citizen, they will travel a lot more.

41:04And that increases those high margin international cross-border payment volumes where Visa just makes a ton of money with basically the exact same model as they usually have. The thesis here kind of overlaps with Airbnbs where they're also banking on people around the world to travel more as developing countries get richer and do things like get more credit cards on average or even just get a credit card in the first place, which can come with these incentives like travel points that push people to take more trips. And that more obviously benefits Airbnb. But behind the scenes, clearly that's going to be great for Visa too, just whenever people are swiping cards more.

41:45And beyond the growth in Visa's core business that we've discussed, they're also expanding with new flows and value-added services it sounds like and from what i understand new flows are basically any type of money movement outside the classic just buying something with a card model and then the value-added services are beyond that so any offerings that help visas existing clients operate more securely and efficiently but maybe you can just tell me if i'm understanding that correctly yeah exactly that's simplified that's kind of what it is And in terms of scope, we're talking about a market that's$200 trillion of an opportunity in just new flows.

42:26And the value-added services, they add another$500 billion, which also seems like a huge number. Not necessarily if you compare it to the$200 trillion before, but there's a lot of opportunity in both of those markets to grow. And Visa's share in both of them is significantly smaller than in their consumer payment segment. So now the biggest chunk of the$200 trillion in new flows come from the B2B payment space. And one of the key ways Visa is tapping into that market is through something that they call Visa Commercial Solutions. This is where Visa helps businesses modernize the way they handle things like supplier payments, reimbursements, and also travel expenses.

43:09So basically they're helping companies just do it on paper checks and inquires. Pretty much. Instead of using outdated payment methods, Visa enables them card-based and also account-to-account transaction between businesses. And that could mean issuing corporate credit cards or so-called single-use virtual cards. And another major growth area in Visa's commercial business is the automation of accounts payable. And this one is especially interesting because it helps companies unlock efficiency and improve working capital management. So imagine a large university that pays thousands of vendors every single year.

43:49They've got HVAC contractors, they've got cleaning crews, and then they got tech suppliers. It's a complex mess of invoices and checks and also approvals. Now, instead of mailing all those checks and keying and invoice numbers, the university can use Visa's AP automation tool with just one click. And then they can generate, again, these virtual Visa cards for approval vendors. They can send payments in real time through their Visa network and automatically close all the books with each transaction tagged and reconciled in their ERP system. It's very easy. It's a really compelling offering, and I'm sure there are probably some other use cases.

44:29but I know from the research I did on comfort systems which I pitched to you a few weeks back that the timing of payments can be such a huge problem for many companies especially those that do contracting work and there's this tension because on the one hand the longer you sit on your cash the better it is for you but on the other hand if someone does that to you and holds off on payment until even well after a service has been performed in some cases that can be really painful for your cash flow and business planning. So it strikes both ways. But it sounds like there's probably a bigger opportunity for Visa here to just generally help companies with the timing of their payments and basically supporting their cash flows coming in sooner.

45:09That's actually one of the services that Visa offers, particularly. So with smart payment timing, the university can choose to pay as late as possible, preserving float while still making on-time payments. And that improves cash flow, which I'm sure the finance professors in that university would highly appreciate. And how does Visa make money from the new flows and value-added services that we've also mentioned? That works mostly the same way it does also in consumer payments. So all the transactions that we've already gone through and discussed through interchange and network fees on those virtual car transactions.

45:47But the difference is that B2B transactions, they tend to be higher ticket. And these transactions, they're going very fast. In 2024, Visa processed$1.7 trillion in payment volume through these kinds of commercial and automation services. That might sound like a large number, but do you want to take a guess at the annual opportunity Visa sees in just that part of new flows alone? Oh boy, you're putting me on the spot here. I'm probably going to be way off. I'm sure it's a very big number, but I actually don't even really know what order of magnitude. Maybe a few trillion dollars? A few is a bit of an understatement, but you're not far off.

46:25It's$145 trillion of payment volume just by those B2B customers. And because that opportunity is so massive, the above-mentioned services are just one part of Visa's entire commercial solutions. The second major offering is something that they call Visa Direct Platform. Visa Direct enables real-time push payments, so it allows businesses and also individuals like you and me to send money immediately to a recipient's debit card or to a bank account. So there's no waiting time and there's no batch processing, which usually happens when you send account-to-account payments. I remember when Venmo first came out.

47:08It seemed like such a game-changer, but also so obvious. Like, why hadn't we all been doing this so much sooner? and it's easy for me to say that and i'm sure there's a lot of technical infrastructure that i don't understand that has to go into place to make peer-to-peer payments happen but yeah i mean it just works so well and is so valuable i'm kind of surprised something like it didn't become popular sooner and to just quickly ask about this last part of the business with the value-added services can you maybe just paint some more color around that for us now that we're talking through it all.

47:43It just shows how huge Visa's business actually is. So yes, let's talk about the final piece of it and that's value-added services. This is basically, and you kind of mentioned it, everything that happens beyond the swipe. It's not about processing the payment itself, but about helping Visa's partners to operate more securely, efficiently, and also intelligently using Visa's data and infrastructure. One of the most important categories here is risk and fraud management. Visa has built a tool set that it calls Visa Secure, which is kind of a self-explanatory name, and that provides real-time fraud scoring doing online transactions.

48:25It helps issuers verify a transaction is legitimate without requiring any annoying two-factor authentication unless it's truly needed. So the system uses a combination of signals and those include biometric data. So that could be fingerprint or face ID, device recognition. So identifying whether the device being used matches the historical behavior of the user. And then also behavioral analytics. Things like when do people usually buy? At night, in the morning, in the middle of the day? How fast do they check out? Are you usually checking the price and see if it's actually the right credit card?

49:01Why are you just immediately typing buy now? And then kind of what device they're using. Is it their phone? Is it their MacBook? And all of that is checked with every transaction that you do. And that data is then taken and compiled into what it's called a risk score, which is instantly shared with the bank issuing the card. And if it's suspicious, they might flag the transaction or the request, and then they ask for more verification. And if everything checks out, then the transaction just goes through. There's no friction for the user anymore. And with all of that, the risk assessment is just one of many segments that I would imagine belong to Visa's value-added services structure.

49:43Yes, the value-added services part is huge and it spans over five categories. And risk and identity is just one of those solutions. And many others are tools for banks and fintechs that use Visa cards, whether physical credit cards or those virtual debit cards. And then Visa offers APIs for instant digital card insurance, real-time spend controls, and all of that stuff. It's all part of the value-added services. So for example, if you've ever frozen your credit card in your online banking, and then just two minutes later you've unfrozen it, that's kind of what Visa enables you to do as part of those value-added services.

50:23It can also issues token management. So cards can be securely stored in wallets like Apple Pay or linked to subscription services. Do you use Apple Pay a lot? I do. I do, yeah. So then what Apple has actually secured in the phone or in the Apple app is not your actual bank code or the card, it's just a token, and that token is personalized for the merchant that you use and all sorts of stuff. So it's a very secure thing, and all of that is part of the value-added services. It would be a bit too much if we now go through all of them, but it's a huge business. I certainly love my Apple Pay, and I've certainly taken advantage of being able to freeze my card, too.

51:06I mean, I'd imagine back in the day, a lost credit card was this real panic-inducing moment. But now it's like, I don't even give it a second thought. Oh, I lost my card. All right, well, I'll just freeze it and request a new one in my card app. It's no big deal. Just as important, though, are there solutions for the merchant side of things? I think my question is, how are they helping small businesses accept payments more easily on that front? Yeah, Visa is really staying kind of in the middle. So they always have to have solutions for every single player surrounding them. So for the merchants, that's where the acceptance solutions come into play.

51:45Visa offers tools that help businesses, especially the smaller ones, to accept payments easily and securely. One great example is Tap to Phone. which lets a merchant turn any phone, if it's an iPhone or an Android phone, into a contactless terminal. So there's no hardware needed except for your phone now. In other markets, they also offer what is called QR-based acceptance. So for small street vendors or digital-first merchants. And all of this basically helps Visa expand acceptance, especially in emerging markets where you have a lot of those tap-to-phone and QR code payments. and digitize long-tail merchants that were previously cash-only.

52:30It is wild how easy it is getting to go cashless, if you really want to. I think my parents are probably shocked that for years I've done all my banking completely digitally and actually really never done it otherwise. Given that our lives sort of revolve around our smartphones for many of us, or at least for me, it does feel like captive pay is this new era of payments. but just to bring it back to visa it sounds like they're leaning into this move beyond cards entirely in some cases it feels like visa's layering all these services on top of the rails they already built kind of like turning payments into this full platform business and to me that sounds brilliant and is kind of a testament to how well-run the company is and it's only natural to try and build all these layered businesses on top when you have so much data and power over the ecosystem at your fingertips.

53:22So beyond the swipe, they're adding software, security, data, and even consulting. How important would you say these value-added services are to the overall picture with Visa's business? Are they sort of just a bonus, a sweetener to profit margins, or are they really becoming a driver of growth? Yeah, that's a great question. Because if you look at the market opportunities, 500 billion might seem a bit small. And on paper, Visa is still very much a transaction business. So most of its revenues still come from processing and volume-based fees. But value-added services are becoming a real growth engine.

54:00And Visa's management is leaning into that very heavily. In fact, in 2024, Visa's value-added services generated about$9 billion, which is roughly 25 % of Visa's total revenues. And even more interesting is that part of the business is growing at about 18 % per year. So that's faster than the overall payment volume. In other words, while people swiping their cards is still the foundation of Visa's business, these extra services are growing faster and they also have higher margins, even higher margins, if you might say so, and they don't rely on consumer spending, which can be cyclical at times.

54:38And as you said, those services not only grow faster, but also make it harder for banks or merchants to switch away from Visa once they're using all that infrastructure. So there is an element of stickiness here that I think factors into Visa's moat. And I guess before we dive more into Visa's competitive advantages, I am curious, we already mentioned how there's still a lot of room for growth in card payments due to these emerging market countries and even across Europe where there's still a high usage of cash. And we discussed new flows and the value-added services and how those can be important drivers of growth going forward.

55:19But could you just, if you have them at your fingertips, maybe some numbers around this growth narrative for Visa. What exactly are the top-line growth assumptions that you anticipate with Visa? And how is that growth distributed across its different business segments? So according to the World Bank, Global real personal consumption expenditure has grown at 2-3 % annually. And that's kind of a key number for Visa. When you adjust that for inflation, that number quickly doubles and you're about 5-6 % nominal growth. And since Visa earns fees on every transaction, that spending alone drives consistent revenue growth for Visa, even if their market share would stay flat.

56:03So that's 5-6 % of pretty secure revenue growth. The second driver is digitization, the shift from cash to card and electronic payments. From 2016 to 2021, card penetration of global PCE, if you exclude China, which like I said, is kind of the country on their own, it rose from 40 % to 56%, so about three percentage points annually. Some analysts even estimate that this trend will add 4-5 % to Visa's volume growth annually. However, this tailwind might get a little bit weaker in the developed markets. So I think a slight decrease is more likely than a further increase. And then finally, Visa is pushing into what it calls new flows.

56:51So these payment volumes that were historically not part of its network. And those will probably also be 1 to 2 % growth per year. If you summarize all this and quantified global PCE at 5-6 % per year nominal. I expect digitization to add 3 % instead of the 4-5 % that many analysts expect. And then new flows and also those value-added services would be another low single-digit percentage supported by Visa's own segmentation and then market opportunities. And taken together, that builds a solid base for low to mid double-digit annual volume growth, even before you would factor in price increases or also margin expansion, which also helps explain why Visa has consistently grown earnings at mid to high teen rates.

57:44So we've got rising spending, more digital payments, and then this opportunity in the B2B space. And it's all very promising. To bring it back to the moat, what is actually protecting Visa from disruptions or from losing market share? I mean, I think I have some ideas, but I do want to hear your thoughts on it since you've covered the company more in depth than I have. And obviously we always try to focus on this piece because even if the market potential is big, it's about as big as a total addressable market as you can have, a company without a moat cannot sustain its outperformance in the sense of it will not be able to consistently earn excess returns on capital beyond the opportunity costs of that capital.

58:30And so what is stopping someone else from doing what Visa does better or cheaper? The first answer and perhaps the most obvious one are network effects. Network effects at scale. Visa is a two-sided network connecting over 4 billion cardholders to more than 130 million merchants. That's a level of acceptance and reach that no one else can replicate overnight, and perhaps not even in the next 10 years. And the more people carry a Visa card, the more valuable it becomes for merchants to accept it. And the more merchants accept Visa, the more likely consumers are to carry around. It's a positive feedback loop that just reinforces Visa's dominance again and again.

59:11That flywheel is very real, it sounds like. And I know I've spent on payments, but come on, it doesn't take a rocket scientists to see that Visa's moats are, I mean, as wide as they come. I don't think they get wider. Not to say they're impenetrable, but boy, are they wide. And this is how I think about moats generally. Just a lot of breathing room, which is so important in business because inevitably mistakes are going to be made. And the question is, if management makes a strategic error, is this going to ruin the company? Is this going to ruin returns to shareholders? or is it just not going to be that consequential?

59:46And I don't want to say that Visa can afford to make a lot of mistakes over the long term, but with moats as wide as what they have, there's probably some room where they can make mistakes for a while and it's not going to be too consequential for the business. And it's even difficult to make mistakes when, and that kind of brings us to the second point, you have near zero marginal costs. Visa doesn't issue credit or hold balance sheet risks, so there's not even much that you have to manage. It just moves data. Once that infrastructure is in place, which it is, then the cost of processing one more payment is basically zero.

1:00:21That's why Visa can operate with 65 to 70 % operating margins and still scale globally. So when Netflix charges a card at the end of the month, then Visa earns a fee. But it doesn't cost them anything extra if$100 million at once would process that payment. Another one of the most important modes, and we've discussed it at length today, is brand and trust. This isn't just a piece of back-end tech, it's a globally recognized brand. When you're shopping in Tokyo, in Sao Paulo or Berlin, you see that Visa logo at the checkout, and then you immediately know this will work. When I'm somewhere as a tourist, I have a pretty bad habit of just looking totally lost.

1:01:03and in those moments it is very reassuring to see that stamp of approval to know okay i'm good at the very least my payment is going to work here i can't speak the language but i can still pay for what i need and one of those problems is more challenging than the other i would way rather be able to pay for something and not be able to communicate than vice versa now is usually the point where i would ask you about competitors but we'll get the market share data and just going off our conversation, I think it's fair to say the only real direct competitor is MasterCard. And what's always struck me as interesting is that even though Visa and MasterCard are technically competitors, they're not really locked in a fierce battle for market share, at least not in the way you would expect from these two global giants.

1:01:51And the reason for that, I think, is because there's this tacit acknowledgement that they both have great businesses and neither of them want to mess that up. You would basically do that by racing to the bottom just to, you know, squeeze out another five percentage points of market share or whatever it is and just undercutting each other and ruining each other's businesses. And that's partly because they're both operating on open loop networks, relying on banks and financial institutions to issue cards and acquire merchants. And what I mean is that they're not directly fighting for end users. They're both just the underlying infrastructure providers, which is kind of the point that I think we've both been trying to hammer home today.

1:02:31And in fact, most major banks issue both Visa and MasterCard, which really blurs the lines further of whether and how they're competing. And obviously most merchants accept both. So that's how you get to this thinking that there's more of a tacit agreement between them than there is truly a head-to-head war. It's a duopoly and they kind of both enjoy reaping the benefits of this kingdom that they look out over. And with that said, the world is changing fast it was obviously been a lot of hype about blockchains over the years and then now we're kind of emerging beyond this traditional card ecosystem and that was a really long-winded way of asking you daniel what does the competitive landscape look like beyond mastercard and what are the main risks or headwinds that could challenge visa's moats in the years ahead with MasterCard it's it's funny because I feel like you could give almost the exact same pitch that you give for Visa also for MasterCard now getting to the challenges ahead and kind of the competitive landscape there are three big categories to be aware of the first is regulatory pressure there's emerging local payment rails and then you have technological disintermediation and each one of them has potential to kind of chip away at parts of Visa's mode at some point in the future.

1:03:55Let's start with regulation because it's kind of the most obvious one. Visa has been under growing scrutiny, particularly around interchange fees and also merchant surcharges in the US. And the original Durbin amendment already kept the interchange fees on debit cards. But now there has been kind of a second wave, the so-called Durban 2.0 bill, which could introduce routing mandates, even on credit card transactions, that would force more competition into the space and at the network level. And that would make it easier for banks to route payments over alternative rails and not just Visa or MasterCard anymore.

1:04:38And then there's the rise of locally emerging payment infrastructure. So while Visa is the dominant player in Europe and the US, it kind of reinforced by switching costs and decades of merchant acceptance. But those advantages just don't exist in your markets and a lot of those emerging markets that we talked about. And in fact, governments in regions like India, Brazil, and also Southeast Asia are actively working on preventing Visa from getting the same power. And you kind of mentioned why. Because payment data is so sensitive that all these local governments don't want that data in the hands of a US company, for example.

1:05:23If we take a look at India, about nine years ago, the government launched what's called UPI, the Unified Payment Interface. That's kind of a real-time account-to-account network that connects consumers and merchants directly. So it's bypassing traditional card infrastructure entirely. People use it to pay via QR code, mobile number, or even just a name. So there's no plastic card needed, and Visa is not getting any share of this. And today, UPI processes more than 70 % of the total transaction volume in India and already represents 36 % of consumer spending. That's a huge chunk that never even touches Visa's payment rails.

1:06:07And I think Brazil is going a similar route, right? While Visa and MasterCard are probably some of the dominant players there, I've heard that PIX is Brazil's version of UPI. It might even account for as much as half of their payments. yet it's only been around for a couple years is that all correct yeah that's true Brazil is kind of going the same route and as we mentioned it's 1.4 trillion dollar market so these markets are huge and it looks more and more like Visa is not really getting into them at least not to the same extent that they were able to in the US or Europe that's kind of why they going this more digitalized route and going into new flows and value-added services to say okay if we do not get the same piece of the pie in consumer spending, then perhaps we can at least get some form of revenues from new flows and those value-added services based on all that new infrastructure.

1:07:04Talking about markets as shut off Visa, China has early on built out its own system. And whenever you look up numbers for Visa or MasterCard, they exclude China. We've talked about China in this episode a couple of times without ever really mentioning what we even mean. And China is the most extreme case. Their payments landscape is entirely dominated by domestic players, especially by China UnionPay, Alipay, and WeChat Pay. So those are the three big players. And UnionPay alone processes the vast majority of card transactions. And you can basically say that Visa has been trying to get into that market for a long, long time, but they just couldn't get a foothold there.

1:07:47And at the end of the day, the regulatory barriers and the state support for union pay have made it close to impossible to get any form of market share. I suspect this is not the last instance of a company we'll cover where they've been boxed out of competing in China. We saw that with Airbnb and Uber and now Visa here too. But competition does not only come from governments, I would think. we've seen the rise of fintechs and some innovation and account-to-account transactions. And today, most fintechs still partner with Visa, but maybe that will change in the future. That's definitely possible.

1:08:26Most of the fintechs that partner with Visa are players in markets, where Visa is the dominant player anyway. So that's PayPal, Apple Pay, or Square. But even they are starting to nudge users toward linking their bank accounts instead of their credit cards or debit cards. So from the fintech's perspective, that would be beneficial because then they won't have to pay those fees. For Visa, it obviously would be a huge burden because then they don't make any money on those payments anymore. But the bigger threat, and you kind of mentioned that, is the emergence of full-fledged account-to-account payment infrastructure.

1:09:04So systems that move money directly between bank accounts and Visa is not seeing any of that money at any point. Now these A to A flows, they're often slower. They require manual logins or extra authentication. They kind of lack the user protection that Visa can offer to all its customers. So that makes it a bit more difficult in markets like the US or Europe to imagine that those will actually become a threat for Visa. But in markets where you don't have the same infrastructure yet, where people are not yet used to all the convenience that Visa offers, it's a huge problem there because they might just accept the fact it's a bit more slower and less protective.

1:09:46And Visa never gets a foothold in that market and can never establish the same amount of market dominance. And then they lose out on huge markets. So we've talked about Visa's business model. It's growth levers. It's very robust competitive advantages. And the question, of course, is what does that all actually mean for the valuation? And before I ask you about that, I'll maybe go on my own interlude just to say that in our Adobe episode, we performed some rough math based on adding together the free cash flow yield and then estimated free cash flow growth. And since Visa has a similar setup of just churning out a lot of free cash flow with its business.

1:10:28I might try to start our valuation using that same rule of thumb again. And look at Visa, we currently have a free cash flow yield of a little more than 3%, which is not bad. And I calculate that by taking Visa's free cash flow per share and dividing it by Visa's share price. And then you add to that the expectations of 10 % expected free cash flow growth, probably. And you're talking about perhaps maybe a 13 % annual return when you combine the two. And that sounds great, sort of just depending on how much of that free cash flow they're reinvesting to drive growth, and then how much of that is being paid out in dividends or share repurchases.

1:11:02And of course, that assumes that your exit multiple on the company stays approximately the same too. So I'm already taking something that's supposed to be this really simple heuristic and making it more complicated. But let me just ask you, Daniel, does that align with how you think about the opportunities and the risk return profile for investing in Visa? It's definitely not far off, but there's a major difference between Adobe and Visa. And that difference is the valuation. We've talked about Adobe and how it's kind of priced to get disrupted. The market is expecting them to not have the same business model five years from now.

1:11:38And with Visa, it's a bit different because they are basically priced for perfection. And if you have to pay a multiple of 28, what you expect is a fantastic business. And you get that with Visa. You have a business that delivers over 40 % on returns on invested capital. It requires almost no reinvestment at all. And the free cash flow margin is in the mid-50s. Its operating margin is somewhere between 65 and 70, depending on the year. So the business is high quality. Now, those cash flows are being used primarily to buy back shares and to pay out dividends. I think the number since 2020 has been$58 billion of repurchases in its own stock, which is representing about 15 % of the entire shares outstanding.

1:12:24Then just last year, Visa repurchased$17 billion. And on top of that, they paid another$4 billion in dividends. That's a yield of about 3 % to 4 % annually. Now, in my valuation model, which we should slowly get to, I try to capture the three core growth engines that we've talked about earlier. So that's global PCE growth, which adds 5 % in my valuation model. Then digitization, so the shift from cash to electronic payments, where I'm using more of a conservative estimate of these 3 % growth instead of analysts' 45%. And then finally, we have new flows and value-added services. where I expect low single-digit growth for both of them.

1:13:10Now I arrive at those numbers by multiplying their revenue share by their annual growth rate that we've seen in the last couple of quarters and years. And put together, that supports long-term revenue growth in the low teens. With the additional tailwind from buybacks, I get to dilute ADPS, so accounting for stock-based compensation, of about 15 % annually, which in my opinion does justify a premium multiple, especially when you consider the business's durability. Now your free cash flow based math kind of suggests that Weezer should deliver a return of about 13 % per year. My base case scenario yields a fair value stock price of approximately$360, which translates to 9.5 % of returns.

1:13:58If we add to that, the average forward dividend yield will reach about 10.5%. So it's a bit lower than your 13%. We kind of have to figure out why that is. And the main difference is that in your Adobe model, the process of weighing the different exit multiples has actually led to an increase in value because Adobe was on the cheaper end. That's why most of the weighings in the exit multiple caused for more upside in the stock. Now Visa is a lot more expensive than that. So most of my assumptions for what multiple they could trade five years from now actually drive down the stock's value. That's kind of why we do not reach the 13 % from your rough free cash flow math in my model.

1:14:42And I think this is a great example of why we need to pay attention to valuation. As you kind of talked about last week, our very rough free cash flow math made more sense with Adobe given its more conservative valuation such that the expected return was about the same. And this time with Visa's valuation, it's just clear there's no margin of safety in the same way. And to get a double-digit return, which is our benchmark typically, everything has to work out exactly as hoped in terms of growth with also no compression in the company's valuation multiple. And that's just not really a recipe for attractive risk risk-adjusted returns.

1:15:22You're banking on everything basically going perfectly and everything else being equal to get maybe 10 % a year. That's kind of how I see it with Visa. And with Adobe, just to show why that was a more attractive opportunity to me personally, it was a company that has been trading at the lower end of its historical valuation range. Actually, it's cheapest price to free cash flow multiple in over a decade. So when you're looking and if that lends, it's not that crazy to say, okay, well, at worst, it's probably not going to get much cheaper in valuation, or at least in multiple terms. And then there's some room for upside where actually it could have some mean reversion.

1:16:03That is kind of a tailwind for your returns. You have the compounding and free cash flows, but then you also potentially have this tailwind lifting your returns further with the valuation multiple. And with Visa, I think the risk reward profile there, at least in the multiple front, is completely flipped. Probably more likely that the valuation multiple will decline, which would be more of a headwind for returns. Even if you're compounding free cash flows at 10 or 12 % a year, your actual returns might be lower than that, depending on how much the multiple compresses. So that's a long-winded way of saying Visa does not strike me as being obviously cheaply priced or attractively priced in the way that I felt excited about Adobe?

1:16:47You know, I'm not a big fan of ratings like buy, hold, and sale. But in my opinion, there are some clear buys. And Adobe was one of those companies just because the evaluation made a lot of sense for what the both of us expect future growth to look like. I wouldn't go as far and say that Visa should be a sell because the business model is incredibly good. You see growth on many fronts. I mean, in my model, for example, by understated almost all the growth levels. I also assumed a slower dividend growth than the company has shown historically. So my base case is probably more on the conservative side and it's still reaching about 10 % annual returns.

1:17:28So I think if that's where you're going for, Visa is definitely a company attractively priced. But as you mentioned, you do not have this downside protection. A company trading at 28 times earnings is just one headline away from declining by, let's say, 20%. And that headline with Visa could very well be something on the regulatory side, where they try to go into another market and then the local government is trying to prevent it. Even in the US, there are still some lawsuits going on. So Visa is priced, as you said, for perfection. And I myself never like businesses that are priced for perfection, because as we all know, that's rarely happening.

1:18:12So it's kind of, I would probably rate it as a hold. If it's in your portfolio and you see the quality of the company, you should probably not sell it. On the other hand, if you're buying into the position from today's prices, it's also not as attractive as it could be. And just one other thing that I wanted to mention is the circle of competence. I know that you often say payments is a sector that you do not understand maybe the best, maybe you have another circle of competence. And I would probably agree with that. If I look at all the levers and all these different business models, it's a very complex thing to understand.

1:18:49And you might know why they say we will grow 10 % from now. But would you actually be the first person to spot if that's not the case anymore? And I just know I wouldn't be. And if I buy a company at that price and I wouldn't be the first person to judge whether growth is slowing down. It's just not a good setup for me. I'd be the first to say I find payments makes my head spin. I think you did a good job kind of walking me through it today, but I just, I don't get payments. As much as I'd like to think that I do, it's still just something doesn't click for me. We're like the way you put it is I wouldn't feel confident in my ability to understand how this industry is changing and then what that would mean for the growth implications for Visa, where if I saw some change, I don't have this intuitive reflex where I could say, okay, this is what it's going to mean for margins.

1:19:47This is what it's going to mean for growth. There's just so many moving parts with payments and so much of it happens behind the scenes. I think that's kind of what we mean when we say it's not our circle of competence. You could probably say something similar with Uber, for example, but I've ridden in a lot of Ubers, and I feel like because of that, I have an intuitive sense of what is happening with that company. And it's different with Visa because even though I've swiped my card in many ways, I don't really know everything that goes into it. And maybe to play devil's advocate, you could say the same thing with Uber, but I just have a different intuitive sense with it.

1:20:24Maybe that's naive. And it's the same with Adobe where I look at, even though we're focused on investing, we also work in media and content creation. And we have a lot of coworkers who are creative professionals. So it's not as much of a leap for me to understand what Adobe does as it is for me to understand the web of financial infrastructure and regulatory overlay that governs what Visa is able to do. Which is why for me, it just falls in the too hard pile. And as you put it, it's probably a good hold. I would lose no sleep at night if I had Visa in my portfolio already and if I inherited it.

1:21:00But at the same time, when we're talking about allocating fresh capital toward an investment and trying to find the most attractive possible investments available to us at a moment in time, maybe we'll get a chance in a bear market where Visa is a dislocation in its price. But I don't feel like we're there now. I would say Visa has probably been pretty efficiently priced by the market. And if you're going to buy it today, you're at best going to get average returns, which is okay. There's nothing bad with average returns, but it doesn't quite meet the threshold for 12%, 14%, 15 % annual returns that we typically try to target, especially where our downside is more protected than in this case.

1:21:41I think we mostly agree on it. I probably see a bit more growth on the Visa side. But as you said, the downside protection is just not enough for me. So I think to sum it all up, we can agree that at this point, Visa will not become a part of our intrinsic value portfolio. And I would hope that maybe the next pitch will actually become a part again. And how about you just give us the typical three hints for the next week's episode? So next week, I've got another really high quality business to pitch that is maybe not so cheaply priced either. They're also instrumental in facilitating commerce, though in a different way, I'll say.

1:22:21And maybe just as another hint, I'll mention that the company is sort of a wordplay on what they do. Hopefully that's not too obvious. You can leave your guesses in the comments. I think it's guessable, but I wouldn't say it's too obvious. No, not at all. All right. So let's close it, as always, with a quote from the person who turned the deep value Buffett into the high quality Buffett. So today's quote is by Charlie Munger and he said, a great business at a fair price is superior to a fair business at a great price. Despite that, we do not yet see Visa as being at the perfect price for us, but still we will keep it on the list.

1:23:01With that said, see you all in the next episode.

1:23:12Thank you.