Amazon recently announced that their UK division will stop accepting Visa branded credit cards. The stock dropped over 5% and lost around 20 billion in market cap.
Was the market reaction to the Amazon news justified? Or was it an overreaction?
What does this showdown with Amazon mean for Visa’s once unassailable business model?
And at Visa’s current price what expectations is the market pricing in and is the reward worth the risk if we buy Visa today?
Overreaction?
Was the recent Amazon news sell-off justified or was it a quintessential market overreaction?
Amazon has around 30% of the UK e-commerce market, according to a 2019 report by Ascential. It’s probably a little higher today but this is the most recent estimate we could find. Total 2020 e-commerce spending was around $323 billion (£243). Amazon UK accounted for $100 billion in e-commerce spending if we round up. This is only 0.87% of Visa’s total payment volume.
Amazon is only dropping Visa credit cards. People in the UK can still pay with their visa branded debit cards. More spending occurs on debit cards in the UK. In 2020 according to Statista, debit card spending was 52 billion British pounds versus 12.89 billion for credit card transactions.
The show down with Amazon is also an effect of Brexit. Visa is about to increase credit card fees from 0.3% to 1.5%. Visa is also about to increase debit card fees from 0.2% to 1.5%.
Visa debit cards are still accepted, more spending happens through debit cards than credit cards in the UK, and fees on debit cards are going up. Based on pure numbers the drop in Visa’s share price does not equate to what they’re potentially losing. It was a classic market overreaction.
But…
Visa has a tremendous business model and a really wide business moat built on strong network effects. What if the showdown with Amazon is a sign that their business moat is not as wide as we think? What if the fight over fees spreads to other markets? What if this pushes transactions away from Visa’s payment rails? What if this causes that wide moat to shrink? Then we have a serious fundamental change to Visa’s business and the 5% drop is not enough.
This is not the first time a big retailer forced a showdown with Visa over their card fees. In 2016, Walmart and Kroger tried to do the same thing and all parties settled in 2019. Excluding Visa was hurting the customer experience at Walmart and Kroger. People wanted to use their Visa cards. They wanted to earn their rewards. Walmart and Kroger probably lost some business by reducing consumer choice and Visa probably lost some payment volume. So, both sides saw a need to compromise.
The most likely outcome is Amazon and Visa reach a settlement too with increased volume discounts for Amazon. Amazon is pushing back against Visa in the UK, a smaller market for Visa, to get Visa to negotiate. It’s not a move designed to punish Visa. It’s to put pressure on them.
Obviously, no one knows if, when, or what type of settlement will occur which creates uncertainty and market participants hate uncertainty. They pay up for the warm comfort of certainty. And that’s part of Visa’s recent stock slide. The stock was bid up to high multiples because it was a certainty that Visa’s business moat was unassailable. Now maybe it is.
Reopening or Closing Again?
Visa is also a part of the coronavirus reopening play. It was certain everything was going to bounce right back as vaccines rolled out. But even with vaccination rates still increasing around the world, coronavirus is still a big disruptor. People had big plans to get out and travel once vaccinated but when they take stock of the world, they start thinking “maybe next year”. Especially as we’ll likely see a 4th wave of infections this winter and the Omicron variant was recently discovered.
Travel has not recovered fully which hurts Visa’s cross border transactions. It was cross border volume that disappointed in Visa’s last quarterly earnings report along with their weakened guidance compared to the market’s expectations. Since then new travel restrictions have been initiated.
BNPL
Then you add a new competitor slash disruptor to the narrative, Buy Now Pay Later.
Fintech especially the payment space is not a zero-sum game. Not yet. The market keeps growing, it’s still highly fragmented, so there is room for a wide range of winners.
Estimates for 2025 put Buy Now Pay Later transaction volume at $357 billion with some estimates as high as $1 trillion. Visa and Mastercard are already in the trillions and still growing double digits. Visa and Mastercard’s total 2020 volume combined was $17.72 trillion. They’re huge. Do you want to take them on directly? Or would you like to partner up with these guys and swim in their wake to grow as fast as possible?
Before being acquired by Square, Afterpay said 80-90% of its installment payments were made by debit cards. And the estimate for all of buy now pay later is 75-80% of installment payments are made by debit cards. One processing fee for Visa and Mastercard now becomes 4. Over time I think we’ll see the growth of Buy Now Pay Later as another channel for increased volume on Visa’s and Mastercard’s payment rails.
This is not to say there are no risks with buy now pay later to Visa’s business moat, for example bypassing Visa and Mastercard’s payment rails by going direct to bank accounts, but the narrative that Buy Now Pay Later will take out Visa and MasterCard is more hype than reality. But the narrative is there and it’s hard to shake. So that is adding pressure to Visa’s stock.
A high starting multiple, then add some new negative narratives, plus lowered expectations for a rebound in cross-border volumes, and you can see why some initial price weakness leads to more price weakness. Momentum is a factor.
Buy Visa?
After this drawdown is Visa’s stock attractive. Does it offer a good risk-reward profile?
When I look at the last 10 years for Visa’s P/E and EV to EBITDA multiples, their mean, and standard deviation. It’s approaching its 10-year average. This is after moving high above the upper bound. What usually happens here is an overshoot and as it approaches the lower bound. Again, momentum.
If it does reach or drop below the lower bound, it should be a great buying opportunity for Visa. Because I believe there will be a settlement with Amazon and the narrative around BNPL and disruption will change too. And at the time the market will discount Visa’s future too much.
And even at Visa’s current price and multiple, it’s a decent risk-reward. The consensus is for 15+% earnings growth over the next 5 years or so. Visa’s current return on invested capital is 24%. We bumped our required return up to 16% because of the 15% growth. Based on this our justified PE ratio is 37-38 times. Visa’s current PE is 35. Now if you want a higher rate of return that would bring the justified PE ratio down and lower the target price for Visa.
Then when I break down the market-implied price expectations as outlined in Michael Mauboussin’s book Expectations Investing, I see that the market is really only giving Visa credit for 10% revenue growth versus the consensus 15% growth. I’m keeping Visa’s operating margin the same because I don’t see an immediate catalyst for Visa’s operating margin to shrink. The market-implied price is expecting slower growth.
If the consensus plays out then the market is currently underpricing Visa’s future.
We’re adding here and we’ll add more if it goes lower. We never know when the bottom will be and I can guarantee that we will not time the bottom in Visa’s stock price. We just want to put money to work when we think the long-term risk/reward is favorable. The caveat is if the underlying fundamentals of Visa’s business do not deteriorate.
