Visa (N-NYSE, $162.79) & Mastercard (MA-NYSE, $249.15): Global Payments as Fast as the Speed of Thought.

A human brain neuron is capable of firing once every 5 milliseconds. Once the neuron has fired, the action that follows, say for example, a sprinter electing to move his legs, can represent a time of perhaps as little as 150 millisecond. In payment terms, from the time that the cashier asks you, “how will you be paying for your purchase”, your decision to use either Mastercard, Visa, or other form of payments will take anywhere from as little as 5 milliseconds to perhaps a few hundred milliseconds at most.

Sprinters develop muscle memory through the process of training and repetition. The goal is to reduce the amount of time needed from the sound of the starting pistol to something closer to the time of the neuron firing. For the global credit card payment processors, as customers repeatedly utilize one or more credit cards to move money on their payment networks, so too is this neuro transmission speed optimized. Eventually, at some point, the muscle memory and neurotransmissions are fully integrated and that is the point when a credit card customer is operating at peak efficiency.

The business of Visa and Mastercard is NOT the operation of credit cards. Rather, both firms operate global payment toll roads. Each set of roads, or interchange network, is distinct from one another. They move money from one point on the planet to another at the wave of a credit card over a machine. The branding of each card, be it Visa, or Mastercard, designates only which set of toll roads (interchange networks) will be utilized to move those payments.

Acceptance of the two company interchange network system has become so ubiquitous that for most customers, the decision to use one or another is largely now down to muscle memory. This has now afforded, for the first time in recent history, the opportunity for each company to increase, by roughly 2/100ths of 1 cent, the cost of moving the money on that toll road.

Interchange fees by Visa and Mastercard are set to increase in 2019. Although puny, almost insignificantly so, and certainly not something that individual card-holders will even notice, the cumulative revenue that might be earned for each company could eventually exceed $1 billion per annum by 2021. As costs are largely fixed in the industry, this piddling per-transactional sum, less than a rounding error, represents a powerfully accretive aggregate sum for the top and bottom lines of each firm. At Mastercard, the accretion of each dollar of revenue produces roughly 60 cents of EBITDA. At Visa, accretion for each dollar of revenue produces about 65 cents of EBITDA.

Ratail investors misunderstand the business of Visa and Mastercard. Neither operate your favorite credit card; that is the responsibility of the issuing bank. On the planet today, there are many small regional interchange networks, but only two truly global toll roads exist. One is operated by Visa, the other by Mastercard. In China, where Visa and Mastercard have been barred from doing direct business, a regional national player, China Unionpay, has sprung up and become enormously successful, to the point that Unionpay processes more transaction than either of the two publicly listed firms. If/as/when China Unionpay ever goes public, I will certainly consider the investment merits of owning that firm. However, for the time being, the two toll road systems operated by Visa and Mastercard are essentially, for lack of a better term, a “global dupopoly”.

Investors pushback on the business case of Visa and Mastercard lies around the notion of alternative payments. They brought up firms such as Paypal, without understanding that Paypal is not a competitor to Visa or Mastercard. In fact, Paypal is one of their larger customers, as most of the payments on the Paypal system move through the Visa or Mastercard interchange networks.

Alternative payment firms are vying for space and revenue. They focus upon speed, upon cost in the peer to peer transfer space, and upon fees charged by banks to transfer money. What none of the alternative payments can compete with, to this date, is the collective muscle memory and firing neurons of more than 4 billion persons on the planet presently utilizing either a Visa, or a Mastercard interchange toll road. When the payment purchase decision is largely embedded in the human brain, just how does anything get faster than that?

New and prospective investors look at the current valuations of Visa and Mastercard and hold their noses. Do these same investors think less of Microsoft, which sells for similar multiples on an EV/EBITDA and sports s slower rates of growth? Microsoft is flirting with a $1 trillion valuation and generates quarterly revenues in excess of $30 billion and produced more than $8.8 billion of net profits (29.3% net profit margin) in the most recent quarter.

Visa and Mastercard, when combined, generate more than $9.4 billion in quarterly revenues and produced net profits of $5.2 billion, for a 55.3% net profit margin.

One could argue, and I do, that with a combined market cap of $609 billion vs $1 trillion, a net profit of $5.2 billion vs $8.8 billion, a net profit margin of 55.3% vs 29.3%, similar revenue growth and a market cap valuation differential of about 40%, in comparison to the present valuation of Microsoft, Visa and Mastercard seem to be fairly valued.