The Visa IPO: Why We’re Going Long…
The Visa IPO: Why We’re Going Long…
by Louis Basenese, Advisory Panelist, Investment U
Associate Investment Director, The Oxford Club
Monday, March 24, 2008: Issue #778
The Visa IPO went public on Wednesday. And it tipped the scales as the biggest IPO in U.S. history, raising $19.65 billion.
I’ll tell you one thing - after tracking hundreds of IPOs in the past four years, I can’t remember a single deal that got so much mainstream coverage. Sadly, most of it was just fluff.
While everyone wanted to talk about the deal (and did), none offered much actionable advice. To me, it’s not worth discussing a particular investment unless you’re willing to get off the fence and pick a side.
So today, I will.
- If you get a chance to buy Visa below $65 per share, pull the trigger.
Visa could easily be worth $80 by year-end. That’s a potential double-digit upside, a rare opportunity in these markets. So grab it. (By the way, the “back door approach” - buying the companies with a stake in Visa - is not a good idea. See today’s Crib Sheet below to find out why.)
Now, here are the reasons I like Visa so much…
The Visa IPO: Own A Piece Of A “Relative” Monopoly
The pitch for Visa is simple, it’s a rare opportunity to own a piece of a relative monopoly, as evidenced by the charts below.
Based on every conceivable metric (total volume, total transactions, cards issued, profit margins, loyalty, etc.), Visa outclasses all of its competitors by wide margins. And there’s little chance it will ever be dethroned.
Since we’re in the throes of a credit crunch, it’s also important you understand that Visa is NOT a credit card issuer, NOT a lender, and NOT exposed to consumer credit risk. It simply is a processor that collects a fee based on the number of transactions and the dollar amount of the transactions it processes.
And to put it simply, business is booming…
The global payments industry is undergoing a massive shift - away from cash and check, to card-based and other electronic payments. In fact, since 2001, credit and debit card purchases went from 13% of payment volume to 27%, a compound annual growth rate close to 15%. It’s worth noting that Visa grew twice as fast over the same period.
Rest assured, this trend still has great legs.
According to The Nilson Report, we can expect the global card purchase market to expand by at least 11% per year through 2012, with particularly strong growth coming from international and emerging markets. Again, expect Visa to deliver even stronger growth.
While management calls for a 20% increase in earnings, I’m convinced that’s a conservative estimate. A growth rate of 30% to 35% is more likely. Why?
4 Fundamentals Driving Visa’s Stellar Earnings Growth
- First, there’s not a weak spot in Visa’s revenue mix. Sales are increasing at healthy double-digit rates across all business segments and geographies.
- Second, Visa benefits from significant operating leverage. For example, since 2003, total transactions increased by 61%, but costs only increased by 12%. And with its payment processing network (VisaNet) capable of handling twice its current volume with almost no increase in costs, any incremental increases in revenues will result in dramatic increases in earnings.
- Third, Visa’s likely to significantly reduce its tax rate. And the savings will flow directly to the bottom line. Prior to the IPO, Visa never had a reason to obsess over tax management. As a result, it has the awful distinction of being one of the few companies with a 41% tax rate. In comparison, MasterCard sports a 35% rate. But this will change.
Expect Visa to get to the same tax level as MasterCard in short order. And a 5% savings on hundreds of millions of dollars in income will no doubt have a dramatic impact on earnings.
- The last reason to own Visa is because it boasts a rarity - a business that’s increasingly recession proof.
A total of 42% of its revenue is now derived from non-discretionary spending. Plus, 80% of its volume is locked into multi-year contracts.
Moreover, history bears out the recession-proof nature of its business. During the last two recessions, Visa kept growing, in terms of total transactions and total volume. And in each of the last 13 months, while a recession has become more and more likely, business continues to grow at high single-digit or low double-digit rates.
The Visa IPO vs. Mastercard’s IPO
Many keep benchmarking the Visa IPO against MasterCard’s wildly successful IPO. But there’s really no comparison. Visa is a far superior company, with a rare combination of growth and safety. Accordingly, it warrants a higher valuation. And that means shares are destined to head higher.
Good investing,
Lou Basenese
Louis Basenese spent years with one of the country’s leading investment and brokerage firms as a top analyst and trading expert, specializing in corporate takeovers and IPOs. He is now the Associate Investment Director of The Oxford Club and regularly contributes his ideas to Investment U.
The Investment U Crib Sheet - The “Indirect” Approach to the Visa IPO is a Bad Idea
- A lot of commentators are suggesting you sidestep the hoopla and play Visa (NYSE: V) indirectly by purchasing shares of one of the companies below: Company: JP Morgan Chase (NYSE: JPM)
Stake in Visa: Class B 23.3%Company: Bank of America (NYSE: BAC)Company:National City Corp. (NYSE: NCC)
Stake in Visa: Class B 11.5%
Stake in Visa:Class B 8%
Company: Wells Fargo (NYSE: WFC)
Stake in Visa: Class B 5.0% - The rational seems logical: Since they control a sizeable stake in Visa, they should benefit without the risk of buying into the traditionally volatile shares of a newly public company.
Bad idea.
- The same thing happened when VMware (NYSE: VMW) stormed the markets. Back then, everyone suggested buying EMC Corp. (NYSE: EMC) instead, because it retained an 80% ownership stake. (Louis took a stance then, too, and instructed subscribers of his HOT IPO service to buy VMW immediately. A move that handed them a quick 77% gain.)
- The fundamental problem with this indirect strategy is two-fold.First, even a 23% ownership stake in Visa will barely move the needle for these companies. Take JP Morgan Chase, for instance. It raked in $3.17 billion in revenues in the fourth quarter. Visa’s sales checked in at $1.49 billion. Doing the math, JP Morgan’s share of those revenues, approximately $342 million, would account for only 10% of its overall sales.In essence, if you buy JPM, you’re getting 90% JPM, and only 10% Visa.
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And aside from watered down ownership, the indirect approach also carries unnecessary risk…
- The credit card industry is highly litigious, and Visa currently faces billions of dollars in claims. The same is true of MasterCard (NYSE: MA). However, Visa put safeguards in place to protect new shareholders.
- As part of the reorganization and IPO, Visa funded a $3 billion escrow account to cover litigations arising from operations prior to the IPO. But the big banks don’t benefit from this protection. As Class B owners, they’re prevented from cashing out until all pre-IPO litigations are resolved. And if the dollar amount exceeds the allocated $3 billion, guess who’s on the hook? Class B shareholders.So while the value of their stakes might be massive now, an unfortunate turn of events could quickly change that. But if you buy Visa directly, you don’t have to worry about the past coming back to bite in the rear.