Visa's Debit Domination Makes Its Stock a Smart Buy

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One of the most basic questions in business is this: Who is your customer? In the case of Visa (V), the dominant processor of debit card transactions, that answer is not the person who uses the debit card, nor even the merchant who lets the consumer use it. The customer is the bank that issues the card. By rewarding banks -- often to the detriment of consumers and merchants -- Visa has turned itself into a money machine. And you might want to consider investing in its stock.%%DynaPub-Enhancement class="enhancement contentType-HTML Content fragmentId-1 payloadId-61603 alignment-right size-small"%% Before getting into how Visa built its money machine, it is important to explain that there are two kinds of debit cards. The one that Visa likes is called a signature debit card: It enables users to access their checking accounts to buy things by signing for them at the point of sale. The type Visa does not like as much is a PIN debit card: It requires users to key in their four-digit codes before they can make their purchase.

Why does Visa prefer the signature to the PIN debit card? It's simple, explains the The New York Times: Visa and the banks make more money off of the signature cards. And that makes perfect sense to Visa -- even though the signature cards cost the merchants more and are riskier for consumers. How so? Visa's extra revenues from signature cards are the result of the higher fees it charges merchants for signature transactions. And it's far easier for someone who steals your debit card to fake your signature than to guess your PIN.


WalletPop: Debit-Card Debate: Use a PIN or Sign? Either Way It Will Cost You


Merchants Pay More, Pass the Costs on to You

Visa's real customers -- the banks -- have gladly lapped up the higher fees which Visa passes on to them from signature-based transactions. The result is that today, 61% of all debit transactions are done with signature cards, even though PIN debit cards are less expensive and less vulnerable to fraud.

Specifically, Visa charges merchants 75 cents for every $100 spent on signature debits -- this includes a per-transaction fee of 5 to 6 cents, plus an interchange fee of 1% to 3% of the transaction amount to promote Visa -- more than twice what it charges them for you to use a PIN debit, according to The New York Times. When you consider that Visa processed 40 billion transactions in the fiscal year ending June 2009, it's easy to see how fast these fees add up.

Interchange revenue is up 125% from $20 billion in 2002 to $45 billion today -- due in large part to the surge in debit card use.And merchants pass that growing cost to consumers: the National Retail Federation told The New York Times that interchange fees cost the average U.S. household $427 in 2008.

Signature debit is a lucrative market that Visa dominates, and it has recently turned its attention to the PIN debit market as well -- capturing the biggest share even while raising the fees it charges the merchants. Today, Visa has a 73% share of the U.S. signature debit market. Its share of the U.S. PIN debit market is smaller, but growing: At 42%, Visa is the biggest PIN network, according to The Nilson Report.

Visa Stock: It's Everything You Want To Buy

It has been said that living well is the best revenge. If you use debit cards, one method of living well might be to buy Visa stock which has risen over 34% since its 2008 IPO, according to The New York Times. Will that rise continue? Below, as I have posted about before, are four tests to consider in a long-term investment. Based on my analysis of how Visa fares on them, I'd say, the company stacks up pretty well.
  • The CEO and other top executives have their net worth tied up in the public shares. Visa does fairly well on this test. According to its proxy statement, Visa's CEO has a relatively modest stake in the company of about 420,000 shares, which, at more than $36 million, I would guess accounts for most of his net worth.
  • The company participates in a large, rapidly growing industry. Visa clearly passes this test based on the above analysis.
  • The company is the market-share leader and has the skills needed to maintain that lead. Visa clearly passes this test based on the above analysis.
  • The company usually beats earnings expectations and raises revenue and profit guidance. Visa does well on part of this test. For the last five quarters it has beaten analysts' earnings expectations, but I do not know whether it has consistently raised guidance.
Visa stock is moderately expensive now -- trading at a Price/Earnings to Growth (PEG) ratio of 1.3 -- on a P/E of 28 compared to 21% earnings growth to $4.35 in 2011.

Consider buying it on dips.

Peter Cohan has no financial interest in the securities mentioned.
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