MasterCard's IPO: A 'Priceless' Opportunity?
The firm's public offering looks very attractive.
by Ryan Batchelor, CPA | 05-18-06 |
In one of the highest-profile initial public offerings (IPOs) in a while, MasterCard expects to begin its life as a public company during the week of May 22. The firm plans on selling about 61.5 million shares, or about 46% of the company, at an estimated price range of $40-$43 per share. At this price, we think the IPO looks like a bargain, given our $80 fair value estimate.
We see two main factors motivating MasterCard's IPO. First, the member banks, which currently own the firm, will reduce their exposure to MasterCard's legal liabilities, both known and unknown. Second, the firm will raise about $650 million in cash to keep as a capital cushion in the event of future legal cash settlements. While we've seen no preliminary indications of the level of interest in the IPO, we believe MasterCard's high profile will attract ample interest in its publicly available shares.
Below is an excerpt from our upcoming MasterCard Analyst Report.
Thesis
We think MasterCard has a great business model, and it competes in the very attractive global consumer payments market, which should provide it with ample growth opportunities. Although the firm faces substantial legal risks, we think MasterCard would be an attractive long-term investment if purchased with an adequate margin of safety.
We think of MasterCard as a brand and a transaction processor, and we're big fans of both things. The firm receives about two thirds of its revenue from its processing functions (operations fees), and the remaining third comes from assessments it charges its members to use the MasterCard brand, based on how much the cards are used.
We think MasterCard has an impressive global brand, which has been strengthened recently by its worldwide "Priceless" marketing campaign. In our view, one of the greatest benefits of its brand strength is that MasterCard is maintaining most of its pricing power, even though its customers--generally the banks that issue cards--are getting larger and gaining more bargaining power, thanks to consolidation. We believe that the firm will make up for any concessions it provides to large customers by charging higher fees to its remaining customers, which don't possess as much bargaining power.
We also like the firm's processing business, which performs functions such as authorizing charges, and clearing and settling the payments between merchants' and consumers' banks. MasterCard charges various fees for performing these services, which averaged about $0.14 per transaction during 2005. These fees are analogous to a small tax that MasterCard receives every time a consumer swipes his or her card. And we believe that consumers worldwide will be swiping their cards more than ever.
We see the global payments industry continuing to move away from cash and checks, which have historically dominated, toward electronic forms of payment, including cards. We forecast worldwide growth in card-based transactions and dollar volumes of almost 11% annually over the next five years. Our estimate is slightly lower than recent global growth rates of 13%-14%, as reported by the Nilson Report, because of our expectation of a slowdown in U.S. consumer spending, which we expect to be partially offset by strong growth in international markets.
Despite a very attractive business model, there are some serious legal issues that cast a dark shadow over the firm. Most of the lawsuits relate to alleged anti-competitive behavior by MasterCard in determining "interchange fees"--fees that merchants pay to the card-issuing banks--and by allegedly stifling competition by not allowing competitors like American Express AXP and Morgan Stanley's MS Discover to issue their cards through banks that issue MasterCards. We've estimated the exposure to these legal issues in our valuation model, which shaved off about 12% of the value of the firm. However, we believe the firm's competitive strengths and bright growth prospects should adequately compensate investors for taking on these risks.
Valuation
We think MasterCard is worth $80 per share, or about $10.8 billion in total, which equates to approximately 32 times 2005's earnings per share, sans legal reserves. Currently MasterCard earns operations fees of about $0.14 per processed transaction (swipe), and charges assessments--fees to use the brand--of about six tenths of a cent per dollar that's charged with a MasterCard-branded card. We expect both of these measures to decrease over time, due to competitive pressures and higher bargaining power among its customers. However, by virtue of its brand strength, we expect MasterCard to maintain enough pricing power that revenues should not be meaningfully impacted. We expect average annual revenue growth of about 10% over the next eight years as the firm rides the wave of global growth in card-based transactions. We see operating profits growing even faster than revenues--about 17% annually--thanks to expense efficiencies that are inherent in MasterCard's highly scalable processing business. We also project the firm to pay an additional $1.75 billion related to current litigation, on top of the $100 million annual payment it is currently making through 2012. Collectively, these legal obligations shave 12% off the total value of the firm. We assume a 10% cost of equity for the firm.
Risk
The biggest risk facing MasterCard is a multitude of lawsuits that allege anti-competitive and anti-consumer behaviors. Although in most of these cases, plaintiffs have not specified the amount of damages they are seeking, we believe the firm's exposure to these lawsuits could reach into the billions of dollars. Also, we see some competitive pressures coming from both financial-services firms, which issue MasterCards, and merchants, which accept MasterCards, because of consolidation in both industries, which leads to higher bargaining power.
Strategy
MasterCard's goal is to flood the globe with MasterCard-branded debit and credit cards that are processed through its proprietary network. The firm aims to accomplish this by fortifying its relationships with financial-services firms, enhancing its brand image worldwide through mass marketing, and hiring more business development personnel to expand the number and types of merchants that accept MasterCard.
Management
At the helm of MasterCard is CEO Robert Selander, who's held the post since 1997 and has been with the company since 1994. Prior to MasterCard, Selander worked with Citigroup C for 20 years. We think management will have a tricky transition from an association that basically promoted its brand for the benefits of its member banks to a publicly held, profit-focused enterprise. In the meantime, we're not ready to heap praise on management. According to industry data, MasterCard has not gained market share over the past few years, so its growth has essentially mirrored that of the industry as a whole. We also have some reservations about the firm's corporate governance and ownership structure. Investors in the IPO will own about 46% of the equity and 82% of the voting power of the firm. However, this voting power is essentially toothless for any major corporate decisions, given the presence of various supermajority voting provisions and anti-takeover measures. MasterCard's existing owners, the member banks, will retain a nonvoting equity stake of about 44% and the power to elect three directors to the board. Because these banks are MasterCard's customers, we'd prefer to see a clean break, given the inherent conflicts of interest in the structure. Further, the firm has established a charitable foundation, the MasterCard Foundation, which will own the remaining 10% of the firm's outstanding stock and control the remaining 18% of the firm's voting power. While this may be philanthropic, we think it's more likely an attempt to keep control of the company close to home.
Profile
MasterCard is home to one of the world's leading payment systems. The firm manages a group of global payment card brands, including MasterCard, Maestro, and Cirrus, which it licenses to financial institutions that issue cards to their customers. The firm acts as the payment processor by facilitating the authorization, clearing, and settlement of transactions that occur on its proprietary computer and telecommunications network. At the end of 2005, there were almost 750 million MasterCard-branded cards issued throughout the world, which generated about $1.7 trillion of transactions during the year. The firm reports that there are more than 24 million locations that accept MasterCard around the world, and there are about 25,000 financial institutions that issue MasterCards.
Growth
MasterCard's revenues have increased at an average annual rate of 15% over the past five years, thanks to global trends moving away from paper-based payments toward electronic forms of payment, including cards. We see revenues growing at about 10% over the next eight years.
Profitability
MasterCard is very profitable, and because there are few variable costs associated with growth in the number of transactions processed, as volumes--and thus revenues--increase, profitability will only get better. We see operating income as a percentage of sales increasing from about 16% in 2005 to 23% by 2013, thanks to this dynamic.
Financial Health
MasterCard's balance sheet looks pristine, although there could be massive hidden liabilities related to its litigation exposure. After the IPO, we expect about half of the firm's total assets to be in cash, enough to cover its long-term debt almost 10 times over. Additionally, the firm's operations spew cash. Free cash flows, excluding legal settlement payments, have averaged almost 11% of sales over the past five years.
The firm's public offering looks very attractive.
by Ryan Batchelor, CPA | 05-18-06 |
In one of the highest-profile initial public offerings (IPOs) in a while, MasterCard expects to begin its life as a public company during the week of May 22. The firm plans on selling about 61.5 million shares, or about 46% of the company, at an estimated price range of $40-$43 per share. At this price, we think the IPO looks like a bargain, given our $80 fair value estimate.
We see two main factors motivating MasterCard's IPO. First, the member banks, which currently own the firm, will reduce their exposure to MasterCard's legal liabilities, both known and unknown. Second, the firm will raise about $650 million in cash to keep as a capital cushion in the event of future legal cash settlements. While we've seen no preliminary indications of the level of interest in the IPO, we believe MasterCard's high profile will attract ample interest in its publicly available shares.
Below is an excerpt from our upcoming MasterCard Analyst Report.
Thesis
We think MasterCard has a great business model, and it competes in the very attractive global consumer payments market, which should provide it with ample growth opportunities. Although the firm faces substantial legal risks, we think MasterCard would be an attractive long-term investment if purchased with an adequate margin of safety.
We think of MasterCard as a brand and a transaction processor, and we're big fans of both things. The firm receives about two thirds of its revenue from its processing functions (operations fees), and the remaining third comes from assessments it charges its members to use the MasterCard brand, based on how much the cards are used.
We think MasterCard has an impressive global brand, which has been strengthened recently by its worldwide "Priceless" marketing campaign. In our view, one of the greatest benefits of its brand strength is that MasterCard is maintaining most of its pricing power, even though its customers--generally the banks that issue cards--are getting larger and gaining more bargaining power, thanks to consolidation. We believe that the firm will make up for any concessions it provides to large customers by charging higher fees to its remaining customers, which don't possess as much bargaining power.
We also like the firm's processing business, which performs functions such as authorizing charges, and clearing and settling the payments between merchants' and consumers' banks. MasterCard charges various fees for performing these services, which averaged about $0.14 per transaction during 2005. These fees are analogous to a small tax that MasterCard receives every time a consumer swipes his or her card. And we believe that consumers worldwide will be swiping their cards more than ever.
We see the global payments industry continuing to move away from cash and checks, which have historically dominated, toward electronic forms of payment, including cards. We forecast worldwide growth in card-based transactions and dollar volumes of almost 11% annually over the next five years. Our estimate is slightly lower than recent global growth rates of 13%-14%, as reported by the Nilson Report, because of our expectation of a slowdown in U.S. consumer spending, which we expect to be partially offset by strong growth in international markets.
Despite a very attractive business model, there are some serious legal issues that cast a dark shadow over the firm. Most of the lawsuits relate to alleged anti-competitive behavior by MasterCard in determining "interchange fees"--fees that merchants pay to the card-issuing banks--and by allegedly stifling competition by not allowing competitors like American Express AXP and Morgan Stanley's MS Discover to issue their cards through banks that issue MasterCards. We've estimated the exposure to these legal issues in our valuation model, which shaved off about 12% of the value of the firm. However, we believe the firm's competitive strengths and bright growth prospects should adequately compensate investors for taking on these risks.
Valuation
We think MasterCard is worth $80 per share, or about $10.8 billion in total, which equates to approximately 32 times 2005's earnings per share, sans legal reserves. Currently MasterCard earns operations fees of about $0.14 per processed transaction (swipe), and charges assessments--fees to use the brand--of about six tenths of a cent per dollar that's charged with a MasterCard-branded card. We expect both of these measures to decrease over time, due to competitive pressures and higher bargaining power among its customers. However, by virtue of its brand strength, we expect MasterCard to maintain enough pricing power that revenues should not be meaningfully impacted. We expect average annual revenue growth of about 10% over the next eight years as the firm rides the wave of global growth in card-based transactions. We see operating profits growing even faster than revenues--about 17% annually--thanks to expense efficiencies that are inherent in MasterCard's highly scalable processing business. We also project the firm to pay an additional $1.75 billion related to current litigation, on top of the $100 million annual payment it is currently making through 2012. Collectively, these legal obligations shave 12% off the total value of the firm. We assume a 10% cost of equity for the firm.
Risk
The biggest risk facing MasterCard is a multitude of lawsuits that allege anti-competitive and anti-consumer behaviors. Although in most of these cases, plaintiffs have not specified the amount of damages they are seeking, we believe the firm's exposure to these lawsuits could reach into the billions of dollars. Also, we see some competitive pressures coming from both financial-services firms, which issue MasterCards, and merchants, which accept MasterCards, because of consolidation in both industries, which leads to higher bargaining power.
Strategy
MasterCard's goal is to flood the globe with MasterCard-branded debit and credit cards that are processed through its proprietary network. The firm aims to accomplish this by fortifying its relationships with financial-services firms, enhancing its brand image worldwide through mass marketing, and hiring more business development personnel to expand the number and types of merchants that accept MasterCard.
Management
At the helm of MasterCard is CEO Robert Selander, who's held the post since 1997 and has been with the company since 1994. Prior to MasterCard, Selander worked with Citigroup C for 20 years. We think management will have a tricky transition from an association that basically promoted its brand for the benefits of its member banks to a publicly held, profit-focused enterprise. In the meantime, we're not ready to heap praise on management. According to industry data, MasterCard has not gained market share over the past few years, so its growth has essentially mirrored that of the industry as a whole. We also have some reservations about the firm's corporate governance and ownership structure. Investors in the IPO will own about 46% of the equity and 82% of the voting power of the firm. However, this voting power is essentially toothless for any major corporate decisions, given the presence of various supermajority voting provisions and anti-takeover measures. MasterCard's existing owners, the member banks, will retain a nonvoting equity stake of about 44% and the power to elect three directors to the board. Because these banks are MasterCard's customers, we'd prefer to see a clean break, given the inherent conflicts of interest in the structure. Further, the firm has established a charitable foundation, the MasterCard Foundation, which will own the remaining 10% of the firm's outstanding stock and control the remaining 18% of the firm's voting power. While this may be philanthropic, we think it's more likely an attempt to keep control of the company close to home.
Profile
MasterCard is home to one of the world's leading payment systems. The firm manages a group of global payment card brands, including MasterCard, Maestro, and Cirrus, which it licenses to financial institutions that issue cards to their customers. The firm acts as the payment processor by facilitating the authorization, clearing, and settlement of transactions that occur on its proprietary computer and telecommunications network. At the end of 2005, there were almost 750 million MasterCard-branded cards issued throughout the world, which generated about $1.7 trillion of transactions during the year. The firm reports that there are more than 24 million locations that accept MasterCard around the world, and there are about 25,000 financial institutions that issue MasterCards.
Growth
MasterCard's revenues have increased at an average annual rate of 15% over the past five years, thanks to global trends moving away from paper-based payments toward electronic forms of payment, including cards. We see revenues growing at about 10% over the next eight years.
Profitability
MasterCard is very profitable, and because there are few variable costs associated with growth in the number of transactions processed, as volumes--and thus revenues--increase, profitability will only get better. We see operating income as a percentage of sales increasing from about 16% in 2005 to 23% by 2013, thanks to this dynamic.
Financial Health
MasterCard's balance sheet looks pristine, although there could be massive hidden liabilities related to its litigation exposure. After the IPO, we expect about half of the firm's total assets to be in cash, enough to cover its long-term debt almost 10 times over. Additionally, the firm's operations spew cash. Free cash flows, excluding legal settlement payments, have averaged almost 11% of sales over the past five years.
