MasterCard Inc. (MA)
William Blair Growth Stock Conference Call
June 12, 2013 9:00 am ET
Martina Hund-Mejean – Chief Financial Officer
Bob P. Napoli – William Blair & Co. LLC
Bob P. Napoli – William Blair & Co. LLC
Okay, we’re going to get started, thank you. My name is Bob Napoli. I am the analyst for William Blair that covers Financial Technology and Services for the complete list of research disclosures of potential conflicts of interest, please visit our website at www.williamblair.com.
We are excited and honored to have with us today MasterCard; the CFO, Martina Hund-Mejean is with us today. Martina joined MasterCard as CFO in November of 2007, prior to that she was the Senior VP and Treasurer of Tyco and with then Lucent, and had various positions at General Motors before that.
I am going to turn it over to Martina for a brief presentation and then we’ll get into some Q&A and then move over to the breakout room.
Thank you Bob and good morning everybody. So I am going to have just a couple of slides that we can go through and then I think Bob you’re going to ask me a few questions. Before we get into the slides, I just have to put up the proverbial Safe Harbor language, which you all know. So with that I am going to move right on.
So, especially for those of you who do not know the MasterCard story, I thought it would be helpful to just go through the three drivers of growth that actually benefit our business. So, the first driver of growth is really personal consumption expenditure in the rose. Now personal consumption expenditure growth obviously can vary by country as well as by economic environment, and that’s typically not a number that we really have any control over. But it does impact fairly significant and benefit our business and I would get to this specific number in a minute.
The second concentric circle that you will see on here is really what we did with our business that means moving cash and check payments to electronic forms of payments. You might hear me say also this is a secular trend and really this is, we spend a big part of our time in order to make sure that we can really get that electronic payments growth going. A lot of this obviously has to be done with differentiated product as well as fantastic partnerships not only with the financial institution, but also with a lot of the telecom companies, merchants, and governments around the world, but that is definitely one item that we impact.
I just want to remind everybody about 85% of the world’s transactions are still in cash and check, 85% of the world’s transaction and when you actually translate that into volume, so and this is just based on personal consumption expenditures. So it doesn’t even include all of the business expenditure. About 60% of the volume is still in cash and check. So that’s just a fantastic opportunity for many, many years to come.
And the last concentric circle that you see in here, the inner one is really MasterCard share of electronic payments. So that is our share of the 15% of transaction that’s already in electronic form. Obviously we are continuing to win share in that space, but also this includes actually expanding electronic payments or in the electronic payment sector for new customers, for new types of technologies and our benefits or what we get from that.
So let me put this in terms of numbers together. So here you see a slide in terms of how from a longer term perspective if you look at our growth, okay. So these three factors do drive our top line growth.
Global PCE, this is kind of a five-year number and you can make any kind of inflation assumptions that you like to make, but we typically have in our mind about 5%, 4% to 5% over the long-term that’s typically where personal consumption expenditure growth is.
The secular trend that was the second concentric circle that I was talking about this is where we are converting from the cash and check transaction to electronic forms of payments that’s on average about 4% to 6%. Again this is kind of a 5 year CAGR number in any particular country this could be different. So since when you look at the United States, where you already have 60% of the PCE awfully in electronic forms of payments, you would expect that this secular trend is a little bit lower.
When you go into countries like Russia or India or South Africa then you would expect that there is a lot more secular trend opportunities because most of the payments are actually done in cash in these kind of countries, so you would expect that percentage is higher. When you put those two things together PCE and secular trend, you get time of at the baseline industry growth of 9% to 11%, and then I cross correct for MasterCard’s mix of 1%.
What is that? That is really when you look at electronic payment systems across the world. There are a lot of domestic debit systems, and when you add all of that together and compare our mix of credit and debit to the worldwide credit and debit, worldwide there is a lot more, emphasis on the debit side. So from a mix point of you we are not participating as much in a number of these domestic debit schemes and that’s why we are pulling down our mix by about 1%.
So MasterCard is kind of available market growth is in this 8% to 10% range, again long-term five, six, seven years.
And then in addition to that and this is really the last concentric circle, we just see those green bar, saying strategic investments and that’s where we’re going after market share and this is where we’re going after new customers, here is where we are investing in new technologies to really be expanding in terms of what we do in this particular space.
So from a total numbers point of view, you would think that long-term revenue growth for MasterCard on a CAGR basis, should be in the low-to-mid teens. And that really frames, when you look at our performance objective; we always put out three performance objective, so these are the latest one 2013 to 2015. And you can see that we anticipate that our net revenue growth in that period is the 11% to 14% on a CAGR basis.
Our operating margin a minimum of 50% annually and earnings per share growth of at least 20% CAGR and this is all on a constant currency basis, okay. So we have the business because we operate about 60% of our revenues outside of the United States, we obviously do have FX impact in our business depending our FX rates behavior versus the U.S. dollar predominantly.
So I just want to pause here at this slide for one minute and reflect a little bit on 2013 because we did make some suggestions about 2013 perhaps being a bit below that range given the economic environment and it really only due to the economic environment. So it’s the first concentric circle that I was talking about because when you look into the United States, when you look what’s going on in Europe and those are the predominantly the two regions that we more worried about, we don't think that they are yet behaving from an economic point of view, where we think it’s a normal environment and that’s why we made the comments already for a number of months. I think we started that really last September that we are a little bit more cautious in terms of what we see coming through this year.
Now we gave an update at our last earnings call on our numbers for the quarter-to-date and I can give you another update and I’m going to contract that versus the first quarter. And I have to say overall it looks like the second quarter is coming in pretty nicely. So we are seeing some better numbers from a business driver point of view.
So I was just going to go, get to the four numbers and first of all I’d start up with cross-border growth. From a cross-border growth point of view, our quarter-to-date number, so this is April and May, down to May, end of May, we see 17% growth. And then the first quarter we saw 16% growth and we are seeing actually better growth in Europe as well as in Asia Pacific, Middle East, Africa.
And Europe, I just want to remind people for those of who are close to our story we’re continuing to see Europeans traveling, but still traveling closer to home i.e. not going as much overseas outside of the European region as what we saw before, which does have an impact on our revenues because we do charge less for cross-border transaction that is done in Europe versus the European going, for instance, to New York.
The second is U.S. processed volume. Also from the U.S. processed volume we see some better numbers. So quarter-to-date is about 7%. That compares to the 4% in the first quarter and both credits and debits have been improving.
Then I’m going to talk a little bit about overseas processed volumes. Overseas processed volume is pretty much on par with what we saw in the first quarter, at about 15% growth.
And last but not least from a process transaction point of view, process transaction is going quarter-to-date about 10%. We had 12% in the first quarter and actually if you had listened to our May earnings call, we were, at that point in time it’s April printing about 8%, this is now 10% from our process transaction point of view and that is really due to what happened as part of the changes in the debit environment last year and then April having very significant increases in volume and so it’s just the basic compare and we are now seemingly coming back to a growth rate that is a market growth rate. We anticipate that the market growth is kind of in the 10% to 11% range.
So that’s our numbers and let me just close here for a minute. As we can see from what I have said about the opportunity, 85% of the word’s transaction still being in cash and check, it’s a significant opportunity for many, many years to come. We are focused on what we do well, i.e. converting cash and check to electronic forms of payment with all of the creative partnerships that we have as well as with innovative products and solutions and technology and we are obviously focused on winning share.
There from an investment point of view, we are making significant investments in our portfolios, but also expanding into a number of countries outside of the United States where we have not been physically and that typically has a very good payback. So very significant investments and I can leave it to Bob or to the breakout session, if you want to ask me for some more specifics in terms of what we’re really focused on.
And finally, you can see a very strong performance. If I just reflect on the last five years, we had a 13% revenue growth CAGR on the constant currency basis and we had a 24% EPS growth on a constant currency basis.
So with that, Bob I think I’m going to hand it over to you.
Bob P. Napoli – William Blair & Co. LLC
Great. Thank you, Martina. Would you say, have your guess, your view on the global economy with the numbers that you gave, do you feel like you’re seeing a little bit of acceleration or at least stable to slightly accelerating, is that what you would call?
I’m not sure I would call it acceleration at this point in time. So what we’re seeing is kind of what we’re hoping we would see that in the United States given that we are seeing what’s going on in the housing sector and given that people are investing and also doing the addition of purchases that we’re going to need to do in order to get a house ready, we’re seeing a little bit of green [shoots] there and I think that’s what you are seeing coming through in the numbers.
In terms of Europe, as I said, the numbers really haven’t changed. When you look over the processed volume growth oversees, not much has changed. You see the travel numbers coming up a little bit, but it’s really within Europe, okay, and I just came back from Europe. I visited five cities in Europe in the last week. And I do have to say it’s starting to be summer season. The Europeans are still taking the vacation and the restaurants are full and the trains are full and the airplanes are full. So we still have the environment where we from our business typically participate because a lot of that spend typically could go on cards, right. So you see that secular trend that is really benefiting us in the European numbers.
When I go around, just continue to go around the road, preserve hasn’t really changed. We were hoping that preserve would be a little better this year and we have not seen that that’s coming through. It’s the terrific market for us. It’s growing very nicely, but given where they were from a GDP point of view last year, we thought that Brazil might come back a little bit more, it isn’t.
Mexico is feeling better and hopefully with all of the structural reforms that the government is trying to take on hopefully we will see from a long-term perspective, it changed trajectory there, because Mexico was kind of not in the greatest shape from an electronic payment from growth point of view, so I hope that will be better.
And then Asia-Pacific, Middle East, Africa I mean including Middle East Africa actually heading in their pretty nicely.
Bob P. Napoli – William Blair & Co. LLC
Great. Thank you. International has been somewhat of a mix bag, I guess from a government wise, there is a fair amount of regulation going on more in developed markets, especially in Europe primarily around interchange, but then on the other hand you have other emerging economies where the government I think are working hand in hand with you to grow the business. I was wondering if you could comment on some of the risks around the European regulation and then maybe give a little color on how you’re working with the governments and other countries.
Yeah, so you know part of our business is obviously balancing the cost of the business between what the issuers has have to do from issuing cards to consumers as well as from what the merchant has to do in terms of accepting the cards. And what you want to do is, you want to balance the system in such a way that the issuers has obviously the impetus to be issuing more and more of those electronic forms of payments and you want to have the merchants being really encouraged to be accept those.
And part of the cost it’s only part of the cost, but a big part of the cost is what you call interchanged, and what bob mentioned is there are number of countries in regions around the world where actually governments take a particular view on interchange and it’s predominantly driven by the merchant community because they really used the cash before. When you use cash you really don’t see all of the ancillary costs that cash is costing coming up on your P&L. I mean you don’t really see the fraud charges and the transportation charges and the deposit charges, all that kind of stuff, counterfeit charges et cetera. But when you have the interchange fee charge to you, you obviously see that as a line item on your P&L.
And so, for various reasons governments around the world are very interested in terms of what the cost balance is in the system. And so, we have actually three relatively large impacts on that particular model, one back in the early 2000s in Australia where the RBA actually regulated interchange for the, what I call, four party model. So that’s a model like MasterCard. And what happens in Australia once the interchange was regulated is that while our business still grows very significantly in Australia, I would suggest to you that the business didn’t grow quite as much as it should have simply because the issuers are getting less compensated for what they do from an issuing cost point of view and what they have to do is, they basically have to go back to the consumer and what you saw is coming in fixed cost fees as well as we did with the rewards programs, right.
From our business, as I said, our business in Australia is growing tremendously and our network fees were not impacted. The second big case was obviously last year in the United States, was debit regulation, where debit fees are basically regulated in this country and again given that this was a little bit of a different issue, given that we were really fairly small provider in the debit space, so we have very small market share. We were able to take advantage of the debit regulation in such a way that we actually grew our market share and I am now participating in a much more significant way in debit. And again, from a network fee point of view, really no impact whatsoever.
And then the last big regulation that we had faced which was a few years ago, three years, four years ago in Europe was pretty much that the European commission they didn’t regulate, but we had an agreement with them in terms of cross-border interchange rates, 20 basis points of debit and 30 basis points of credit and that was a agreement with them.
And again lots of people thought that when interchange gets regulated the business might not grow as must but also that our network fees are impacted and in this case it has not, okay. So we have three big cases on this. Now what’s happening, what's on the docket at this point in time and you mentioned Europe, so there are number of things going on in Europe in terms of the European commission really going after its builder space. They really feel like that they need to do regulation in this space from a cost point of view, as well as from an innovation point of view. And so they have a number of things going on, one, last year they put out a paper where they basically stipulated all of the interest that they have in terms of regulating the sector.
We are waiting a draft regulations coming out, that could be any moment. It could be in a few weeks, I don’t know.
In terms of what the commission actually wants to do in this particular space and that could be from a cross border regulation, interchange regulation point of view, this could be domestic interchange regulation. And it could be some rules that we have in this payments base.
So we will have to see what the European Union is coming out and then separately the European Commission also just undertook another investigation of us that they already have an investigation into VISA Europe. And what they did is even though we closed, I mean we closed our investigation with them quite some time ago. They closed it with us, let’s put it this way. They reopened the case, because they had three additional things that they wanted from VISA Europe, which they haven’t asked us for.
So those are all the gyrations there and I would say when you go into other countries it depends, it’s a little bit less nascent, right, because electronics payments basis in other countries are little bit less nascent. But what I do see is that the governments are obviously are talking. They’ll all have an extremely high interest in making sure that the countries goes from more of a cash economy to electronic forms of payments, because of obvious things. Right cash is very expensive for a country, all sorts of unfavorable trade is being supported when you have cash payments. People are not paying their taxes and I would like to get the hands around that.
So there is a huge interest by the government. And what we have been doing over the last few years is really work over the government and that’s why you are seeing all the gyrates coming out of South Africa, Nigeria and number of other countries. In terms of, if a government really has a true interest in propelling the payments space into the 21 st century and if you can help them to really think through all of the various parameters that go in that then we find that we can participate in that sector extremely well. So there is more work to be done, but that’s kind of how we are tackling it.
Bob P. Napoli – William Blair & Co. LLC
One issue coming up China in particular, I guess there was a release last week that China was going to prevent MasterCard from processing locally. The World Trade Organization is trying to force China open that market. They have to have a plan out by the end of July. China UnionPay on the other hand is trying to compete globally aggressively to grow, but yet the Chinese market hasn’t opened up. You’ve partnered quite a bit with in China. What are your thoughts around the Chinese market, what did they need to do and what’s your response if that the Chinese government doesn’t sufficiently open their market?
So, look, I mean, this is a very complicated topic of course and let me just make sure that we have some of the facts right, right. First of all, it’s true that international schemes like MasterCard cannot compete at this point in time domestically. So we cannot compete for domestic payments. What we can compete for and where we’ve been growing our business in a significant way is really in the cross-border space. So that means when Chinese consumers travel overseas and their card have a MasterCard, so besides the CUP logo you have a MasterCard logo on it. They can obviously use it that way and then when tourists are coming into or business people are coming into China they can obviously use our product. So the cross-border is freely and that is really not an issue.
Where as WTO it was not or the WTO verdict was not contested by China, which we think is actually a good sign that they’re looking similar to what they have done with other sectors in the past that they’re actually looking to open up that sector.
Now, when you look at some other industries, the auto industry, which is a bit more familiar to me or be it the electronic industry and the number of other industries. China usually is very careful in opening up this kind of sector, it’s typically not that they would allow all of the international companies to just come in and buy out some companies or set up shop in 100% fashion. It’s typically down in a very arrange type of way, where potentially you might have to partner with somebody, where you have to get some sort of agreements in terms of what you can do and how you can do it. And then over a number of years typically the sector opens up more and more.
So that if you can do more and more investment. I may have no reason to believe that China would do that differently in this sector, but we do believe that going forward there will be opportunity and all of the things that we are doing. So, we have a very good partnership with CUP, we have a very good partnerships with quite a few very important people obviously in the government and then in the regulators. We are trying to make sure that we are as open, as we can be to be taking advantage of the opportunities down the road as well as ready as they can be for both from the technology point of view as well as product and service point of view.
Now there is one other thing that I just want to make sure that we don’t have the facts around, the recent announcement that came out in terms of MasterCard not being able to process, this was a very specific item. Basically there is a provider in the e-commerce space that has been using our virtual card numbers and what they chose to do is settle the domestic currency Renminbi in Hong Kong under law only CUP is allow to do that.
And the regulation actually is applicable to everybody. This is not just MasterCard, but I would presume our name was quoted in the press, just because we made such forays into the China business that we’re kind of all over the place, right? But it doesn’t impact one, i.e. our cross-border business or do we think that this impacts at all, the positive outlook that we have eventually being able to participate in the country.
Bob P. Napoli – William Blair & Co. LLC
Great, thank you. If there aren’t any questions from the floor, I can keep going on. Your outlook over the next three years, I guess as you’ve stated several times, little bit below in 2013. So, I mean are you anticipating an economic acceleration in your guidance? And then, with regards to your margins, they have 20% earnings growth, 11% to 14% revenue growth.
I know you would probably need some margin expansion, and I think the mass I’ve already spoken with says we’re not relying on margin expansion. The market tends to get upset whenever MasterCard says, there’s no more margin expansion, wondering if you could reconcile those, and just talk about the philosophy behind your three year guidance.
And so obviously, when we think that 2013 will be a little bit below, and it’s predominantly due to the economic environment both in Europe, and as well as what we see in the U.S. So obviously, we are expecting that the U.S and Europe are eventually returning to a more normal economic environment.
I mean, I don’t like to use the word accelerate, because accelerate means the economy has to shoot up in a significant way, which we are not relying on. We’re just relying on that it comes back to a more normal kind of GDP type environment. So, and that’s what I said, you know and from numbers point of view, we like to quote PCE okay so in the United States. So at this point in time our PCE growth assumption is more like around the 3% and quite frankly in Europe it’s like closer to zero, zero to 1%. So it’s very low, so you just have to have a little bit of a better feeling and hopefully we see the interest in the U.S. to be coming back to a more normal environment. Okay, so that’s on that one.
On the second one, yeah that is an interesting one, look we’re looking at ourselves as a growth company and obviously all of our investments that we are doing are really pointed to make sure that the top line continues to grow. You saw from my numbers that from a market growth point of view as we work the PCE growth, we can’t work really that’s given to us in terms of economic environment. But, the secular trend and what we do from a market participation in the electronic market that’s we can work. Okay, and so obviously all of that stuff that we’re doing is focused on making sure that we keep that trajectory going.
In terms of our bottom line performance the 20% plus EPS over that three year period, how I look at it? We have a number of levers; of course top line is one of the levers. Operating margins could be one lever and I get to that in a minute. Our tax rate is still a lever and share repurchases are lever right given that we are fairly high cash generation kind of company, you would think that you would be using your cash in some fashion and part of it would be share repurchases.
So on the operating margins, what I will putting down 50% plus operating margins. Simply because when we want to make sure is that people understand we are not running this business just for operating margin expansion. We are not looking to get this business to 60% or 70% or 80% margin, what we’re looking to is, everything that we have incremental from the top line to reinvest in order to continue to half the top line growing.
Now from time-to-time and we happen to have that over the last couple of years, you have just the terrific revenue growth in a particular year, you find yourself with that one quarter, two quarters perhaps three quarters into the year, it’s not that P&L, we are just going to take that slack of extra money and put into expenses, and then you have a margin expansion. But there might be a number of years, where I have something that we want to fund, and then we will be taking that out, and we might be going back on the operating margin.
So that’s why we’re just seeing to make sure that everybody feels comfortable that we’re doing this the right way. We think with the current trajectory of the business, with the composition of the business that we have at this point in time, a minimum 50% in our threshold. And what comes above that, comes above that, but really that comes out of how we run the business.
Bob P. Napoli – William Blair & Co. LLC
Great. Thank you. I believe we’re out of time. I don’t know, sorry, we have two minutes. Oh, sorry. Okay. Now we are out of time, the two minutes are over. I’m sorry, we’re going to go to the breakout room downstairs into LaSalle Room. Thank you very much.
Bob P. Napoli – William Blair & Co. LLC