In reviewing the comments of others that I shared in my previous post, The Visa Franchise, and even reading my own earlier analysis, one might wonder whether market sentiment on Visa has become unreasonably bullish such that its proponents are blind to key risks that could unfold. Indeed, even as I read numerous analyses to improve my understanding of the industry and see the positive opinions, I haven’t come away without significant concerns.
With that in mind, I digress to flash back to much earlier days before my career in finance. Back then, I was riding the rails myself. Not Visa’s, mind you, but rather those of a Class I railroad now owned by Berkshire Hathaway. On the congested tracks, it wasn’t uncommon to spend 75%-90% of a 10- or 12-hour day parked on the rails watching other trains go by. Each time one did, it was the responsibility of one of the train crew to step off to inspect the passing train. The purpose was to watch for dragging equipment, notice any unusual smells, or listen closely for out-of-the-ordinary sounds.
After watching hundreds pass with nothing to report, the whole effort seemed fruitless. But upon the lone occasion when it uncovered a key risk, the endeavor proved a worthwhile one. Observe below: (A) the healthy bright blue wheel journal on the left, and (B) the hot, glowing, bright white, nearly disintegrated wheel journal on the right.
This procedural safety exercise proved to be a very valuable one, and may well have prevented an inevitable derailment. Applied to investing, such an exercise reminds us to be vigilant with our holdings in hopes that we can avoid a similar impending derailment of our finances.
With that in mind, let’s take our own safety precautions by considering some factors that may have potential to derail an investment in Visa stock. Some of the things I’ve seen suggested as a threat to Visa’s dominant competitive position are the following:
1. Venture capital in the financial services and the payments industry has skyrocketed in recent years. Will a new market entrant or current competitor disrupt Visa?
2. Others have suggested Bitcoin, but to me that seems a long, long way off, if not altogether highly unlikely (for many reasons) in the first place.
3. However, the blockchain technology that powers bitcoin “could conceivably pose a threat to any kind of centralized settlement activity,” per Morningstar. Since payment networks are responsible for authorizing, clearing, and settling transactions, this could pose a threat to the business model if it becomes viable and adopted on a large scale. However, it’s an opportunity for Visa as well, and it’s encouraging to learn that the company has been actively researching and experimenting with the technology.
4. Some have prognosticated that Apple will take measures to become a larger part of the payments value chain and attempt to disrupt Visa if Apple Pay becomes a more ubiquitous and recognized part of the payments process for consumers.
5. Large merchants have come together to create a solution that bypasses Visa and reduces merchant fees, but this has largely failed due to an inability to provide consumers any incentive to adopt the method.
6. Tokenization is a method of security that authorizes only single transactions such that hackers stealing a token would have the spending power authorized only for that one transaction rather than the spending power offered by stealing an entire card account number. Some have suggested that this new technology could provide a pathway for new technology startups to create new payments clearing methods and disrupt Visa.
In reality, an upstart needs to put in place a fast, reliable, and secure method that fulfills the needs of all players in the value chain, while also garnering broad acceptance among consumers, merchants, and financial institutions. For the moment, no one does that better than the dominant payment networks.
According to Morningstar, bulls argue that Visa need only adopt new technologies to retain its competitive advantage. Perhaps so, but a long list of wounded former industry stalwarts may argue that such a feat is easier said than done in the face of rapid technological innovation. Among them are Blockbuster, Kodak (KODK), Blackberry (BBRY), Macy’s (M), and Wal-Mart (WMT). That’s why I’m not dismissing these threats, and will plan to share more detailed thoughts on them, although doing so will require a future post in order to give them the attention they deserve.
Are Visa’s Profits Regulated?
Another potential risk not contemplated above is regulation and litigation which are often pointed to as possibilities for Visa. One factor insulating Visa somewhat from this risk is that it collects the lowest share of fees in the payments value chain. And Morningstar notes that the Durbin Amendment (which affected interchange fees) cost issuers $14 billion but left the payments networks largely unaffected.
Still, Visa is subject to ongoing lawsuits from merchants who wish to retain a larger share of card-based transactions. There’s no question that merchants (and disruptive new payments upstarts) would love to dislodge Visa and MasterCard from their strong competitive position. This reality has led some investors to the prescient conclusion that, “despite. . .excellent returns, the moat is not so safe that it deserves an abandonment of diversification.” So, with some of the possible risks in mind, what is a good target portfolio allocation for Visa stock?
For me, the question of whether Visa will retain its position as the dominant payment network is the million-dollar question, and the only uncertainty that keeps me from allocating 15% to 20% or more of my investment portfolio into Visa and its counterpart MasterCard versus the smaller allocation that I’ve currently reserved. Right now, The Prime Portfolio holds a small allocation in Visa and a large cash hoard.
Looking ahead, I’ll be watching the evolution of the payments industry very closely. If the questions I’ve laid out resolve favorably for Visa, there appears to be at least a decade-long runway for growth in front of the company over which time there may well be better opportunities to invest greater sums in the stock. By contrast, if Visa is unseated from being dominant in the payments industry, I’ll likewise want to watch carefully in order to consider an investment in the company that accomplishes that feat.
In the meantime, although I would much prefer to buy it at a cheaper price, I have little reservation about Visa’s premium valuation. It exists for a reason, and, when viewed over the course of a 5-to-20-year time horizon, it will have little bearing on the ultimate success or failure of the investment as long as the company can retain its strong competitive position in payments. That is, in my view, the only valid concern for a new investor in Visa stock, at least from what I can foresee based on the knowledge of our present day.