s a consumer, you may not spend much time thinking about the series of connections and interactions
that take place within a few seconds after you swipe your credit card, click “complete purchase,” or tap
your smartphone. But as active investors, we believe that what goes on behind the scenes comprises a compelling opportunity that deserves our attention.
Why We’re Paying Close Attention to Digital Payments
Fundamental Perspectives
Six Compelling Aspects of the
Global Payments Industry for Active Investors
3. Complex Ecosystem Worth Understanding
The global payments ecosystem consists of three primary components: merchant acquirers, networks, and issuers. While it is useful to think about these three components separately, they are far from siloed. Many payments companies operate in more than one segment, and the lines have blurred significantly in recent years. Payments companies are looking for economies of scale as well as economies of data that can result from having access to information about transactions and consumers generated from more than one segment of the payments chain.
How Money Flows Through the Digital Payments Ecosystem
This hypothetical example illustrates the flow of money when a consumer makes a $100 purchase at a department store using a credit card. The fees shown here represent typical amounts for U.S. in-store purchases.
1. Massive Addressable Market With Sustainable Growth
The digital payments industry represents a truly enormous addressable market that continues to expand due to strong, durable secular tailwinds. These drivers include the growth of e-commerce, consumer preference for cashless transactions, the opportunity for payments providers to add value for small and medium-sized businesses (SMBs), and governmental support of digital payments. Many analysts estimate global business-to-consumer (B2C) digital payments volumes to be more than $30 trillion; the undeveloped business-to-business (B2B) payments market represents even greater potential.
2. Global Industry Defined by Distinct Regional Trends
While digital payments penetration exceeds 40% globally, it varies significantly across regions and countries. Major variances in penetration rates—as well as marketplace, regulatory, and cultural differences—mean that the digital payments industry faces different growth trajectories and risks around the world. Click on the markers in the map below to learn more about these trends.
Digital Payments Penetration Around the World
Sources: For Brazil, China, and Kenya, Edgar, Dunn & Company, as of 2017. For other countries, company reports, MoffettNathanson estimates and analysis, Visa Investor Day, Nilson, IMF, World Bank, OECD, U.S. Bureau of Economic Analysis, U.S. National Health Expenditure Accounts, as of 2016.
China
Japan
4. High Multiples Reflect High Expectations—and May Be Too Conservative
The payments industry has been valued at high multiples in recent years, reflecting durable, growing revenues and profit margins. We believe that this is a prime example of how high multiples do not necessarily equate to high valuations.
Four Pillars Supporting High Payments Multiples
High-quality, visible, and sticky revenues are the result of stable pricing and persistent growth. Even during the 2008-2009 global financial crisis, non-cash payments increased by the mid-single digits.
Revenue
United States
Brazil
Kenya
Sweden
Italy
Germany
United Kingdom
India
Profit margins that are already attractive can grow further due to high operating leverage derived from a largely fixed cost base. Scale is key in the industry.
Margins
Attractive business models can generate solid cash flow and high operating profit, with low capex requirements supporting dividends, buybacks, M&A, and low-volatility returns.
Cash Flow
Management teams in the payments industry tend to be conservative with respect to future growth expectations, leaving the potential for earnings surprises to the upside.
Earnings Guidance
5. Disruption Concerns May Be Overstated
We believe that many investors are overestimating the near- and medium-term disruption risk facing payment networks. The existing networks are firmly entrenched, efficient, inexpensive, safe, and reliable. In other words, there is nothing overpriced or inefficient about the current system that would make it ripe for disruption. Over the longer term, alternatives such as blockchain, real-time payments, and other models may have the potential to take volume from the existing networks, but many of the networks are preparing for this risk and using their powerful balance sheets to invest in alternative systems.
Transaction Volumes per Second: Bitcoin vs. Visa
4.6
Bitcoin
Visa
The near-term potential for digital currencies and blockchain to disrupt the payments industry is limited currently because the technology simply isn’t capable of handling the bandwidth needed to support any sort of systemic shift.
Source: Hacknoon. “The Blockchain Scalability Problem & the Race for Visa-Like Transaction Speed.” October 14, 2019.
1,700
6. Technology and Data Analytics Drive Growth
Leading payments companies are using data analytics, machine learning, and artificial intelligence to improve fraud prevention, acceptance rates, and targeted marketing for merchants of all sizes. These capabilities are especially valuable for small and medium-sized businesses (SMBs) when bundled with other core business functions as part of integrated payments systems.
How Integrated Payments Systems Create Value for SMBs
Fraud Prevention
Acceptance Rates
Targeted Marketing
Omnichannel
Experiences
Inventory Management
Payroll
Lending
Pursuing Sustainable Value Creation in Payments
The global payments industry is both highly complex and highly attractive. This creates opportunities for us as disciplined, fundamental managers to identify the aspects of the value chain that are best positioned to capitalize on the growing and shifting pools of profitability.
Learn how we are applying our rigorous, bottom-up approach to each segment of the payments industry and how we rank the relative attractiveness of the industry’s various business models.
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Global Card Purchase Volume and Card Penetration (ex-China, Nominal, in Trillions)
Driven by forces such as increased internet access and mobile phone adoption, the growth of e-commerce, government policy, as well as globalization and demographic trends, the ongoing shift toward noncash transactions benefits all segments of the global payments industry.
Global Card Purchase Volume Growth
2012 - 2017 CAGR = 10%
2017 - 2022E CAGR = 9%
Global Card Purchase Volume (Left Axis)
Global Payment Card Penetration (Purchase Volume on Global Payment Card / Total Purchase Volume) (Right Axis)
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018E
2019E
2020E
2021E
2022E
$30
$25
$20
$15
$10
$5
0
60%
50%
40%
30%
20%
10%
0
26%
32%
42%
52%
Source: WEO, World Bank, Nilson, corporate reports, Bernstein estimates, as of 2017.
A
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61%
Merchant Discount Rate
2%
Acquirer / Processor Fee
$0.35
Network Fee
$0.15
Interchange Fee
$1.50
Pays
$100
Consumer
Receives
$98
Merchant
Merchant Acquirers
Network
Issuer
Issuer
Processor
1
1
2
2
3
3
5
4
This hypothetical example illustrates the flow of money when a consumer makes a $100 purchase at a department store using a credit card. The fees shown here represent typical amounts for U.S. in-store purchases.
The merchant acquirer’s software and hardware allow the purchase to be initially accepted.
The merchant acquirer sends the transaction to the network, which authorizes the transaction and sends it to the issuer.
The issuer—either through an internal system or via a third-party processor—verifies that the consumer has sufficient credit available.
A message is sent back through the network to the merchant acquirer authorizing the transaction, and the consumer’s purchase is completed.
Merchant Acquirer: Entities that create software and protocols that make it possible for merchants to accept credit cards and other forms of digital payments.
Network: The "pipes" or "rails" through which all transactions flow, connecting merchants and issuers.
Issuers: Banks that issue credit and debit cards and issuer processors that are either internal functions within banks or external partners.
How Money Flows Through the Digital Payments Ecosystem
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5
4
Credit issuers charge high fees that help fund rewards and loyalty programs that are much more generous than what are offered in Europe.
30%
Credit cards are extremely popular among Brazilian consumers, but merchants must wait up to 30 days to receive their payments.
15%
Nearly 50% of Kenya’s GDP is processed via the country’s mobile-based M-Pesa payments system. This has helped push the percentage of Kenya’s population with access to formal banking services up 83%.
62%
Digital payments penetration in Scandinavia is among the highest in the world, a result of early adoption and the region’s culture.
26%
Cash is predominant, often as a means to avoid taxes. The government wants to accelerate digital payments penetration, but at a low cost to merchants.
16%
Despite having a highly advanced economy, digital payments adoption is low because of consumer behavior and the fact that one of the largest payment methods isn’t available online.
60%
The U.K. government, along with the broader European Union, has implemented interchange limits on issuers that are much lower than in the United States.
6%
India is a sleeping giant in terms of digital payments, with a huge unbanked population. The government’s investment in building a real-time payment infrastructure has attracted major investments from the world’s largest fintech players.
47%
Alipay and Tenpay, which use a closed-loop system, currently capture more than 90% of China’s digital payments market.
20%
Cultural aversion to borrowing limits the current use of credit cards, but the government is pushing digital payments, targeting 40% penetration by 2023.
2009
Sources: For Brazil, China, and Kenya, Edgar, Dunn & Company, as of 2017. For other countries, company reports, MoffettNathanson estimates and analysis, Visa Investor Day, Nilson, IMF, World Bank, OECD, U.S. Bureau of Economic Analysis, U.S. National Health Expenditure Accounts, as of 2016.
Japan
20%
Cultural aversion to borrowing limits the current use of credit cards, but the government is pushing digital payments, targeting 40% penetration by 2023.
China
47%
Alipay and Tenpay, which use a closed-loop system, currently capture more than 90% of China’s digital payments market.
India
6%
India is a sleeping giant in terms of digital payments, with a huge unbanked population. The government’s investment in building a real-time payment infrastructure has attracted major investments from the world’s largest fintech players.
Kenya
15%
Nearly 50% of Kenya’s GDP is processed via the country’s mobile-based M-Pesa payments system. This has helped push the percentage of Kenya’s population with access to formal banking services up 83%.
Germany
16%
Despite having a highly advanced economy, digital payments adoption is low because of consumer behavior and the fact that one of the largest payment methods isn’t available online.
United Kingdom
60%
The U.K. government, along with the broader European Union, has implemented interchange limits on issuers that are much lower than in the United States.
Sweden
62%
Digital payments penetration in Scandinavia is among the highest in the world, a result of early adoption and the region’s culture.
Italy
26%
Cash is predominant, often as a means to avoid taxes. The government wants to accelerate digital payments penetration, but at a low cost to merchants.
Brazil
30%
Credit cards are extremely popular among Brazilian consumers, but merchants must wait up to 30 days to receive their payments.
United States
61%
Credit issuers charge high fees that help fund rewards and loyalty programs that are much more generous than what are offered in Europe.
A consumer uses a credit card at a store to make a purchase.
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Back
1
5
3
3
4
4
5
5
5
5
Merchant Discount Rate
2%
5
A message is sent back through the network to the merchant acquirer authorizing the transaction, and the consumer’s purchase is completed.
Network
Network Fee
$0.15
5
3
5
3
Merchant Acquirers
Acquirer / Processor Fee
$0.35
5
2
5
2
Receives
$98
Merchant
Back
4
The issuer—either through an internal system or via a third-party processor—verifies that the consumer has sufficient credit available.
Issuers: Banks that issue credit and debit cards and issuer processors that are either internal functions within banks or external partners.
Network
Network Fee
$0.15
5
3
5
3
Issuer
Interchange Fee
$1.50
4
4
4
4
Issuer
Processor
Next
Back
3
The merchant acquirer sends the transaction to the network, which authorizes the transaction and sends it to the issuer.
Network: The "pipes" or "rails" through which all transactions flow, connecting merchants and issuers.
Merchant Acquirers
Acquirer / Processor Fee
$0.35
5
3
5
3
Network
Network Fee
$0.15
Next
Back
2
The merchant acquirer’s software and hardware allow the purchase to be initially accepted.
Merchant Acquirer: Entities that create software and protocols that make it possible for merchants to accept credit cards and other forms of digital payments.
Receives
$98
Merchant
5
2
5
2
Merchant Acquirers
Acquirer / Processor Fee
$0.35
Next
Back
1
A consumer uses a credit card at a store to make a purchase.
Pays
$100
Consumer
1
1
Receives
$98
Merchant
Next
Back
How Money Flows Through the Digital Payments Ecosystem
This hypothetical example illustrates the flow of money when a consumer makes a $100 purchase at a department store using a credit card. The fees shown here represent typical amounts for U.S. in-store purchases.
Start the journey
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February 2020 / Investment Management
Source: William Blair. For illustrative purposes only.
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