MasterCard Initiated with Outperform Rating

by StockJockey

Tuesday, August 26, 2008 - 12:49 pm

Dan Loeb has had a rough summer, but William Blair’s initiation of MasterCard International (MA-NYSE) might put a smile on his face.

The stock is barely clinging to its 200-day moving average, and William Blair’s analyst notes that the valuation in aggressive even at its current quote...the stock’s valuation earlier this spring was unsustainable in hindsight.

With the stock at the top of Third Point’s sheets last we knew, Dan might be picking at it long to keep the ball in the air.

I know I would be...and sweating bullets.

Excellent Growth Profile. We expect MasterCard to produce noteworthy top- and bottom-line growth, which we believe will be driven by the company capitalizing on positive trends in the payment
card industry. We expect it to uniquely benefit from opportunities in Europe (particularly as a result of SEPA). We forecast revenue growth of 13% per year and EPS growth of 22% per year over the
next five years.

Positive Momentum. MasterCard has produced better-than expected growth and financial results since completing its IPO in May 2006, leading to consistent increases in EPS forecasts. At its investor day in May 2008, management raised its long-term performance objectives.

Global Financial Institution. MasterCard processes transactions in more than 160 currencies from more than 210 countries/territories and has more than 25,000 issuer customers worldwide. In the first
half of 2008, 49% of revenue came from outside the United States, up from 52% one year prior. We expect non-U.S. revenue growth to continue to exceed U.S. revenue growth.

Key Risks. MasterCard faces interchange regulation and litigation, competitive and recession risks, and customer concentration. However, unlike Visa, MasterCard has not established reserves for
potential damages from ongoing antitrust and interchange litigation.

Valuation Summary

At its current stock price of $234.20, MasterCard shares trade at 21 times our 2009 EPS estimate, compared with 14 times for the S&P 500, representing a 50% premium to the S&P 500. That said, the shares have traded at a premium as high as 137% (April 2008). Its shares trade in line to its growth rate (21 times 2009 EPS versus 22% estimated five-year EPS growth). We believe a premium P/E
multiple to its growth rate is warranted given its unique global growth opportunities, attractive financial profile, limited risk to a U.S. recession, no credit exposure, and positive earnings momentum.

RISKS

Interchange Regulation
We view the regulation of interchange as the biggest long-term risk for the payment card networks. Interchange rates are set by MasterCard and Visa and paid by merchants to card issuers to cover
some of the issuer’s costs of providing payment card programs. While MasterCard and Visa do not receive interchange, they are paid by the card issuers for the processing transactions from which the
issuers receive interchange. Therefore, if interchange is reduced, it could reduce the fees paid to the payment card networks.

Competition
MasterCard faces competition on several fronts, including from cash and checks, Visa, American Express and Discover, and other non-card electronic payments. Overall, we believe MasterCard is in a solid position due to its established network and recognized global brand. While some competitors (Visa, American Express, Discover, and noncard electronic payment schemes) are likely to continue to experience growth in volume as electronic payments become more prevalent globally, we expect MasterCard to continue to grow volume and increase its share of global payment volume.

Reduced Consumer Spending
While we believe MasterCard is more insulated than most financial institutions from the effects of deteriorating economic conditions (as previously discussed), they are not immune. In a recession, or if recession-like conditions exist, credit card issuers may adopt tighter lending standards (i.e., curtail new card issuance and/or reduce customers’ credit limits), which would likely reduce dollar volume growth.

Interchange Litigation
MasterCard faces a potential liability from antitrust charges made by Discover. Unlike Visa, MasterCard has not established reserves for potential damages to ongoing antitrust litigation. Therefore, shareholders would be on the hook for any settlement or adverse judgment against the company. MasterCard recently settled an antitrust suit against the company by American Express for
$1.8 billion, and will make payments of $150 million per quarter beginning with third quarter 2008 and through second quarter 2011. We view a settlement with Discover as likely in the near future, but
expect such a settlement to be of a lesser amount than the American Express settlement due to Discover’s significantly lower share of overall U.S. card volume.

Issuer Concentration
Roughly 31% of MasterCard’s revenue comes from its five largest customers, but none represent more than 10%. Issuer consolidation can lead to pricing pressure. As issuing banks acquire other
issuing banks, the volume from the single customer increases. As volume increases, the issuer is likely to reach certain breakpoints where issuer rebates increase.

High Expectations
Growth expectations are fairly high for MasterCard, as evidenced by its 2009 P/E multiple of 21 times, a premium to other financials. If growth were to slow substantially, MasterCard’s premium P/E multiple could decline.

William Blair Research Note
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The first gap fill in early July was predictable..but the bounce it did not hold

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The content contained represent the opinions of 1440 Wall Street. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author. No position