MasterCard Initiating Coverage

7/21/2019 MasterCard Initiating Coverage

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INITIATING COVERAGE REPORT William C. Dunkelberg Owl Fund

February 18th, 2015

COMPANY OVERVIEW MasterCard (MA) operates in the global payments industry

connecting consumers, financial institutions, merchants,

governments and businesses worldwide, enabling them to use

electronic forms of payment instead of cash and checks.

Geographically, MA operates in the U.S. (29.9%), Europe

(30.1%), Asia (29.1%), Latin America (8.0%), and Canada

(2.9%). The company uses a three-tiered business model: as

franchisor, processor, and advisor. As franchisor, the

company markets a portfolio of brands and products

worldwide, including MasterCard, Maestro, Cirrus and

MasterCard PayPass, facilitating commerce to a network of

more than 28.5 million acceptance locations around the

world; as processor, the company's streamlined and intelligent

approach to processing enables efficient commerce on a

global scale, as well as offering customized solutions that

deliver value through technology; and as advisor, through

MasterCard Advisors, the largest global professional services

firm focused exclusively on the payments industry, the

company provides strategic and operational solutionscovering the payments process from end to end.

INVESTMENT THESIS

MasterCard is currently trading at a 6.3% discount to its card

network services peer group 5-year P/E average. This is a

result of MA’s greater international exposure than its peers.

Investors overreacted to the threat of negative foreign

exchange (FX) translation impacting MA’s core business and

its reliance upon international opportunities to fuel double-

digit revenue growth. Finally, compression of MA’s operating

margins in Q4 ‘14 related to recent acquisitions caused a

short-term earnings weakness relative to MA’s primarycompetitor, Visa. However, MA’s innovative mobile

payments platforms, fraud-reduction services and greater

international exposure make it the best positioned card

network provider to capitalize on strong global growth in

electronic payment volumes and secular decline in cash

payments. These services, in tandem with the macro-

environment tailwinds, will drive MA back to fair value at a

29.22x P/E and a dividend-adjusted return of 17.0%.

Card

Network

Systems

TECHNOLOGY

MasterCard, Inc.Exchange: NYSE Ticker: MA Target Price: $101.39

Nathan Eisenberg: Lead Analys

[email protected]

Goutham Bollu: Associate Ana

[email protected]

Kyle McGarry: Associate Analy

[email protected]

Sector OutperformRecommendation: BUY

Key Statistics: Price $87.20 52 Week Low $86.8

Return 17.0%52 WeekHigh $88.3

Share O/S(mm) 1,150 Yield 0.73%Market Cap(mm) $100,200

Enterprise Value $96,21

Earnings History:Quarters EPS Δ Revenue YoY Δ Price

1Q14 $0.73 17.17% 0.80%

2Q14 $0.80 15.11% 9.40%

3Q14 $0.89 22.59% -2.32%

4Q14 $0.72 36.28% 0.91%

Earnings Projections:

Year Q1 Q2 Q3 Q4 Total2014 $0.73 $0.80 $0.89 $0.72 $3.1

2015E $0.80 $0.89 $0.96 $0.83 $3.4

2016E $0.98 $1.07 $1.14 $0.99 $4.1

2017E $1.07 $1.14 $1.29 $1.25 $4.9

1-Year Price Chart

All prices current at end of previous trading sessions from date ofreport. Data is sourced from local exchanges via CapIQ, Bloombergand other vendors. The William C. Dunkelberg Owl fund does andseeks to do business with companies covered in its research reports.

mailto:[email protected]












Spring 2015

CATALYSTS & POSITIVES

Virtual Cards & B2B Payments

B2B transactions, still dominated by cash and check payments globally, have

begun to see diminishing relevance in light of secular electronic paymentadoption. This is providing significant opportunity for virtual card providers,

which offer the convenience of credit cards with improved security in processing

online payments. Virtual cards currently only account for around 2% of the $16.5

trillion global B2B transaction market, but thanks to innovation in bill payment

and banking platforms like MasterCard’s MasterPass, GlobalVCard, and Travel

Controller, businesses are expected to flock to the convenience, security, and

features provided by virtual cards. Recent B2B adoption and growth in MA’s

virtual payment systems include:

One of the four largest Chinese e-Commerce firms and B2B retailer,

DHgate, adopted MasterPass toward the end of 2014 to process its

transactions, which handled over 5 million buyers in 2014 alone. DHgate’sbuyer volume is expected to more than double by 2017 as it connects U.S.

businesses with a growing Chinese e-Commerce export market. This also

reflects MA’s opportunity to tap the world’s largest and underserved

economy in electronic payments.

Fleet card provider, WEX, expanded MA-branded virtual cards to ~5

million in 2014, nearly a 20% increase. This came after a 20% increase in

MA-branded cards from ’13 to ’14, as well.

These recent examples of virtual payment banking processing illustrate MA’s

opportunity in a transformative time for the payments industry.

Tokenization

Tokenization, a platform developed jointly with other payment service providers,

serves as the security infrastructure that enables emerging payment platforms like

Apple Pay, Samsung Pay and digital point-of-sale (POS) transactions.

Additionally, MA’s Digital Enablement Service is securitizing these mobile wallet

and device-based payment platforms. Apple Pay has seen remarkable growth

since its launch just six months ago, with 50% of all large U.S. retailers planning

to support it by the middle of 2016. Samsung Pay is expected to see similar

growth. We expect these emerging payment systems and digital POS transactions

to contribute incremental revenue growth to MA by the beginning of 2016.

International Focus

With 60% of MA’s revenues derived internationally and continued expansion

from 40 countries in ‘13 to 55 in ’14, MA is the global card network leader.

Exposure to the least saturated and fastest growing gross dollar volume (GDV)

regions is strategic to MA’s long-term growth. MA’s innovative payment

platforms and early positioning in underserved electronic payment markets will

drive network volume growth, allowing MA to grow its share of a rapidly

growing market.

Risks

Increased Regulation: the paymeindustry, specifically interchange fe

is subject to significant and intense

global, legal, and regulatory which

have material adverse impact.

Regulators have been seeking to

establish the authority to regulate

certain aspects of payment system

such as MA. These regulations cou

restrict interchange fees as well as

types of products MA offers to

customers.

Governments: Governments in

countries such as Russia, Ukraine,

India could provide preferential

treatment or protection to selected

national payments and processing

providers.

Security: Risks for payments and

technology companies have

significantly increased in recent ye

in part because of the escalation o

security threats. The increased

sophistication of organized crime,

hackers, and terrorists poses an

ongoing risk for MA.

Economic Moat

Network Effect: MA has built a

network that is widely accepted by

merchants around the world. MA

operates in a near duopoly with its

main competitor, Visa. As consum

spending ramps up in developing

networks, sheer transaction volum

cement MA’s position as a market

leader.



Spring 2015

T h e W i l l i a m C . D u n k e l b e r g O w l F u n d Page

INDUSTRY OVERVIEW

Cashless Payment

As spending trends shift away from cash and check

payment methods, credit cards, debit cards and prepaidcards continues to grow in importance. This growth is

particularly strong outside of the U.S. (OUS) as cash still

accounts for roughly 85% of global consumer

transactions. Emerging economies are expected to

continue rapid adoption of cashless payment solutions.

Non-cash transactions have seen exponential growth in

the Asia-Pacific region.

Mobile Payment

Mobile payments utilize device-interconnectedness to offer on-the-go payment options. Mobile pay has seen impressive

growth thanks to widespread use of smartphones and improvements in security. Global mobile payments volumes grew25% over the past five years to $325 billion in 2014. This is expected to more than double to over $700 billion by 2017

as more merchants accept mobile payments. The advent of mobile wallets and broad convenience factors are expected

to aid mobile payments in gaining further market share against cash transactions.

Apple Pay, Samsung Pay & Google’s Softcard

Launched in October of 2014, Apple Pay marks a growing trend for tech firms entering the mobile payments market. In

February of 2015, Google acquired mobile wallet platform, Softcard. Google has since negotiated with AT&T, T-Mobile

and Verizon Wireless to pre-install Softcard on all Android phones sold in the U.S. Finally, Samsung’s acquisition of

LoopPay will allow it to launch Samsung Pay sometime in the middle of 2015. While still largely U.S.-focused, mobile

payment platforms like these have also seen regional entrants in Africa. Additionally, the required fraud reduction and

security protection improvements payment processors need to host mobile payment platforms is expected in 1H 2015.

These innovations are expected to drive mobile payment adoption beyond the U.S.

European Payment Regulation

At the beginning of 2015, the EU’s Committee on

Economic and Monetary Affairs agreed to cap

interchange fees on debit and credit card transactions

to 0.2% and 0.3% of total transaction value,

respectively. This multilateral interchange fee (MIF)

change is expected to be in effect by 2H 2015. The

MIF includes specific provisions for both three party

payment card schemes (such as: American Express,

Diner’s Club) and four party payment card schemes

(MA, Visa). While this legislation provides loopholes to the MIF cap for three party networks, it also requires them to

provide comprehensive EU coverage, a restriction that could likely squeeze these smaller card systems out of the EU

altogether. This will likely reduce competition from existing three party networks and squelch competitive entrants

offering four party networks further market dominance.



Spring 2015


FINANCIALS

Revenue

Assessment Fees

These are fees that are charged to the bank which issued the card.

Assessment fees are based on the gross dollar volume for the year

and are also domestic only, where the issuing bank and the

acquiring bank are in the same country. The rates depend on

multiple factors such as the nature of the transactions and the

region of the issuer. These assessment fees grew at a 5-year CAGR

of 8.47% to a value of $3,967 million, which represents 41.88% of

net revenue. MA is losing ground to Visa in this regard, growing

2.29% slower compared to Visa’s 5-year CAGR of 10.76%. This disparity is due to Visa’s focus in the United States, where it has 50% of the market with 53% of its revenues originating in the United States compared to MA where only

39% of its revenues originate domestically. MA has more of a focus on non-domestic assessment fee, which comes to

the company via cross border fees. Gross Dollar Volume, or GDV, is the measure of all transactions used by an

institution within a year and is used by MA to charge a cumulative fee. GDV has risen 9% overall, the most growth

coming from Asia/Middle-East/Africa at 13% growth and Europe at 9%.

Transaction Fees

MA acts as a transaction processing service for its customers.

MA authorizes, clears, and settles transactions made with its

network. The customers also use MA’s network to transmit

financial messages between the issuing and acquiring banks. Transaction fees make up 42.6% of net revenue, totaling $4,035

million and grew 20.13% YoY, outpacing Visa’s growth in the

same area by 8.31%. Some of the fees that make up the total

transaction fees include authorization, settlement, connectivity,

and switch fees, all on a per-transaction basis. What drives the

revenue for this segment is the total amount of transactions using

MA’s network, which saw 12% growth YoY.

PEER GROUP IDENTIFICATION

Visa (100% of FY ’14 Sales) o U.S.-focused card network service provider.

Total System Services. (70% of FY ‘14 Sales)

o Database management, analytics and business

applications.

Global Payments (58% of FY ’14 Sales

o Electronic transaction processing and system

services

TARGET PRICE

MA is currently trading at a 6.3% to its card network

services peer group 5-year P/E multiple. We believeMA will appreciate back to its peer group premium,

implying a P/E multiple of 29.22x. Multiplying this by

NTM EPS and factoring in a 0.73% dividend yield

gives us a projected return of 17.0%

Implied P/E Multiple: 29.22x

Valuation Price Target = $101.39Projected Return: 17.0%



Spring 2015


Cross Border Fee

Transactions that occur from one country to another carry additional fees which also include currency conversion fees.

These fees are usually high compared to assessment and transaction fees and vary greatly based on the risk of

international merchants. Cross border revenue totals $3,054 million, representing 32.2% of net revenues. 2014 saw a

9.34% rise in cross border fee revenues, which outpaced Visa’s growth by 4.3%. The fee for this type of transaction has

historically been around 0.8% of the total transaction amount. If there are regulations in a block of countries placing a

ceiling on that fee, MA will only see significant drawback if the fee drops below 0.6%.

Other Revenues

These include acceptance development fees, warning bulletin fees, consulting and research fees, and others fees such as

penalties, hologram, and publications. None of these sub-segments dominant this section, which totals $1,688 million or

17.8% of net revenue. This is the only segment where MA generates more revenues over Visa, generating only $770

million. MA is also outgrowing Visa in this segment by 19.28% with MA’s segment grow ing 26.82%. This shows us that

MA is able to generate revenues from means not directly tied to GDV, providing protection to our catalysts and macro

trends.

Rebates and Incentives

Rebates and incentives are paid to customers and merchants to help bolster card issuance and acceptance of MA cards.

These contra-revenues vary with the gross dollar volume. These rebates are given both on assessment and transaction

fees. MA saw this segment grow 11.18% to -$3,271 million, representing -34.5% of net revenue. MA and Visa saw near-

identical growth figures but Visa has a lower absolute value, totaling -$2,592 million. We believe that with increased

rebates and incentives, MA will be able to draw more card issuing,

which leads to both GDV and transaction volume growth.

Margins

MA has an adjusted EBITDA margin of 64.58%, which is above

Visa’s of 64.02%. MA saw EBITDA margin expansion of 7.53%

from 2013 whereas Visa saw a contraction of 81bps. The story

changes when we take a look at the operating margin, with MA

weighing in at 53.9% against Visa’s 60.6%, both companies saw very

slight margin contraction of less than 1%. MA underwent 8

acquisitions over the course of 2014, adding 25.61% more

employees than it had in the year prior, raising SG&A costs 16% to

$4,046 million in addition to a one-time restructuring charge of $54

million. We see this as a strategic play by MA and something that

isn’t as appreciated as it should be. MA is investing for future

endeavors, positioning itself well in future market conditions. As we

move to the profit margin, MA and Visa decline at similar rates

from the operating margin. MA’s profit margin increased 84bps

to38.18% from 2013 while Visa expanded its profit margin to

42.81%, a 53bps expansion. The disparity of the profit margin is due

to the reasons discussed previously.



Spring 2015


Debt

MA has debt principal payments of $500 million in 2019 and $1,000 in 2024. MA’s total debt reaches $1,843.75 million

with $343.75 million in interest payments. MA’s current debt/equity is 21.89%. Additionally, the company has an annual

interest payment of $22 million in 2015 and then $44 million through 2016-18 and then decreasing steadily from $39

million in 2019 and then $34 million through 2020-23 and then decreasing to $17 million finally in 2024. The company

also has an unused revolver credit line of $3000. MA has an interest coverage ratio of 106.38x, which shows that it is

more than capable of fulfilling its short-term debt obligations. Additionally, MA’s current ratio is 1.59 and its quick ratio

is 0.79. MA also has an investment grade of an A. We believe debt is very low and in a position to expand or eye future

acquisitions.

Shareholder Returns

MA currently pays out a dividend of $0.44, a 12-month yield of 56bps. The

dividend is growing at a 3-year CAGR of 101.38% and YoY growth of 68.97%.

This dividend carries a payout ratio of 14.2%, compared to Visa’s payout ratio of

18.7%. This lower payout ratio gives the capacity for MA to grow it, giving

shareholders more dividends in the near future with higher yields to suit. MA is

also committed to return value to shareholders via its share repurchasing

programs. In December of 2014, the board of directors approved a $3.75 billionbuyback program. We believe that MA will deliver on its program, given that

the company purchased $3.225 billion in 2014 out of a $3.575 billion purchase

plan. This leftover allocation gives MA a total of $3.8 billion to repurchase. As

free cash flow increases we expect MA to increase its share repurchasing

program and for the company to complete its said plans.

Free Cash Flow

In FY2014, MA had a free cash flow of $3.2 billion with cash flow from operations of $3.4 billion and capital

expenditures of $175 million. FCF grew at a 5-year CAGR of 14.6% since 2010, but declined 18% in FY ‘14. This was

due largely to a 17.6% decrease in CFFO as a result of a 120% increase in prepaid expenses in Q4 ’14. Management did

not shed any light on this increase, however we expect prepaid expenses to return to historic levels moving forward. Adjusted for this expense, CFFO was flat FY ’13-’14. On the whole, CFFO grew at a 5-year CAGR of 15% since 2010

as a result of net income growth and more efficient working capital management. CAPX increased at a 5-year CAGR of

23.4%. While CAPX is important to maintaining the physical component of MA’s network infrastructure, it represents

only 25% of cash outlays in investing activities. Through 2018, we expect FCF to continue to grow at low double-digit

rates and CFFO to grow at mid double-digit rates owing to rapid international GDV growth. This maturation of MA’s

cash flows will enable MA to return more to shareholders and continue expanding its network into more countries.



Spring 2015


Earnings

MA’s EPS grew at a 19.29% CAGR since 2010, to 2.4 billion. 2014 top line growth came in at 14%, lower than the 5-

year average due to negative FX translation and a mixed economic environment. EPS growth was driven by an increase

of cross-border volumes of 19% and a 13% increase in gross dollar volume, on a local currency basis, and increase in

processed transactions of 11%. These factors were partially offset by an increase in rebates and incentives. Earnings are

expected to grow at a rate of 16.9% through 2018.

MA Comparables Analysis

Visa and MA operate in a near duopoly due to their network effect and strong brand recognition, with their combined

market share of 87.4%. Total System Services (TSYS) is a credit card processor, merchant acquirer and bank credit card

issuers and Global Payments (GPN) is a provider of electronic transaction processing services for merchants,

government agencies and multi-national corporations. While comparing MA to Visa is the most direct peer, MA’s

international presence direct us to include internationally weighted comps.

Discounted Cash Flow Statement Assumptions

We are forecasting 2015 sales growth of 10.5%, in line with many analysts’ estimates. Following 2015, we continued sales

growth at low double-digit rates in 2016 and 2017. This is a result of expected incremental revenue from tokenizationand emerging payments support, as well as rapid adoption of electronic payments in emerging markets. From 2018 out,

we are projecting sales growth to step down from high single-digit rates to 6.5% in 2021, reflecting our view that MA

will remain a critical component of the global payments market while understanding that double-digit growth for a

maturing company is not feasible. All other assumptions were derived from long-term averages or management

guidance, e.g. plans to return capital to shareholders.

Valuation

MasterCard is currently trading at a 6.3% discount to its card network services peer group (Visa, Total System Services &

Global Payments) 5-year P/E average. This is a result of MA’s greater international exposure than its peers. Investors

overreacted to the threat of negative foreign exchange (FX) translation impacting MA’s core business and its reliance

upon international opportunities to fuel double-digit revenue growth. Finally, compression of MA’s operating margins in

Q4 ‘14 related to recent acquisitions caused a short-term earnings weakness relative to MA’s primary competitor, Visa.



Spring 2015


APPENDIX

DCF Assumptions

MA to Network Card Services Peer Group

1-Year



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3-Year

5-Year



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MA’s Historical P/E Graphs

1-Year

3-Year



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5-Year

10-Year



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Consumer Spending & Payment Companies Index

MasterCard & Visa Revenue Breakdown



Spring 2015


DISCLAIMER

This report is prepared strictly for educational purposes and should not be used as an actual investment guide.

The forward-looking statements contained within are simply the author’s opinions. The writer does not own any

MA Incorporated stock.

TUIA STATEMENT

Established in honor of Professor William C. Dunkelberg, former Dean of the Fox School of Business, for his

tireless dedication to educating students in “real- world” principles of economics and business, the William C.

Dunkelberg (WCD) Owl Fund will ensure that future generations of students have exposure to a challenging,

practical learning experience. Managed by Fox School of Business graduate and undergraduate students with

oversight from its Board of Directors, the WCD Owl Fund’s goals are threefold:

Provide students with hands-on investment management experience

Enable students to work in a team-based setting in consultation with investment professionals.

Connect student participants with nationally recognized money managers and financial institutions

Earnings from the fund will be reinvested net of fund expenses, which are primarily trading and auditing costs

and partial scholarships for student participants.

Documents

MasterCard Initiating Coverage