How Does GDV Affect MasterCard’s Volume Based Business?

In a recent note, we analyzed the business model used by card companies such as MasterCard (NYSE:MA). To recap, MasterCard’s clients are banks and financial institutions who issue cards bearing the company’s famous logo. Once these cards are used for a transaction with a merchant, transaction information is transferred via MasterCard’s network to the issuer bank and to the merchant’s bank, known as the acquirer, for authorization. After authorization, the acquirer sends a clearing file containing final transaction data which is processed for the final settlement between the issuer and the acquirer. The acquirer earns a discount fee from the merchant and is required to pay an interchange reimbursement fee to the issuer bank.

MasterCard and Visa charge data processing fees and service fees from their financial clients. Data processing fees, or transaction fees, are charged for providing authorization, clearing, settlement, maintenance and network access services, and are charged as a percentage of the total transactions processed for a client. Service fees are charged on the basis of the gross dollar volume (GDV) of transactions processed for a client. In our last article, we discussed the impact of transaction volume on data processing fees. In this article, we look at the impact of GDV on MasterCard’s income. Due to the similarity of operations, a similar analysis would apply for Visa.

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The service or assessment fee is charged when the issuer and acquirer are based in the same country. This fee accounts for about 35% of MasterCard’s revenues. The fee is charged on the basis of factors like number of cards issued by the bank, development of merchant relationships, brand promotion at point-of-sale, cross-border usage and other marketing developments. On average, the service fee has been around 0.096% of the gross-dollar volume for the last seven years and can be expected to remain around that figure in the coming years. Therefore, the revenues generated by MasterCard depend primarily on the GDV of the transactions processed by the company.

The Breakdown

Although growth slowed down in 2009, MasterCard has maintained a double-digit GDV growth rate for each of the last four years. This has been driven by the increased use of debit cards. MasterCard has 1.3 billion cards in circulation worldwide. Of these, around 700 million are consumer credit cards, 540 million are debit and prepaid cards, and the rest are commercial credit cards. The annual GDV generated per credit card is $2,830 while the figure for debit cards is $3,318. Commercial cards are used more often and generate GDV of $8,437 per year. Since the 2008 financial crisis, consumers have shifted preference from credit cards to debit cards, in order to avoid taking on debt. Debit and prepaid cards in use increased by 28% over the last year while consumer credit cards increased by just 4%.

International Prospects

Geographically, the U.S. accounts for a third of MasterCard’s GDV, but the company has been expanding its international operations, particularly in Asia. A quarter of the company’s GDV comes from the Asia-Pacific region. Increased penetration in emerging markets such as India helped the company achieve high growth of more than 20% from the region in the last few years. However, 2013 growth was slowed down by currency fluctuations; GDV increased 21% on a local currency basis but nominal growth was just 17%. During the fourth quarter conference call, management suggested that an economic slowdown in China might also have a big impact on growth in the Asia-Pacific region, particularly Australia, which relies a great deal on exports. ^[1] However, we believe that the company can sustain growth through expansion in countries like India and Indonesia. Electronic payment penetration is still below 60% in these countries and personal consumption expenditure (PCE) growth rate has been around 10% for the last four years.  ((Visa Investor meeting for 2013))

Europe accounts for 30% of MasterCard’s GDV. In 2013, the company was able to gain from a strengthened Euro, as GDV grew 15% on a local currency basis and 16% on a nominal basis. The European Commission is planning to limit interchange fees charged from merchants by banks on the use of credit and debit cards. ^[2] The fees are generally set by card companies like Visa and MasterCard, and vary from around 0.2% of the value of transactions in the Netherlands to 1.5% in Poland. However, the legislation is yet to be adopted and the process will likely take some time to unfurl.

U.S. Growth Depends On Consumer Sentiments

More than 60% of PCE in the U.S. are through non-cash transactions, indicating a high level of electronic payment penetration. ^[3] Unlike Asia and Latin America, which have potential for increased penetration, future growth in the U.S. is dependent on consumer sentiment. MasterCard accounts for 10% of the PCE in the country and reported a 7% increase in GDV last year. ^[4] This growth rate was lower than the 9% rate reported in 2012 and the 10% rate observed in 2011. However, the U.S. economy is showing signs of improvement; the unemployment rate was around 7.9% at the start of 2013 but has dropped to 6.7%. ^[5] Americans are also more inclined to spend now; personal savings as a percentage of disposable personal income dropped from 6.6% during the fourth quarter of 2012 to 4.3% in the December quarter of 2013. ^[6]

As the U.S. economy improves and MasterCard continues its foray into international markets, we believe that the company will be able to sustain a high-single-digit GDV growth rate through the decade. However, currency fluctuations and uncertainty in the U.S. economic recovery might be detrimental factors. You can modify the interactive chart below to gauge the effect a change in forecast would have on our price estimate.

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1. MasterCard Incorporated Management Discusses Q4 2013 Results – Earnings Call Transcript [↩]
2. EU Plans Limit on Credit-Card Fees, Wall Street Journal, July 17, 2013 [↩]
3. investor meeting for 2013 [↩]
4. Personal Consumption Expenditures, U.S. Department of Commerce: Bureau of Economic Analysis [↩]
5. U.S. Department of Labor, Labor Force Statistics from the Current Population Survey [↩]
6. Table 2.1. Personal Income and Its Disposition (A) (Q) [↩]