Looking at the recent financial results of six key incumbent vendors (four payment processors and two card schemes, all global vendors) highlights where the industry is going and what it takes to succeed. Below are results for the quarter ended September 30, 2014 (refer to NelsonHall’s tracking service articles for more detailed analysis).

How Payment Processors are Winning in the Current Environment

Headline results for payment processors are:

• Alliance Data: Q3 FY 2014 revenues of $1,319.1m, up 20.3 % year-on-year (yoy). International revenues grew at 23.5%
• Euronet: Q3 FY 2014 revenues of $453.4m, up 25.7 % yoy. International revenues represent almost all revenues (~90%). EFT services grew 28.6%
• First Data: Q3 FY 2014 revenues of $2,791.1m, up 2.9 % yoy. International revenues grew at 4.1%. Merchant services grew 0.3%
• TSYS: Q3 FY 2014 revenues of $552.9m, up 8.5 % yoy. International revenues grew at 12.2%. Merchant services grew 1.2%.

Vendors growing revenues (and profits) are focused on:

• Non-U.S. and non-mature markets growth
• Emerging services such as mobile payments, EFT payments (especially ATM networks in emerging markets), and P2P payments, including cross border money transfers

Among the payment processors, two vendors with winning strategies are Euronet and Alliance Data.

Euronet

Euronet's growth is the result of:

• Continuing expansion of its payments network (primarily ATM machines in India and Europe)
• Products:
  • Electronic payments in Middle East, Germany, and India
  • Money transfer, consumer to consumer, and Walmart2Walmart

The key to Euronet's success has been its ability to identify under-penetrated markets and pursue those opportunities. For example, Germany is not typically thought of as emerging, but its use of EFT is accelerating. Similarly, Walmart is a merchant with leading technology, but deployment of money transfer capabilities into retail merchant environments is leading edge in the U.S. 

Euronet should continue to grow revenues in double digits just based on its existing footprint, which is not yet fully saturated. As it develops new initiatives, its revenue growth can accelerate further. 

Alliance Data (ADS)

ADS’ growth is the result of:

• Growth of its loyalty programs in Canada and Brazil (Loyalty One in Canada, Dotz in Brazil, and BrandLoyalty/LoyaltyOne for grocers in Europe and LATAM)
• Growth of its merchant marketing programs in Europe and LATAM (Epsilon globally)
• Growth of its private card program, primarily the loan balances on the merchant clients’ private label cards)

The key to ADS’ success has been supporting clients in increasing their sales. ADS centers its offerings on marketing and sales support, driven from its proprietary technology and underlying transactions data. Payment processing, a core deliverable of ADS’ services, does not stand center stage in its value proposition.

ADS’ delivers services which are scarce in the marketplace, but not unique. For example, funding and managing card loans is especially important to merchants now that banks are withdrawing from that market. ADS is embracing this profitable business, while other participants are withdrawing.

ADS should grow its revenues in double digits by expanding into new markets in LATAM and Europe. Its Canadian market opportunities are saturated, by logo, but not by service offering. New analytics and payment types (e.g. mobile) should help drive growth in the Canadian market for ADS over the next five years.

Card Schemes Find Their Own Path to Success

Headline results for card schemes are:

• Mastercard: Q3 FY 2014 revenues of $2,503m, up 12.8 % yoy. Cross border volume grew 15% on a constant dollar basis. Total processed transactions grew 18.3% to 11.7 bn
• Visa: Q4 FY 2014 revenues of $3,229m, up 9.9 % yoy. Cross border volume grew 10% on a constant dollar basis. Total processed transactions grew 4.2% to 20.9 bn.

The card schemes face a somewhat different set of challenges because they sell highly standardized services, which are underpinned by massive capital investments, through card issuers (banks). Despite the limitations placed on card schemes by the nature of their underlying services, card schemes are finding the same drivers of success. Critical to growing the business is international markets and new services.

Mastercard has aggressively moved into emerging markets, staking out an aggressive growth strategy in Asia, Africa, and the Middle East. Key examples over the past year alone include:

• National identity card program in Nigeria with payments capabilities
• Electracard acquisition in India to expand processing services for banks in 25 countries
• Opening various delivery centers in Middle East and Asia
• Launch of a development platform in Ireland for ISVs to develop APIs and solutions for Mastercard processing services

These aggressive moves into markets and services have allowed Mastercard to grow revenues faster than Visa over the past year, and in the past quarter alone 28% faster.

Competitors Face Limited Window of Opportunity to Challenge Incumbents

In summary, the winners are moving into new markets and services. Critical new markets are emerging markets with little payments infrastructure and mature markets with legacy payments infrastructure where newer payments technologies (mobile, EFT networks) are starting widespread adoption. Establishing proprietary networks or distribution outlets (such as P2P payments) will create barriers to entry in the future and the opportunity for upsell of additional services, such as analytics.

Over the next two years, the window for competitors to catch up by pursuing these vendors will close. Already, presence in smaller countries, such as ADS in Brazil, makes it challenging for competitors to displace an entrenched vendor. Once payments vendors have created dominant market positions in major country markets, over the next five years, the payments industry will begin a consolidation phase in order to convert local leadership into multi-country leadership.  

Top line results for each vendor in the quarter ending June 30, 2014were: 

• Visa: $3,155m, up 5.1% y/y
• Mastercard: $2,377m, up 13.4% y/y.

Looking more closely at each vendors' income statement: 

Visa continues to grow revenues at a moderate pace due to increasing sales incentives. Earnings, overall are growing faster due to concerted operating cost control. Per share earnings are also growing faster than revenues due to share buybacks. The income statement dynamics can be shown in an income statement percent growth waterfall for Q3 FY 2014:

• Overall revenues: +5.1%
• Number cards outstanding: +6.0%
• Payments volume: +9.0%
• Net income: +11.0%
• Net income per share: +15%
• Sales incentives: +22%

This waterfall shows that revenues are growing at a level similar to recent quarters, but the cost of generating those revenues (selling costs: pricing reductions and sales incentives) keeps growing at a faster rate. Aggressive share buybacks are driving EPS up even faster than prices and marketing. 

Visa's moderate revenue growth coupled with strong operating earnings (+10.5%) is typical of most payments vendors (and most IT services vendors) today. However, it does mean the business is becoming progressively less efficient at generating earnings (payments volume grew 12%, much faster than revenues or operating earnings, meaning pricing or revenue per payment fell). Pricing can only continue to fall for so long before margins begin to shrink despite operating cost cutting. Declining prices have been going on for three years. 

Mastercard, in contrast to Visa above, is growing revenues faster than cards and transaction volumes.  

• Overall revenues: +13.4%
• Number cards outstanding: +12.6%
• Payments volume: +11.4%
• Net income: +9.8%
• Net income per share: +14.3%
• Advertising and marketing: -7.0%

Mastercard is able to grow its revenues faster than cards and transactions because it has pricing power. The pricing power reflects it aggressive push into key markets (outside the mature markets) and key services (merchant acquiring services, especially consulting) where pricing reflects the introduction of services under conditions of uncertainty. 

All levels of Mastercard's income statement waterfall show strong growth in double digits (except sales cost which is declining, a plus) versus Visa.

When the next downturn in consumer spending comes in the next one to two years, Mastercard will be better able to withstand the downturn with a client base tilted towards emerging market.

Visa will face a downturn with a client base tilted towards mature markets, where consumer debt levels will make the downturn harder and more resistant to sales incentives. Visa needs to aggressively focus on building out its emerging market presence faster, even if it means slower net income growth in the short term. 

Q2 2014 revenues (and revenue change) by activity, excluding reimbursables, were:

• North America: $233.2m (+8.7%)
• International: $84.7m (+10.6%)
• Merchant services: $108.3m (-4.1%)
• Netspend: $116.8m (n.m., acquired Q2 2013)
• Intersegment: ($5.1m) (-59.1%).

TSYS grew its revenues slower than it grew its transaction volumes in:

• North America (transactions +20.7%)
• International (transactions +13.3%)
• Merchant services (transactions -8.0%, a slower shrink)

TSYS is facing pricing difficulties in its core businesses and volume/revenue shrink in what should be its primary growth engine. Its overall revenues have primarily grown due to its acquisition of Netspend.

TSYS has announced a new CEO (starting on July 31, 2014) who will face the task of putting its organic business back on track for revenue growth at profitable margins. Since the payments market is strong overall, if TSYS focuses on aggressive contract pursuits at good prices, it should be able to resume revenue growth with good margins. 

In 2013 TSYS continued to enjoy strong revenue and earnings growth. Growth in the merchant business is continuing to accelerate, based partly on:

• Competitor weakness (others such as First Data will report in early February and will indicate whether that trend will continue) 
• Merchant dissatisfaction with card schemes and the desire to obtain a processor with fewer if any issuer loyalties.

The international business grew at 5.8% in fiscal Q4, the strongest of any segment. This growth occurred in spite of headwinds from currency exchange rates due to a strengthening dollar. If the dollar moderates, TSYS will have very strong double digit growth in its international business, where its long-term growth opportunities lie. 

The next few years should see international growth for TSYS accelerate to even higher levels (20% and 30% growth rates). The payments business, in particular merchant acceptance, is certainly not subject to the rules of the "new normal". The question is whether high growth rates and low capital charges from regulators will draw in new competitors to the payments business - but the complexity of the business would make it very difficult for most would-be entrants.