Payment networks can be seen as railways: once in place, it makes no sense to put down new tracks right next to them. Visa has put down its global network, but is expanding with tracks to new destinations and upgrading with new payment methods. As co-owners of a company approaching a 70 percent operating margin, we are happy that the journey is still long with Visa.

Visa is the world’s largest payment network and operates the only global payment networks together with Mastercard (which you can also read about in this book). This creates a duopoly in which the titans are difficult to avoid – and where size is no obstacle to double-digit annual growth in net revenue, earnings and free cash flows.

Visa processes 160 billion transactions per year, an almost astronomic figure. In spite of this, electronic and card payments still only account for 45 out of 100 consumer payments, a share which grows by a couple of percentage points per year. This helps drive double-digit annual growth in the number of transactions processed and thereby expected revenue growth in excess of 10 percent.

The growth in electronic payments is driven by several factors, but in the chase for an increased growth rate, and at the same time retaining their leadership position, Mastercard and Visa are investing significant sums in developing payment methods. By making it as easy as possible to pay, the customer experience in stores is improved, shop-owners spend less time per payment, hence increasing satisfaction for all parties.

In Scandinavia and parts of Europe, we have become increasingly accustomed to contactless payments – without having to ”swipe” the card or insert the chip. In an otherwise highly developed country like the US, chip-readers and contactless payment are only just starting to gain ground. To briefly characterise the development, USA is now at the point with chip-based payments where the Danes have come to with contactless payments. This may be a fairly basic observation, but still indicative of the potential inherent in continuous development and optimisation of the payment experience.

Until recently, the European business was not part of the global Visa. Back in 2007, Visa went from being a member-owned company to being listed on the stock exchange. The European members elected to not participate – but retained a put option by which they would be able to sell themselves to the global network based on a pre-defined price formula. In 2016, happily, this option was exercised.

Integration process in place and management able to look ahead

An integration of this scope has obviously required energy and focus and has therefore taken up a lot of the management’s attention. As a member-owned company, the European business did not have the same focus on optimisation of value-creation, meaning that there has been a lot of potential for the acquiring management. Part of the work related to the merger was to renegotiate a long line of customer contracts as these generally run for five years. Today, the merger is complete, and the management can now focus all its time on expanding the global business.

Visa’s customers are not the cardholders of the more than three billion payment cards issued. Instead, the more than 13,000 card-issuing banks and credit institutions are the clients. This is positive for Visa as they do not run a financial risk related to credit portfolios or the like – this lies with the card issuer.

As mentioned, it is in Visa’s best interest to make it as easy as possible for card holders to use a Visa card compared to other payment types – in particular cash. The ability to make electronic payments easier and more wide-spread, combined with a high level of security for both payer and payee, the average amount per payment is, indeed, decreasing. Visa’s revenue is mainly based on the total transaction value and so it is a positive development when electronic payments are made more often, where in the past small cash payments was the norm.

Online payments are still even more positive. For these, Visa receives around 43 cents per 100 dollars per transaction – in comparison with around 15 cents for transactions where the buyer is physically present. The difference is primarily due to a greater need for security from higher risk of fraud in transactions where the card is not present. To Visa, security for both parties of the transaction is vital for the continued trust in and willingness to use the payment network.

Consequently, more than a third of operating expenses is spent on technological development, including investments in development and optimisation of security. This investment helps to strengthen Visa’s – and Mastercard’s – massive entry barriers. The companies are using technology to ensure that the moat around the business is getting steadily deeper and wider.

70 percent operating margins within sight

Both Visa and Mastercard see, analyse and assess a variety of technologies, including the blockchain technologies mentioned, as crypto currencies were a much discussed and hyped topic during 2016 and 2017. Both payment titans are investing in the development of blockchain technology, which is likely to become a feature of some payment types over time. The speed, security and trust are not at all comparable with the electronic payments offered by the networks today. We find that Visa and Mastercard will remain strongly positioned to keep increasing their share of processed electronic payments.

The fixed costs of a global payment network are substantial, but once these have been covered, the incremental operating margin is very attractive. Visa’s operating margin is currently 66 percent – and this increases in step with growing revenue. For comparison, the margin was 60 percent in 2011. Visa has the potential to increase this level up to 70 percent, but it will not happen overnight.

The return on invested capital at Visa is affected by a significant item of intangible assets which came about as the result of accounting requirements in connection with the merger with the commercial Visa in 2007 and also from the acquisition of Visa Europe. The underlying return on invested capital, is, however, above 100 percent, which really highlights the profitability and quality of this business.

Since 2016, the Visa CEO has been Alfred Kelly who previously had a long career with American Express and has been on Visa’s board of directors since 2014. Alfred Kelly competently heads Visa together with CFO Vasant Prabhu, who has been the CFO since 2015. Although this management duo enjoys shorter seniority than typical for our companies, they are supported by an organisation in which country managers have been with Visa for more than 10 years on average.

As an element in increasing revenues, Visa is participating in, and winning, many tenders for so-called “co-brand” cards. This could be payment cards issued to members of loyalty clubs with, e.g. the hotel chain Marriott or the coffee chain Starbucks. In this way, Visa can give more cardholders the opportunity to claim rewards points for relevant customer programmes – but most importantly, of course, to run more payments through Visa’s well-run network. Visa currently has more than 800 such collaboration partners and a clear focus on expanding on this.

The operating profit grows faster than the top line

While Visa is innovative and highly focused on driving forward the distribution of cards and payment options, the company is more conservative in relation to the financing of operations. Prior to acquiring Visa Europe, Visa had no debts – but rather cash in the bank. The purchase sum was of such scope, however, that it could not be financed by cash, leading Visa to issue bonds and a small amount of equity in order to finance the transaction sum of around 20 billion dollars. Today, Visa holds a small amount of debt, equivalent to less than four months’ operating profit before depreciation and amortisations, and we definitely do not view this as a problem.

Visa’s annual free cash flows amount to more than four percent of the market value. With annual revenue growth in excess of 10 percent and a highly scalable business in which operating profits outgrow sales, we find it perfectly realistic that earnings per share can grow by 14-16 percent per year.

The business model has a highly limited need for capital expenditures, for which reason the investment in tangible assets is limited to around three percent of revenue. All revenue is thus converted into cash which is distributed to shareholders in a disciplined manner. Less than a year after acquiring Visa Europe, Visa had bought back shares in excess of the small number issued as part of the acquisition financing.

The management has a disciplined approach to the allocation of capital and Visa therefore distributes more or less all the free cash flow to shareholders. This is done via a small dividend, equal to just under one percent of the market value and repurchasing shares for more than three percent. Distributions should increase in line with the free cash flows and we see the potential for annual growth of 15 percent or more.

As previously mentioned, Visa’s network processes 160 billion transactions per year. To put this number into perspective, it equals almost 440 million per day or more than 5,000 per second. That the network has the capacity to do this – and to do it securely – speaks of solid and well-maintained railway tracks.

We are happy to be on board this train and smile broadly knowing that there is still a long way to go.