Raymond James Equity Research
Analyst(s): Wayne Johnson
[Industry Classification: Business & Industrial Services/Transaction Processing]
We think the trends in the global electronic payments industry are positive and the Greenfield opportunities in this industry warrant investor attention. Market share gains by electronic form factors at the expense of traditional mediums such as cash and check still represent a meaningful growth opportunity for payment card service providers in the U.S. and overseas. For example, we size the worldwide merchant acquiring service revenue market opportunity at $45.9 billion this year, growing at a 7% CAGR to $64.4 billion by 2015. We believe a $12 billion domestic merchant acquiring service market opportunity exists, which could expand at a 5% CAGR. However, we also estimate if alternative electronic payment form factors are adopted, like mobile payments and other innovative, enabling services, the domestic merchant acquiring business could expand by 50%, or an incremental $6 billion. Approximately 40 billion transactions, 37% of total U.S. consumer retail purchases, or $1.8 trillion in annual domestic retail sales, were still paid by cash and check in 2009. Furthermore, payment card processors enjoy a large and growing market opportunity by enabling e-commerce businesses globally.
We think the domestic E-commerce payment service revenue opportunity could exceed $5 billion by 2015 and on a global basis could exceed $25 billion in 2015. Worldwide there are 4-4.5 billion mobile phones in use and roughly 250 million, or 6%, are Internet-enabled, but by 2015 750 million, or 15%, could be eCommerce capable smart phones. In the U.S. 74 million, or 26%, of the 285 million cell phones are Internet-enabled, but that figure could double to 158 million, 55%, by 2015. Large e-commerce-oriented companies like PayPal (owned by eBay), Amazon, Google, and the payment card associations such as Visa and MasterCard are designing mobile payment applications for widespread use. The global financial crisis in 2008 caused a contraction in consumer lending with revolving credit card lines reduced by 20-25% from 2007 peak levels. Consequently debit cards have become the payment medium of choice for U.S. consumers with transaction volumes exceeding those of credit cards at the retail point of sale. Moreover, the shortage of consumer credit has stimulated the adoption general purpose reloadable prepaid cards, which provide an attractive electronic payments alternative to the 15% of Americans who do not have a bank account.
The domestic and international payment card industry has been under the scrutiny of government regulators and the most impacted party is the card issuer. Last year, the U.S. government passed the Credit CARD Act of 2009 restricting interest rate increases on credit cards. Regulation E, which went into effect July 1st 2010, forces debit cardholders to opt in for overdraft transactions. The recently passed Durbin Amendment (part of the Dodd-Frank financial reform bill) seeks to regulate debit card interchange fees received by card issuers in the U.S. On the international legislative front, SEPA (Single Euro Payment Area) is designed to flatten and standardize the processing cost of any payment card transaction in Europe by treating all payment cards issued in that region as domestic. We believe the financial metrics of the Transaction Processing sector are attractive, including: clean balance sheets (cash heavy, debt light); low capital expenditures; strong free cash flow; 80+% recurring revenue; 6-10% organic top-line growth; and EPS of 10-15% on 20% operating margin. These outsource service companies operate leverageable business models that expand profitability from processing incremental transaction volume over a fixed-cost infrastructure.
The Transaction Processing industry benefits from a number of defensive growth characteristics, such as targeting large market opportunities with low overall service penetration. We have designed this in-depth, top-down electronic payment discussion for investment professionals who are interested in exploring many of the sector topics that may impact the business and stock performance of participating companies. We postulate on the condition and future of the following categories of the transaction processing industry: credit, debit, and prepaid card processing; e-commerce; mobile and alternative payments; transaction security; electronic bill presentment and payment (EBPP); and money transfer.