What Do Visa and Mastercard Have to Fear From Fintech?

On this week’s episode of Industry Focus: Financials, host Jason Moser sits down with Motley Fool contributor Jason Hall. Tune in as they take a look at the most recent earnings reports from Mastercard (NYSE:MA), Visa (NYSE:V), and Robinhood Markets (NASDAQ:HOOD).

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This video was recorded on Nov. 1, 2021.

Jason Moser: It’s Monday, November 1st. I am your host, Jason Moser, and on today’s Financials Show, we’re digging into the latest earnings reports for Visa, Mastercard, and Robinhood. Joining me this week, it’s Jason Hall. Jason, good to see you.

Jason Hall: Jason Moser, it is a pleasure to be on with you.

Jason Moser: We don’t get to do this often enough. I’m glad we have a plethora of material to get through. We could probably talk about this stuff for a lot more time than we were allowed to today. Let’s just jump right in.

Jason Hall: Yeah, we’ve got an hour’s worth of content and 30 minutes to get it done.

Jason Moser: Easily, we’re in the middle of earnings season of course. A lot of companies reporting last week and this week. Last week, we had a few of our favorites to cover reporting. We’re going to start the show this week with Mastercard. Mastercard, I think everybody is very familiar with the brand and with generally speaking, what they do. Not the greatest week. They had a tough week last week, shares down about six and a half percent. It felt like a good report that in fact, the market received it with cautious optimism. What are your takeaways from Mastercard’s recent report there?

Jason Hall: Yeah, I think so too. Jason, if you look at the stock chart, to think about what’s going on with the stock price versus what’s happening out here in the actual world, it feels like Mastercard and Visa, the two we’re going to talk about, got tied up in that reopening trade. The result that we’ve seen over the year because that was the big talk at the beginning of the year and early in the winter. The results, I guess just haven’t met expectations. I think maybe I’m taking a look at Mastercard. You go back into the second quarter, and it reports all of these different metrics or different parts of its business. In general, we think about the e-commerce stuff, so transactions card-not-present. That’s largely people ordering stuff online has just exploded and that’s driven their number of transactions above 2019 levels. That’s another thing that we’re doing that’s helpful is they’re not just giving us the comps to last year because we know last year was bizarre land and not representative of the kind of business that this normally is. We get those 2019 comps, and I could look at switched volume, you look at switched transactions, 127 percent in the second quarter, 131 percent in the third quarter, and then through October 21st, 132 percent. We’re seeing that continued acceleration. But then you look at their international travel number, that cross-border volume, and it was still 77 percent of 2019 levels, right?

Jason Moser: Yeah.

Jason Hall: I think it’s cautious optimism, I think that word is right, just caution, maybe. Because these stocks really from the beginning of the year, they’re not doing great at all.

Jason Moser: No, they’re not and that’s obviously because it’s becoming very hyper-competitive environment, and we’ll talk a little bit about that when we discuss these together. Mastercard being the smaller of the two, it feels like perhaps there’s a little bit more of a growth opportunity there. I’m glad you mentioned the comp to 2019 numbers because clearly coming from 2020, that’s maybe not as helpful, but generally speaking, this recovery rate we’ve seen with bank earnings here over the past several quarters, the consumer is in a great spot. The consumer, generally speaking, has been at a very good spot. This job, this employment issue, not enough people to fill the jobs that are available out there is interesting to note. I feel like what remedies that is you just you could just go without a job for long enough and [laughs] you’re going to run out of money, that takes care of itself, doesn’t it?

Jason Hall: Yeah, I think you’re right. At the end of the day too, if you think about the jobs that are open, they’re the jobs that people didn’t really want to have two years ago anyway, right?

Jason Moser: Yeah.

Jason Hall: People in the service industry, if you’ve ever dealt with any kind of travel when people are already stressed, hotel staff, all of those sorts of jobs. That’s the stuff that the people aren’t filling, so here we are. Given time, I think you’re right. I think that gets addressed.

Jason Moser: One thing I noticed in Mastercard’s call and I’d be interested to hear your perspective on this because we’ve seen so much in the financial media landscape recently regarding the I-word, inflation. That is the word of the day. Seemingly every day for the past several months. Clearly, inflation is an issue. You have some folks arguing whether it’s transitory or a bit more permanent in nature. I tend to feel like it’s a little bit more permanent in nature, but I guess we’ll find out when we get there. But I did notice that the call with Mastercard. One of the questions was, how does a business like this respond to inflation? Is inflation a good thing or a bad thing for a business like Mastercard? Management had an opinion there, they said in the call they felt like, if inflation is something where it’s measured, it’s relatively modest, it’s paced, you’re not talking about some sort of hyperinflation type of environment. Typically that is going to end up being a tailwind for a business like Mastercard, just based on the business model itself. I mean, they’re getting their interchange. They’re getting the cents per transaction. I mean, when you see something like inflation going through our economy at a measured pace, ultimately the spending, the dollars that are going through these networks are growing. Whether it’s Mastercard or Visa, they are going to benefit from that unless it’s a hyperinflationary type of environment which can have other sorts of ongoing impacts.

Jason Hall: Yeah, Jason, this is exactly why FinTech is a thing. This is exactly why you have the Squares and the PayPals of the world that want a larger and larger portion of that payments business. Because at the end of the day, the business model is so incredibly powerful. You mentioned operating leverage because even if inflation does affect them and their operating expenses to some extent, the benefit is like orders of magnitude larger. In terms of you think about the revenues. These are [laughs] businesses that generate better than 50 points of gross margin, so it is good. But again, the risk and I really want to define it is if it’s inflation that hurts the economy like really hurts the economy, that’s definitely not good. I think that’s the key thing that they wanted to stress is that really it is good inflation, which like it or not is a real thing. Good inflation is good for this business, too much inflation that stalls the economy, takes us back to where we were a year ago.

Jason Moser: Yeah, well, let’s talk a little bit about Visa because very similar business, of course, a little bit bigger, a very similar business. A little bit of a tougher week shares down about eight and a half percent. Again, what I feel like it was a pretty good quarter, I mean you saw numbers that indicate growth, that indicate spending more dollars going through these networks, more transactions happening. But there was one headline we saw throughout the week that I think along with the type of guidance, and you could talk about that. But along with the type of guidance, I think we’re seeing Visa, it seems like Visa’s being targeted a little bit more by regulators here recently. Whether that’s earned or not, that’s another debate entirely, but it certainly feels like these relationships that they have with companies like Square and PayPal like you mentioned, it started getting that headline where regulators looking into what you’re doing and how you’re making your business happen. Certainly, that’s going to create some near-term uncertainty, I would think.

Jason Hall: This is a business that’s gotten it’s hand slapped in the past over anti-competitive practices. When you have more than half of the US share of those transactions, regulators should be watching closely. Frankly, I think it’s good to have a dominant business for reasons but when you start running into anti-competitive practices, I don’t think it’s a threat to the business, but it’s a risk that investors need to be very conscious of because if the company is forced to take steps that’s going to cede some of their market, guess what? That’s the bottom line that’s affected. I think you have to be conscious of that. I think the other thing too with Mastercard compared to, I don’t want to jump the gun here. But Visa’s done an incredible job growing, I mean it’s gigantic even compared to Mastercard, at least in the U.S. and overseas as well. But the growth opportunity for both of them is largely not just in these merchant transactions. You go into the store to buy stuff transactions, you’re getting a new Visa or Mastercard from your bank. That’s great business and there’s certainly growth there as the world moves to more digital transactions, but you move to like business-to-business payments, you think about the person-to-person payments. Those are like, I don’t know, four times the size of the merchant markets that they do? I think Mastercard’s done a better job there and I don’t think that the market is responding to that. I don’t think the market in general even really realizes broadly, you know what I mean? 

But I think the big thing for Visa is it was like one of those sell the news things. There was this expectation for guidance of being closer to 20 percent growth, driven a lot by not just the strong transaction processing volumes that we’ve seen that have recovered and grown in some of these other areas. But just into like the whole travel thing started to get back to normal, and that really important part of their business being just like gravy. Obviously, management’s not 100 percent sold that that’s going to happen next fiscal year, because they’ve just started their new fiscal year right now. It just doesn’t seem like management’s convinced that that’s going to be like 20 percent revenue, enough to push them to 20 percent revenue growth. Guidance was closer to like upper mid-teens, right?

Jason Moser: Yeah. I’m glad you brought up all of these different ancillary almost. I shuttered a call on the ancillary because there’s such a big market opportunities, but I think so many people out there just think of Visa and Mastercard as the consumer card that is in your wallet. When you read into these two businesses, both of them their strategy, they start talking about this network of networks. That’s why these businesses are so strong because there’s such massive networks, and they are looking to basically parlay that success of that mass of networking into the other networks within that network. I think that is part of the story that a lot of folks don’t necessarily focus as much on, but when you look at the sheer numbers involved, you’re talking about trillions and trillions of dollars moving around the world and these are two businesses with the networks that can absolutely help facilitate all of those different types of networks. Whether it’s business to business, business to consumer, government to consumer, whatever it may be.

Jason Hall: It’s bananas how many of those transactions are still something that comes across an accounts payable department, and they process it, and an actual physical check comes off a printer somewhere, goes into an envelope, and gets mailed. Just the inefficiencies that are there are enormous, and the ability to facilitate less human interaction, drive a lot of those operational costs out, but also speed up processing time. Because at the end of the day, when there’s money that’s literally in the mail somewhere, that’s money that’s not in your bank account. That’s something that a lot of organizations they can improve their cash efficiency using what Visa and Mastercard can do. That’s powerful.

Jason Moser: Yeah. That’s exactly why I think you’re seeing so much enthusiasm of companies like Bill.com for example. The company that just taking the world by storm here. If you look at the stock chart, it’s astounding honestly, but it’s because they’re tackling that specific opportunity that you just talked about. The inefficiencies in small and medium-sized businesses, just the nature of cutting physical checks. Just as an individual like when I have to cut an individual physical check, I die a little bit inside sometimes.

Jason Hall: That’s a moment that you will never get back in your entire life.

Jason Moser: I know.

Jason Hall: You’re literally paying somebody and taking more of your time to pay them. It’s 2021, come on, what are we doing here?

Jason Moser: Well, speaking of 2021, given the nature of FinTech, this is a very fast-changing, evolving space. There are a lot of different players and I get it. It is a massive market opportunity and there are a lot of hands in that cookie jar. Now some are going to succeed, some are going to just disappear. But generally speaking and the conversation goes, well, this is FinTech. You look at Visa and Mastercard, your days are numbered. I feel like that is a very simplistic argument that doesn’t take into account a lot of the things that we just discuss there. But I’m curious to know, how concerned should investors actually be about these two businesses being meaningfully disrupted from this move toward digital payments because I feel like maybe they’re finding ways to participate as opposed to necessarily being edged out of the transaction entirely.

Jason Hall: Yeah. By and large, I think that’s the case is at the end of the day FinTech, generally, again, we’ve only got a few minutes we can’t really dive into this. We could do like a five-part show on this if you want to. That’s what it would take to cover it. But I think the key thing to remember here is that the reason FinTech exists is all of these companies want to be in the middle. They want to participate somewhere in between you as the purchaser and me as the merchant. Or they want to be somewhere in between me and the bank, or you and the bank. They want to be in that middle because it’s so lucrative. Think about, again, those margins I mentioned that these companies generate at scale are enormous. You think about these relatively small fees that they charge to generate this incredible profitability. Being in the middle is really powerful. I think viewing Visa and Mastercard is at risk of disruption from that is inaccurate because they have competition. Competition is increasing and at the end of the day the network effect, if your Visa and Mastercard is so strong. They have their relationships with the merchants already. The merchants trust them because they know they’re going to get paid. The banks trust them because they know that they are secure, and they have relationships with 99 percent of the merchants out there. 

All of those things are there. If you’re a consumer, having their cards is either just a prerequisite because that’s a debit card your bank offers or there’s a rewards program that gives you some incentive and gets back to the power. There’s so much strengthen that network effect that it’s easy to overlook that. You know what, it’s hard to build that. It is really hard to build that. Technology has helped. It certainly helped the cloud has helped making it easier to build those networks out and attracts the different stakeholders and users. But I think sometimes we rushed to they’re going to get disrupted and forget that guess what all these other FinTech companies that are in the same cabal. They want to do the same thing already and a lot of times, they’re going to partner with Visa and Mastercard anyway. I think we missed that. But to me, Jason, I think the biggest potential disruption is he who can pay me fastest and at the lowest structure fees wins. I think technology like blockchain is more likely to be a bigger source of disruption at some points than any of the FinTech players are to these businesses because it essentially eliminates the middle, right?

Jason Moser: Yeah, it seems like it improves the operating system. If you think of Visa and Mastercard these operating systems of the payments network, and you search to their calls, you’ll see mention of blockchain frequently. They are utilizing that technology. So it’s good to see them embracing that in order to be able to evolve because I think you’re right. Getting that money from point A to point B as quickly as possible, as cheaply as possible. That’s ultimately what people want, that’s what businesses want, that’s what everybody wants. We’re certainly finding new ways to do that, and it feels like blockchain technology is going to be something that ultimately helps these businesses. To your point, building a network like that. I think people just don’t really think about the billions of cards that are out there with these brands on them. Whether it’s Visa or Mastercard, it’s not easy to build that network. Regardless of your feelings of any particular FinTech operation, that operating system is core to so much that’s going on.

Jason Hall: Yeah, no doubt about it. It really is. The other aspects of it too, you have regulation in hundreds of countries and thousands of municipalities. The scale to have the resources to make sure you’re meeting the regulations where you’re doing business is another thing I think people forget about. Because the world is getting smaller and more international. Those are things I think that are easy to overlook. But at the end of the day, the technology that gets people pay the fastest. When you can go from months to weeks, that’s great. But when you go from weeks to days, that’s incredible. But when you can go from days to now, and again, I think it’s 5, 10 years before that thing happens. The big problem with cryptocurrencies, which are the monetary side of the blockchain, is the volatility in value. Because sure, it’s great to be able to get it as a crypto asset, but then they turn it into cash, the thing that’s still money, that’s another process in and of itself that has to be continually refined. But I think that’s the biggest risk right now.

Jason Moser: Well, the toughest week of them all goes to Robinhood. Robinhood earnings came out late last week as well. Shares had a tough week down about 11 and 1/2 percent in total. It feels like this is a polarizing business. There’s some people who love it, there some people who just can’t stand it. I don’t know that I would say I can’t stand it, but I certainly don’t have any interest in owning these shares. Now, you may feel differently, but let’s talk a little bit about the quarter because it did seem like they’re starting to realize some challenges, particularly because they are so heavily exposed to crypto.

Jason Hall: Yeah, and it’s certainly showing in what’s going on with the user base. Bottom line, it’s not even just crypto, but I think we’re seeing the same thing just in their volume of stock transactions, it’s also coming down. Options might be the only part of the business that is actually doing OK.

Jason Moser: But how much of that do you think it’s like the people don’t fully understand what they’re doing? There is a gambling sense to options unless you really actually know what’s really going on.

Jason Hall: Yeah. No, this isn’t like Motley Fool Options. It’s like the most boring possible way to do options that also generates income 97 percent of the time or whatever it is. Yeah, it’s gambling; it’s just straight-up gambling. I think, again, that gets back to the big challenge with Robinhood from the beginning for so many long-term focused investors to say it’s awesome that we have more people particularly young people that are thinking about making money with stocks. But it’s like everything about the way their system is built gamifies it and turns it into the short-term quick-hit thing. If you look at the numbers, if you look at something, I sent a note to you. They reported third-quarter. They said that their monthly active users increased 76 percent and assets under custody increased 115 percent. But if you go back and look at the second quarter, what you see is that they ended the second quarter with 21.3 million users, they ended the third quarter with 18.9 million monthly active users; that’s going the wrong way. Assets under custody ended the quarter at 95 billion, they ended the second quarter at 102 billion. ARPU, average revenues per user fell from $112 in Q2 to $65. Jason?

Jason Moser: That’s a big drop.

Jason Hall: What do you think?

Jason Moser: Well, there are a lot of different ways can look at Robinhood. I like the idea that we’re getting a platform out there that wants to democratize investing and give everybody the access, I feel like they can do a better job on the education side of things and maybe they’ll get there. I think building that brokerage, it can be sticky and from there, once you have people in there, then you can start rolling out educational and advisory services, I think, as you like. There’s a lot of potential there. 22.4 million net cumulative funded accounts with $95 billion in assets under custody, that sounds like a lot, but when you do the math actually, you’re talking about the average net funded account, $4,200, a little over $4,200, and that number is coming down. You don’t have very high-value clients, first and foremost, right?

Jason Hall: Yeah. They lost about 100,000.

Jason Moser: I’ll bet you the median is far lower than that 4,200. You’re looking at a business that clearly, they’re doing some neat things, but you have to wonder about the market that they are actually pursuing, the demographic that they’re pursuing. Because look at something like Charles Schwab, for example, Charles Schwab, $7 1/2 trillion in assets under management and it’s a $154 billion company. You’ve got Robinhood with just under $100 billion in assets under custody, that’s a $30 billion company. Those numbers don’t even come close to making sense. There’s clearly a lot of enthusiasm there for Robinhood, I just feel like it’s not been earned yet.

Jason Hall: I agree, Jason. I want to like this business, I really do.

Jason Moser: Yeah, I do to.

Jason Hall: I want to like it so much, you know what I mean? I think there’s levers they can pull. You start adding IRAs, you start letting people do rollovers and open up a Roth, and start really thinking about the long-term distance future. I know they’re working on those things. Maybe that can turn these losses and users that we’re seeing, maybe it can start turning that around. But how long has this company going public, earlier this year?

Jason Moser: Yeah, just a bit of a short time.

Jason Hall: Yeah. Thirty-five dollars a share, IPOed at 38. The market is obviously, nowhere near convinced.

Jason Moser: No.

Jason Hall: Is it going to be able to turn it around, right?

Jason Moser: It’s obviously very competitive environment. You’ve got companies out there like Public.com, which is not public but if you’ve ever interfaced with Public, that is a very slick mobile, fast experience for investing. They really embrace the educational side of it. Much less of a focus on just things like crypto and options, building neat thematic ETFs. When I see a company like Public, and that to me, I feel like Public is playing the long game whereas Robinhood is not quite sure what they’re doing yet, and that’s what really concerns me.

Jason Hall: Yeah. I think that says it well. Here’s the thing though, the business is strong, it’s tons of money in the bank. Starting to burn cash though. Cash burn, I think it’s a real concern. The economics should be really good with this kind of business that it should generate pretty good operating cash flows, but that’s not the case this year. I think that’s a real concern because when you’re losing users, when your average account balances are falling, trading is falling, your average revenue per user is down 40 percent, those are some real things, particularly for a cash-burning business. As much as I want to like the business, I wouldn’t touch the stock right now until the metrics, they have to earn it, right, Jason? They have to earn it, right now they’re not.

Jason Moser: We’ll leave it there. I think that’s going to do it for us this week, Jason. Thanks so much for taking the time to be here.

Jason Hall: I appreciate you having me on, this is always fun. We’ll do it again.

Jason Moser: Yes sir. Remember folks, you can always reach out to us on Twitter @MFIndustryFocus or drop us an email at industryfocus@fool.com. As always, people on the program may have interest in the stocks they talk about and the Motley Fool may have formal recommendations for or against, so don’t buy or sell stocks based solely on what you hear. Thanks as always to our guy Steve Broido today, the original man behind the glass, tidying this show up for us. For Jason Hall, I’m Jason Moser. Thanks for listening and we’ll see you next week.