Dear reader,
Welcome back to another deep dive into a wonderful company.
Today, discover the story of Visa, the biggest global payments company in the world, connecting consumers, businesses, banks, and governments using its sophisticated payments network. Explore the founding of Visa, how the company grew into an essential piece of infrastructure in the modern world, and learn of the company’s future prospects.
Visa facilitates global commerce and money movement across more than 200 countries using its transaction processing network VisaNet. Visa enables consumers, merchants, banks, and governments, to move money with ease, everywhere, anytime. Together with Mastercard, Visa is a cornerstone of modern capitalism, and both companies are vital to the economy. In this article, we’ll explore whether Visa is worth investing in.
Table of Contents
1. Visa’s History
1.1 The Drop
1.2 Cash Cow
1.3 Credit Card of America
2. Visa’s Business
2.1 How Visa Makes Money
2.2 Visa’s Moat
2.3 Key Financials
2.4 Future Outlook
2.5 Management
2.6 Risks
3. Conclusion
1. Visa’s History
1.1 The Drop
Visa’s origins date back to 1958 in Fresno, California, when Bank of America, then the largest bank in the US, introduced credit cards to its customers. Back then, Bank of America was confined to operating within the state due to laws prohibiting interstate banking. Yet even so, Bank of America had built up a substantial customer base, as California was—and remains—one of the larger states.
During the post-war economic boom, consumer spending surged, with individuals taking out loans not only for major purchases like homes and cars but also for smaller items such as furniture, televisions, and vacations. However, the process for obtaining these loans was time-consuming and manual, requiring physical visits and extensive paperwork for even modest amounts. The Washington Post described the situation as follows:
“Among the things he [a Bank of America executive] most remembers is how cumbersome it used to be to make a small personal loan. Every time a man came in to the branch to get a loan, he had to sit down with the loan officer and fill out his family history -- even if he'd just been there a few months before. The loan officer had to re-evaluate the man's fitness to get a loan. The man had to return to the branch with his wife to sign a note. Only then would the loan officer transfer the funds to the man's account. With that much effort needed to generate a $300 loan, it was difficult to make a profit, despite the volume of such business.”
Recognizing the need for a more efficient system, Bank of America mailed 60,000 unsolicited credit cards to residents of Fresno in mid-September 1958. These new plastic cards, part of the initial test of the BankAmericard, introduced an entirely new financial tool to the bank’s customers, who were initially unaware of the card’s purpose.
While credit accounts weren’t new, they were traditionally offered by individual merchants, requiring consumers to manage separate accounts for each. In other words, consumers had to juggle dozens of separate credit cards for different merchants. Bank of America’s card offered numerous benefits:
It simplified the loan process, significantly reducing operational costs.
Consumers could use a single card to pay at multiple merchants, streamlining their experience.
Credit cards reduced friction in transactions, leading to more frequent use and additional revenue for the bank.
This "drop" in Fresno marked the beginning of the modern credit card era, setting the stage for what would eventually become Visa, a global payments leader.
1.2 Cash Cow
Today, Visa and Mastercard are universally accepted, but at the time of the "drop," this was unprecedented. The challenge was to ensure both a sufficient number of credit card holders and a broad network of accepting merchants—a classic "chicken or the egg" dilemma. The solution lay in the initial "drop."
As 60,000 Fresno residents suddenly received credit cards, local merchants quickly recognized the potential benefits of joining the BankAmericard program, despite the 6% transaction fee imposed by Bank of America. The convenience of credit cards outweighed the cost, making the fee seem reasonable for participating in this new merchant network.
Following the Fresno rollout, Bank of America rapidly expanded its credit card network across California. By October 1959, approximately 2 million cards were in circulation, and over 20,000 merchants accepted the BankAmericard.
Despite this growth, the program faced significant challenges:
Fraud was rampant due to a lack of security features like chips, magnetic stripes, or PIN numbers, combined with limited merchant training and Bank of America's struggle to manage and monitor fraud effectively.
Merchants were resistant to the 6% fee, leading to a concentration of early adopters in pawnshops, taverns, and bail bond houses—major merchants were reluctant.
Handing out credit cards was done indiscriminately, leading to duplicates and high-risk individuals being issued cards, further increasing problems.
Despite these challenges, Bank of America remained committed to the long-term potential of the credit card system. To address the issues, the bank introduced several key measures. It introduced comprehensive training programs for merchants, ensuring they were well-equipped to verify transactions and identify potential fraud. Additionally, Bank of America improved card designs to make it easier to detect counterfeits and incorporated magnetic stripes, which allowed for the storage of encrypted data and enhanced transaction security.
By 1961, the BankAmericard became profitable and continued to grow, though Bank of America kept its success secret. Between 1958 and 1966, Bank of America was the sole credit card provider in California. The secret was unveiled in 1966 when Bank of America initiated the BankAmericard Licensing Association.
1.3 Credit Card of America
It seems ironic that Bank of America called itself the Bank of America while operating only in California. However, this name became increasingly fitting in 1966 when the bank decided to expand its reach by licensing other banks across the U.S. to issue the BankAmericard. These banks eagerly joined, recognizing the success of the BankAmericard and its position as the world’s largest credit card network.
This expansion, however, introduced new challenges, particularly concerning interchange—the process of transferring funds between the cardholder’s bank and the merchant’s bank. In California, the BankAmericard operated as a closed-loop system, with both the cardholder and merchant bank being Bank of America. Outside California, the situation was more complex, with different banks involved in transactions. Bank of America lacked experience with such interbank transactions and needed a more robust network and operational infrastructure.
In 1968, frustrated licensees demanded a meeting with Bank of America to address the interchange issues. In response, Bank of America appointed a committee of licensees to study the problem and propose a solution. Among the committee members was Dee Hock, who would later become Visa’s founder and first CEO.
Hock proposed creating an independent organization to manage the BankAmericard program, recognizing that the program under Bank of America was inadequate for the complexity and scale required for a nationwide—and eventually global—payment system. Hock was thinking big from the beginning.
Bank of America allowed Hock to pursue his vision. In 1970, Hock took control of the BankAmericard program, which was renamed National BankAmericard Inc. (NBI). Under this new organization, participating banks shared a common payment processing system while issuing cards under their own brands. The network rapidly expanded, including international banks, and outgrew the “BankAmericard” name. In 1976, the organization was rebranded as “Visa” for its simplicity, universal recognition, and association with freedom and accessibility, similar to a travel visa.
Simultaneously, Visa developed its technology, notably VisaNet—a global network that processes secure and reliable digital payments at scale. VisaNet includes authorization, clearing, and settlement services, which reduced fraud, sped up transactions, and facilitated the rapid expansion of the credit card network.
Over the years, Visa continued its growth, with Dee Hock unfortunately resigning in 1984. He played a crucial role in the founding of Visa, realizing it needed to be independent. Today, Visa is a global leader, with around 14,500 financial institutions as part of its network and 4.5 billion Visa cards in circulation. Visa has become integral to the global economy, empowering businesses and consumers worldwide.
2. Visa’s Business
2.1 How Visa Makes Money
Visa is a global leader in digital payments, facilitating transactions between merchants, consumers, banks, and governments. With a Visa card, you can make payments almost anywhere with ease. This is made possible using Visa’s four data centers, powering more than 100 billion processed transactions per year. Over the years, Visa has carefully expanded its network, establishing relationships such that merchants and other entities are eager to join.
But how does Visa generate revenue, and how does this payment network operate?
When analyzing Visa’s business model, it is insightful to first invert—to consider what Visa does not do. As outlined in Visa’s annual report:
“Visa is not a financial institution. We do not issue cards, extend credit or set rates and fees for account holders of Visa products nor do we earn revenues from, or bear credit risk with respect to, any of these activities.”
Visa operates as a third-party network, connecting banks and facilitating transactions for a fee. Its core business lies in enabling secure, reliable, and efficient money movement among consumers, financial institutions, and merchants. Here’s how a typical Visa payment transaction works:
Transaction Initiation: A consumer makes a purchase from a merchant using a Visa card, which could be a credit, debit, or prepaid card. Notably, Visa does not issue these cards; they are issued by the consumer’s bank, known as the issuer, under a licensing agreement with Visa.
Transaction Processing: The merchant submits the transaction data to their bank, known as the acquirer, for verification and processing.
Authorization: The acquirer forwards the transaction data to VisaNet, Visa’s comprehensive digital payment network. VisaNet routes the data to the issuer, allowing the issuer to verify the consumer’s account balance or credit line.
Settlement: Once the transaction is authorized (i.e., the consumer has sufficient funds or credit), money flows from the issuer to the acquirer, minus interchange fees. The acquirer then pays the merchant the transaction amount, minus a merchant discount rate.
Visa, along with the issuer and acquirer, earns a small fee for every transaction that utilizes its network. This fee structure underpins Visa’s revenue model, allowing it to profit from the vast number of transactions it facilitates globally.
Besides the above explained core business, Visa also generates revenue through value-added services like fraud mitigation, data analytics, and consultancy. Additionally, Visa earns from international transactions, including cross-border payments and currency conversion fees.
2.2 Visa’s Moat
Visa benefits from a strong moat, driven by its network effect, intangible assets, and cost advantages.
Visa’s network effect is particularly strong due to the involvement of five parties: cardholders, merchants, issuers, acquirers, and Visa itself. This extensive network enhances both its strength and complexity. Unlike traditional network effects, such as Meta’s, which primarily involve two parties (users and content creators in Meta’s case), Visa's network effect is more robust due to the interaction of multiple groups. Furthermore, Visa's network is the largest in the payments industry, reinforcing its dominant position.
As seen in the above exhibit, Visa leads in processing dollar volume, transactions, and cards. Only Mastercard comes close, which boasts a comparable network effect, yet obviously smaller.
Visa’s brand is another significant asset. As one of the world’s most recognized brands, Visa commands strong customer loyalty and confidence. It is the sixth most valuable brand globally as of 2023, with Mastercard ranking ninth. Visa’s extensive marketing efforts, including its long-term partnership with the Olympics, further bolsters its brand strength.
Additionally, Visa benefits from cost advantages due to its scale. As the market leader, Visa can spread its fixed costs efficiently, resulting in high margins—its operating margin was 67% in 2023, compared to Mastercard’s 58%. This scalability and cost efficiency are key components of Visa’s moat.
Overall, Visa’s moat is outstanding, creating high barriers to entry and enabling the company to generate high returns on capital. However, Visa and Mastercard operate as a duopoly with similar competitive advantages. It’s important to realize that the two companies don’t hold a significant competitive advantage over each other.
2.3 Key Financials
Visa's revenue growth is marked by consistency. The company has achieved high-single-digit growth over recent years, with a compound annual growth rate of over 9% since 2019.
Visa’s return on invested capital (ROIC) reflects the strength of its moat and scalable business model. The company’s ROIC has improved due to increasing operating income and stable invested capital, as Visa doesn’t require significant new investments in property, plant, and equipment (PP&E) or ongoing technological upgrades.
Visa generates substantial free cash flow, which grows slightly faster than revenue. Free cash flow and net income have grown consistently—Visa converts roughly all net income into free cash flow. The company’s free cash flow margin in 2023 was over 60%, a feat only a handful of companies can claim.
Finally, Visa has its balance sheet under control, holding $12.9 billion in cash against $20.6 billion in long-term debt, resulting in a net debt position of $7.7 billion. With free cash flow of nearly $20 billion in 2023, Visa’s net debt-to-free cash flow ratio is a healthy 0.4. Besides, the company’s interest coverage ratio of 33 indicates manageable interest expenses.
2.4 Future Outlook
While past performance is an important indicator, it is no guarantee for the future. Visa’s historical performance is impressive, but future growth must be evaluated in the context of secular trends and growth potential.
A significant long-term trend is the shift from cash to card payments, though some regions are already transitioning to digital payments like Apple Pay and Google Pay. Either way, Visa’s network remains integral to payment systems, whether by card, by phone, or digitally. Thus, Visa benefits from the overall decline in cash usage. For example, cash still accounted for 59% of point-of-sale transactions in Europe in 2022 and 20% in North America, indicating there’s room for further growth.
Another positive trend is the global increase in wealth, which drives more transactions through Visa’s network, translating to higher revenue. The amount of wealth globally has been on the rise for a long time, and as this trend continues, Visa will reap the rewards.
The question remains whether Visa’s industry has become too saturated, or whether Visa itself has become saturated. Evidence suggests that the above secular trends aren’t over just yet, but it is clear that Visa isn’t growing at its historical pace.
2.5 Management
Visa is led by CEO Ryan McInerney. He assumed the role in 2023, and has been with Visa since 2013, having previous experience at JPMorgan Chase and McKinsey. As of December 1, 2023, McInerney owns 211,316 Visa shares, equating to a stake worth about $59 million. In 2023, he received $23 million in total compensation. While McInerney’s stake is substantial, a higher shareholding relative to his compensation could align his interests more closely with shareholders.
Visa’s capital allocation strategy reflects its maturity. The company primarily allocates capital to maintain its PP&E and does not invest heavily in R&D. Instead, Visa allocates significant cash flow towards share buybacks and dividends. In 2023, Visa bought back over $12 billion in shares and paid $3.8 billion in dividends, despite having high ROIC. Returns from dividends and buybacks are lower than if the capital were reinvested at historic ROIC rates, but Visa lacks reinvestment opportunities.
2.6 Risks
Visa faces multiple risks, but in my view, the following two risks are the most important for shareholders to consider:
Visa appears to have reached a stage of maturity where substantial capital is allocated to buybacks and dividends. While this may be appealing to investors, it also indicates a lack of opportunities for reinvestment in the business. Given Visa’s high historic return on invested capital (ROIC), reinvesting into the business would be more beneficial. Additionally, maturation typically leads to slower revenue and earnings growth, particularly when margins are already exceptionally high.
As a near-duopoly with Mastercard, Visa is exposed to potential regulatory challenges. On the other hand, however, Visa and Mastercard are fundamental to the global economy. Governments (should) recognize that these two companies are crucial. Nevertheless, regulatory scrutiny will always be a risk in such an industry.
3. Conclusion
Visa is a standout company, the big brother of Mastercard, with a seemingly unbreakable moat. The company boasts high returns on capital, solid growth, and a strong track record of shareholder returns. However, in my mind, concerns arise about its future growth trajectory despite favorable trends like the shift from cash to card and increasing wealth.
Visa has no significant reinvestment opportunities thanks to its business model and stage in its life cycle. For risk-averse investors seeking stability without aiming to outperform the market, Visa seems an excellent choice. This is also the reason, however, why Visa will not be added—at least at the current price—to the Summit Stocks portfolio.
Disclaimer: the information provided is for informational purposes only and should not be considered as financial advice. I am not a financial advisor, and nothing on this platform should be construed as personalized financial advice. All investment decisions should be made based on your own research.