Dan Davidowitz, portfolio manager and analyst for Polen’s Focus Growth strategy, shares his insights on the often-misunderstood world of digital payments.
What interests you the most about the digital payments space from an investment perspective?
There’s a lot to like about digital payments. First, it’s an area of secular growth. People are using digital payments more and more every year. Not long ago, most U.S. transactions were in cash and check. Now, the majority use digital forms of payment and outside the U.S., there’s even more room to grow.
Exhibit 1: Card Penetration of Purchase Personal Consumer Expenditure (PCE)
Source: Nilson, World Bank, IMF and Bernstein estimates and analysis.
Secondly, it’s exceedingly hard to process digital payments quickly, accurately, and with minimal fraud or downtime. Very few companies can do it on a global scale like Visa and MasterCard, so it’s difficult to compete with them.
What else stands out to you about Visa and MasterCard?
These two companies sit at the nexus of consumers, merchants, and banks. They enable a whole payments ecosystem that wouldn’t be able to function without them, as they link to all counterparties and confirm that transactions between them can happen. And they make these approvals happen anywhere on the planet within milliseconds, billions of times per day. So, they’ve become trusted partners that can operate cost-effectively because of their scale.
Exhibit 2: The Payments Value Chain
Source: Polen Capital.
One nuance that investors don’t always understand is that the credit risk these companies assume is minimal. They take credit risk for only the fractions of seconds that it takes to confirm the validity of the transactions.
Over time, we’ve heard about many potential disruption risks for Visa and MasterCard. Years ago, some predicted that retailers would organize their own payment networks. Later, there were presumptive threats from other networks and digital wallets like Apple Pay. More recently, the focus has been on whether cryptocurrency might displace the incumbents. However, none of these threats seem to have changed the business model for these companies. Why is that?
We’ve observed that each time one of these new, disruptive players comes along, they eventually partner with Visa and MasterCard. And again, this is because no one has figured out how to transact as cheaply, reliably, or globally.
Why do new entrants struggle to replicate the model?
With their massive volume of transactions, Visa and MasterCard have access to a tremendous amount of information. Due to their longevity, they’ve also overcome three huge hurdles of acceptance—from consumers, banks, and merchants—that are difficult for newcomers to surpass.
You’ve studied many other high-quality businesses in this space. How do their models compare?
That’s a tricky question because we only focus on analyzing companies that we believe are outstanding and competitively advantaged. That said, it’s tough to find a duopoly of this caliber, with robust secular growth trends behind it and such a critical position within the global economy. Visa and MasterCard enjoy pricing power and have a history of making strategic capital allocation decisions. In our team’s view, these factors make their businesses extremely hard to disrupt.
Visa and MasterCard are holdings in Polen Capital’s Focus Growth and Global Growth portfolios as of March 31, 2023.
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