Visa's surprising resilience

    Many analysts say the credit card company has gotten a bad rap just by association, but its stock carries on.

    By Janet Morrisseyr

    "More people go with Visa" -- the company's slogan may hold true for credit card holders, but it's a tougher sell for stock pickers who wonder how safe the business is during a recession.

    Many industry watchers say Visa has been surprisingly resilient during the current chaos, and investor concerns are overstated at best -- and misguided at worst.

    "It seemed anything that looked like a financial stock last fall was under pressure" and Visa got lumped into that group that was sold off, says Craig Wildfang, a partner at Robins, Kaplan, Miller & Ciresi LLP, which specializes in financial law.

    The selloff began only months after Visa (V, Fortune 500) exploded into the public arena in March 2008 with an IPO that raised $17.9 billion -- the largest in U.S. history. Initially, the stock rallied, more than doubling in value over two months. But jittery investors, spooked by anything even remotely associated with credit, started dumping the shares in May.

    Fears about credit risk, as well as concerns that a recessionary plunge in consumer spending could cause a subsequent drop in credit card purchases weighed on the stock. Visa shares tumbled to a low of $41.78 last January, down 53% from their all-time high of $89.83 set in May 2008.

    The crush came even though the company continued to exceed Wall Street's expectations by cranking out healthy revenue growth and double-digit quarterly earnings increases over the past year. Visa CEO Joe Saunders says the company remains on track to generate annual earnings-per-share growth of at least 20% (excluding one-time items related to pre-IPO merger costs and litigation settlements) over the next three years.

    "I think the concerns have been overblown," says JPMorgan analyst Tien-tsin Huang. Visa shares recently traded at $62.98, but Huang has a 12-month price target of $73. Piper Jaffray analyst Robert Napoli is even more bullish with a target of $78.

    Credit risk concerns are largely unfounded. Unlike banks and other credit card companies, such as American Express and Discover, Visa doesn't take on risk because it doesn't lend money. The credit card company simply collects transaction fees every time a card is swiped and assumes no risk for late payments or defaults on cards.

    No one goes untouched

    Saunders admits the company hasn't been unscathed in the recession. In the latest quarter, Visa reported a 10% decline in the average dollar amount spent in U.S. credit card transactions, which cuts into the processing fees it receives. Big-ticket items, such as airline tickets and hotel bookings, dropped off. Even gasoline purchases, which historically account for about 10% of credit card purchases, were down. Changes in foreign exchange rates and a decline in cross-border transaction fees also took a toll.

    Saunders ratcheted down revenue guidance for fiscal 2009, which ends Sept. 30, to a single-digit increase from previous estimates of 11% to 15% growth. But the revenue slowdown hasn't affected Visa's bottom line. In the latest quarter, a 6% increase in the number of transactions and a surge in the use of debit cards globally offset smaller-sized purchases. "To see that the number of transactions is growing in the high single-digits in the worst economy in 70 years is a pretty eye-opening statistic," says Saunders.

    Cost savings of $300 million related to the merger of Visa's six operating units prior to its IPO also helped keep earnings up.

    "They're delivering 20% earnings growth despite a lot of pressure on the top line," says Huang.

    A new threat to the bottom line

    Shares have rebounded in 2009, rallying as much as 71% off of their January lows, but another cloud of uncertainty has moved in: the threat of federal changes to so-called interchange fees and a merchant antitrust litigation related to those fees. This prompted another selloff, and shares are now up 51% from the low.

    Several bills are floating in the House and Senate, which, if passed, would allow merchants to negotiate lower interchange fees, which are the charges merchants pay each time a card is swiped at their stores. Credit card companies currently set the rates that banks can charge merchants and only occasionally negotiate different rates with individual merchants, usually larger retailers. The fees amount to about 2% of the value of each transaction or about $50 billion a year.

    Investors worry that legislation and lawsuits affecting interchange rates could potentially take a bite out of Visa's bottom line, but analysts dismiss these concerns. It's the banks -- not Visa and MasterCard -- that receive interchange fees, says Huang. However, David Robertson, publisher of the Nilson Report, a research firm that tracks the industry, believes banks will likely pass on the cuts by trimming Visa's processing fees.

    As for the merchant lawsuit, Visa locked up about 155 million shares, or about $9.9 billion, in trust from banks at the time of its IPO to cover litigation costs. But Wildfang, who represents the merchants, wonders if it will be enough.

    Saunders isn't worried. He says the banks will assume any damages above the $9.9 billion as a result of a "retrospective responsibility deal" that was hammered out prior to the company's IPO - a protection that rival MasterCard doesn't have. "Financially, we're protected," he says.