Retail Tremors Shake the Payment Ecosystem
Consumers who use credit and debit cards are typically aware only of the card they’re using and the merchant they’re buying from; the payment process is a “black box” from a consumer’s perspective.
But as the first image below shows, the black box hides a complex ecosystem of firms with different specialized functions — including many publicly traded firms with exposure to specific trends in the technology, finance, and retail sectors.
A still-simple, but more comprehensive picture of the payment ecosystem looks something like the second image.
Source: Federal Reserve Bank of Atlanta
Source: Federal Research Bank of Atlanta
(There are some variations to this outline; when it comes to cards such as American Express [NYSE: AXP] or Discover Card [NYSE: DFS], for example, the card issuer and the card association are the same entity.)
Consumers are not generally aware of the various firms that stand between them and the merchant. When a customer presents a credit card to a merchant to purchase a good or a service, the merchant acquirer manages the payment processing and secures approval for the transaction. These merchant acquirers aggregate and separate payments made to merchants. The card associations (such as Visa [NYSE: V] or MasterCard [NYSE: MC]) in turn stand between merchant acquirers and the card-issuing banks. Payments are debited to the card issuer, and ultimately the cardholder. The issuing bank sends a credit for all their daily payments back to the acquirer, who completes the cycle by funding the retailer’s bank account, of course taking a fee in the process.
(As an aside, we note that the many intermediaries in the credit-card payment process, and their fees, are another impetus behind the rise of bitcoin and other digital currencies — where technology promises to replace those intermediaries with algorithms and encryption.)
While consumers are used to interacting with the bank that issued their card, merchants are used to interacting with the acquirer. Some acquirers perform services such as payment processing and customer analytics themselves; other smaller acquirers outsource these services to third parties.
Since the black box usually functions smoothly, customers are rarely aware of its internal workings — until, for example, they want to dispute a charge, or they become aware of fraudulent activity on their account. As you can guess, though, the rise of online retail, mobile payments, and other technological innovations has upended the inner workings of the black box, resulting in a lot of mergers and acquisitions during the past few years. A recent example is the bid by U.S. acquirer Vantiv [NYSE: VNTV] to merge with British acquirer Worldpay [London: WPG]. VNTV is the largest U.S. acquirer, spun out from Fifth Third Bancorp several years ago. It has little exposure to overseas markets, and more significantly, a relative overexposure to U.S. big box and mall retailers, with only 10% of revenues coming from e-commerce. 2017 has thus far been a tale of the decline of the brick-and-mortar retailers that are VNTV’s bread and butter.
WPG, on the other hand, was spun out of the Royal Bank of Scotland in 2015, and its e-commerce operations are global and growing quickly. It has a strong foothold in Europe; in the UK, it has a 42% market share, and in Europe, a 26% share of web-based transactions. WPG also has U.S. operations; between the U.S. and Europe, 41% of its revenue originates online. If the acquisition goes through, it will boost VNTV’s e-commerce business from 8–12% of its revenues to 20–25% of its revenues.
Thus, the same disruption that’s visible to merchants and consumers as they watch events like Amazon’s [NASDAQ: AMZN] purchase of Whole Foods [NASDAQ: WFM] is also visible within the payment-processing universe. This reinforces our view that for now, the company narratives that include secular growth will continue to rule the roost.
Investment implications: The shift to e-commerce will benefit merchant acquirers with a strong e-commerce presence and global reach. One simple way to invest in the development of global e-commerce is to buy the stocks of the credit card networks, such as Visa [NYSE: V] or MasterCard [NYSE: MC]. However, investors may also identify merchant acquirers who derive a significant part of their revenue from e-commerce, and who are able to offer compelling services to merchants in an environment where their fees are under pressure.