Mad Hedge Technology Letter
January 7, 2022
Fiat Lux
Featured Trade:
(THE DEATH OF VISA AND MASTERCARD)
(MA), (V), (SQ), (PYPL), (AFTPY), (AFRM), (AMZN)
Posts
Visa and Mastercard’s card networks are a relic of the past, not in terms of reach or footprint, but the technology of it.
This will cost their stock price and we are already seeing it play out in the market.
The canary in the coal mine was fintech players Square (SQ) and PayPal (PYPL) whose share prices were pummeled at the back end of last year.
PYPL is down 40% from its 2021 peak and SQ experienced a similar 42% drop.
This fierce competition and the crowded marketplace have investors paying less of a premium than ever before.
In a tightening rate environment, it’s clear the wolves are out for more flesh and the contagion will spread to those further up the food chain.
Fintech business models aren’t as robust or foundational as the bulwarks of MA and V, but questions must be asked if small businesses aren’t willing to pay an extra 2% on sales for outdated technology.
The fintech space has moved a long way in a short amount of time causing investors to be concerned about secular growth sustainability.
Among them are concerns that consumers are shifting to debit, away from higher-margin credit cards.
Consumers are also using more alternative payment methods that may bypass the card networks, including “buy now pay later” services offered by companies like Klarna, Afterpay (AFTPY), and Affirm (AFRM).
Visa has also come under pressure from a recent announcement by Amazon.com (AMZN) that next year it will stop accepting Visa-branded credit cards issued in the United Kingdom and this could be the beginning of a narrowing of Visas’ moat that could trigger a domino effect in other rich western countries.
The bulls would say that the stocks could undergo a reversal if the Omicron variant is not as bad as initially thought creating a tsunami of consumer spending massaging the bottom line for Visa and Mastercard.
But it’s looking more like V and MA are the victims of tightening travel restrictions around the globe and elevated positive cases that are immobilizing consumers.
The big card networks rely heavily on revenues related to cross-border travel as consumers and businesses use their cards for airfare, Airbnb’s, and Ubers, as well as duty-free gifts in foreign countries.
Multiples may need to come down if the Omicron variant puts the shackles on travel as countries reimpose bans or quarantine rules.
Investors had been counting on a recovery in cross-border travel to boost revenues for the card networks. This is definitely a kick in the nuts after initially seeing momentum as countries in general trended to loosening restrictions.
International transactions brought in $1.9 billion, or 21%, of Visa’s $8.9 billion in revenues for the 2021 fourth quarter.
The segment is highly profitable due to steep transaction and foreign-exchange fees. Cross-border margins come in around 69%, contributing significantly to Visa’s overall earnings per share.
The Christmas season has been confronted by a bevy of new restrictions as many places consider other measures to curb the spread of the Omicron variant.
Ultimately, even if MA and V can get positive reinforcement from increased short-term travel which seems unlikely, alternative business models are breathing down their neck as the technology of money has advanced.
The “buy now, pay later” phenomenon, although risky, is a rapid gut punch to the incumbents.
Then consider there is speculative technology like Bitcoin out there that bypasses these dinosaur networks altogether.
I believe 2022 is the year that MA and V get exposed as a luxury in a frugal world where small businesses can’t afford to give away 2% of revenue.
There’s too much money being invested into the technology of money for small businesses to reach for MA and V’s network.
Even open banking and digital networks can really dent the traditional payment networks.
Basically, I believe these companies have hit the high-water mark, and the likes of Zelle and Venmo will start to put pressure on these high fees.
Places like China don’t even use them by bypassing them through digital wallets like Wechat pay and Alipay.
Pie shrinkage and revenue decelerate — I believe this is one of the seminal trends we will see in fintech in 2022.
Mad Hedge Technology Letter
August 4, 2021
Fiat Lux
Featured Trade:
(FINTECH CONTINUES THE MOMENTUM)
(SQ), (AFTPY)
This guy leading Square, Jack Dorsey, has accomplished some phenomenal things during his tenure in San Francisco.
But with the fast-moving tech sector, he’s venturing into uncharted territory as his outfit purchased Australian buy now, pay later provider Afterpay (AFTPY) for $29 billion in stock.
This is the largest buy-out done by Dorsey signaling a large wager on Square’s ability to catch up with more established retail banks.
Afterpay offers its 16 million users a way to get their purchases right away and pay for it in four regular, interest-free installments.
What a great deal for the poorer Millennial generation!
This is just another tool that Square will be able to integrate on its interface as another way to pull in more users and capital.
It’s almost a credit card proxy.
If payments are missed, Afterpay levies a fee and locks their accounts.
These late-payment penalties, along with fees paid by merchants, form the main sources of revenue for Afterpay. The system is popular among young shoppers who make up the bulk of bad credit scores.
Square’s popular Cash app gets another notch in its belt as it competes with Affirm and Klarna.
A secret meeting in Hawaii consummated the deal with executives reasoning that speed is paramount - banks and new entrants are aiming for a bigger piece of the buy now, and pay later services.
These offerings have boomed in the past year, as homebound consumers used them to borrow and spend online during the coronavirus pandemic.
There are reports that Apple is in the process of building a buy now, pay later feature in coordination with Goldman Sachs.
These services usually mean up to a few thousand dollars, which can be paid off interest-free.
That means such providers are not required to run background checks on new accounts, unlike credit card companies, and normally request just an applicant's name, address, and birth date. Critics say that makes the system an easier fraud target.
Executives at Square and Afterpay shared a desire to expand access to customers globally and saw combining forces as the best way to take on competitors.
Ultimately, Square has been slowly morphing into a bank, and this acquisition accelerates the process.
Square’s banking ambitions were already becoming very clear on the merchant-facing side of its business.
The company first applied for a banking license in 2017, and last year, it received conditional approval from the Federal Deposit Insurance Corporation (FDIC).
The new bank, called Square Financial Services and based in Utah, was structured as a subsidiary of Square and started offering small business loans this past March.
Even before Square Financial Services went into operation in March, Square had been giving merchants small loans, using its detailed knowledge of transaction volumes to help approve applications quickly.
These loans, though, were disbursed through a partnership with another existing bank in a 10-K filing, Square revealed it collected on these loans by automatically deducting a fixed percentage of every card payment a merchant accepted.
In this way, Square had disbursed nearly $9 billion in loans before its small business loan and banking functions came online.
Square is diligently using its vast technology infrastructure build-out to maneuver into financial services.
They have been ahead of the curve in rolling out cutting-edge services such as its crypto offerings.
Retail banks will have a hard time competing with Square since they aren’t technology companies that think of challenges in terms of the technicalities of delivering a digital experience.
The problem with retail banking now is that the people who lead them are still bankers and not digitalists in a technology-first world.
Unsurprisingly, Square’s stock cheered the news and was up 10% on the news.
This move also continues the momentum of Square massively overperforming as a stock, management team, and business model in the past 18 months.
I have been highly bullish Square ever since the inception of the Mad Hedge Technology letter and the company has only validated my calls for outperformance.
The stock is somewhat volatile and prone to 5-7% pullbacks and I do believe those are precious opportunities to wade into Square with dollar cost averaging.
After pulling back to $200 in May, the strong lurch up to $270 needs time to digest, and readers just need to wait for the next consolidation.
