Wealth Management: Podcast - A closer look at Mastercard and American Express

Our in-depth research approach and close engagement with all our holdings’ management teams form vital parts of our investment process. To delve further into this, Sophie Kilvert is joined by Ramesh Rajagopalan, Head of Equities, and Shannon Magee, Equity Analyst, as they take a deep dive into the two payments companies in our portfolios: Mastercard and American Express.

To the consumer, Mastercard and American Express might appear quite similar at first glance. However, their business models differ significantly upon further examination. American Express, for example, is an integrated payments platform, issuing cards to consumers and enabling merchants to accept these payments. It generates revenue by collecting fees from consumers with an Amex card, as well as charging a percentage commission from the merchants based on the total volume of spend. Making this an attractive business model, American Express maintains a competitive rewards platform, thereby encouraging consumers to use their Amex as their primary purchasing card. At the same time, merchants are willing to pay American Express a percentage of their spend because their customers are high-spending consumers.

While American Express generates profits on both sides of the transaction, Mastercard operates as a payments network. While American Express maintains direct relationships with both consumers and merchants, Mastercard maintains direct relationships with banks, who then establish relationships with the end consumer. This represents a much smaller part of the payments ecosystem; where American Express generates $2.30 for every $100 which goes on its network, Mastercard keeps only $0.30. Nonetheless, Mastercard still maintains a competitive advantage in this space. With a network of 50 million merchants and 2.7bn consumers, it’s almost impossible to replicate their network effect and scale.

Despite operating within the same payments ecosystem, both companies benefit from similar structural tailwinds, such as the shift towards digital payments, justifying their place in our portfolios. At the same time, we are confident in the distinct advantages presented by both companies. American Express is a well-known brand with significant increase in market share gain and growth potential, although it is exposed to some balance sheet risk by extending credit to end consumers. Meanwhile, Mastercard maintains no credit risk exposure, and as a technology platform is well placed to take share in the B2B payments ecosystem, which is still in the early stages of digitisation.

Having owned American Express since 2013, Mastercard was the more recent addition to our portfolios in 2018. Before making any investment decisions, we take a long-term, hands-on research approach, engaging with management teams to really understand a business. Describing our in-depth research approach, Ramesh emphasises the close relationship we fostered with Mastercard in the lead-up to our investment. Over several years, we analysed the business’ financial performance, and further to this worked closely with their management team, meeting with the CEO and CFO several times and attending investor days for many years. Differentiating ourselves from other investors, we approach these meetings as potential long-term business owners, looking to invest for five to ten years and develop fruitful partnerships with management teams.

These relationships are fundamental in periods of volatility when our conviction might be tested, and 2020 was a prime example. In a year when consumer spending and international travel dropped, naturally both Mastercard and American Express were affected, and we continued to work closely with both companies to understand the impact they were facing. This close communication helped inform our stress tests, where we questioned if the pandemic posed any fundamental risk to the businesses and how their earnings power might be impacted. Through our stress tests and ongoing engagement, we remained confident in their ability to deliver attractive returns, as we found no liquidity or solvency issues, and no fundamental risk to either business.

In fact, Mastercard exceeded our financial expectations for the year. With a significant portion of their revenue driven by cross-border transactions, we expected the halt in international travel to result in a decline of 20-25% in 2020 revenues, but Mastercard actually outperformed such expectations. At the same time, we have seen a change in underlying consumer behaviour over the last year, as the shift from cash to digital payments accelerated due to COVID-19. The resulting aversion to cash and preference for both contactless payments and online spending was therefore beneficial for both Mastercard and American Express, in a world where 40% of value in spend is still in the form of cash or cheque.

Although we remain confident in both Mastercard and American Express’ ability to deliver returns, we always monitor ongoing or future threats to ensure both companies continue to hold their competitive advantage. For Mastercard, the biggest potential threat is blockchain, a technology which allows data to be stored and processed in a decentralised manner. Mastercard relies on the smooth occurrence of payments between two parties who don’t know each other, and blockchain could therefore evolve to be a credible alternative to this process. While blockchain could represent a threat to American Express too, the greater risk to their competitive advantage is the emergence of a brand capable of outperforming their rewards system. While these risks do not pose threats today, as long-term investors, we continuously monitor such risks for all our holdings within portfolios.

From our ongoing engagement with their management teams, together with our risk- monitoring and detailed research approach, we remain confident in both companies’ growth potential. Indeed, since our investment in 2018, Mastercard has grown significantly and now processes almost five trillion dollars, which translates to approximately 65 billion transactions a year. As consumers continue to shift away from cash and cross-border commerce grows, we expect to see this growth trajectory continue over time.

This podcast is produced by Rothschild & Co for information purposes only.  This podcast does not constitute a personal recommendation or an offer or invitation to buy or sell securities or any other banking or investment product. Nothing in this podcast constitutes advice of any sort and no responsibility is accepted in relation to the content accuracy or any reliance on the information provided.

The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment.  Past performance should not be taken as a guide to future performance.  This content should only be used or reproduced with the express written permission of Rothschild & Co.