Today, I d like to explain why Visa is such a wonderful business Odlum Brown Annual Address Page 1

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1 By the time I am done this sentence, Visa will have processed $3.5 million in 67,000 transactions around the world and by doing so, they ll earn a profit of $5,000. Today, I d like to explain why Visa is such a wonderful business Odlum Brown Annual Address Page 1

2 Image source: Visa Inc. If you use a Visa card today, the transaction involves four parties and it takes less than one second to complete. In a nutshell, Visa connects the banks that issue Visa cards, the cardholders that want to make purchases, the merchants that accept Visa, and the merchant s bank. What s important is all of this takes place over VisaNet, which is Visa s proprietary payment network Odlum Brown Annual Address Page 2

3 Image source: Visa Inc. How does Visa make money? This might come as a surprise: Visa does not lend money and they do not earn interest on late payments. The bank issuers do all of this. Visa takes ZERO credit risk! Instead, Visa makes money three ways: First, they earn a fee of about 6 cents for each transaction processed on their network. Next, there s international transaction revenue Visa absolutely loves it when you travel because they earn cross border and currency conversion fees. Lastly, Visa earns a sliver of the total amount spent on its payment cards this is volume based revenue Odlum Brown Annual Address Page 3

4 For Visa, this is a toll like revenue stream on consumer spending and the best part about it is, it s naturally indexed to inflation because it s based on the dollar value being spent Odlum Brown Annual Address Page 4

5 Let s say you buy $100 dollars in groceries and pay with a Visa debit, credit, or prepaid card. Well of that, the grocery store would pay about $2.00 to have access to the payment network with the bank issuers taking most of this fee because they re the ones taking on the credit risk, providing payment guarantee to the merchants, and running the rewards programs. Visa just takes a sliver about 20 cents and if you add in the transaction fee, Visa might make 26 cents on your purchase Odlum Brown Annual Address Page 5

6 Now, you re probably thinking: 26 cents on a $100 dollar purchase isn t a lot of money but consider that Visa s network processes $6.4 trillion each year. $6.4 trillion is almost four times the size of Canada s economy. This all adds up for Visa Odlum Brown Annual Address Page 6

7 This year, the company is expected to generate $15 billion in revenue and Visa is insanely profitable. It has 65% profit margins, so $10 billion should drop straight to the bottom line Odlum Brown Annual Address Page 7

8 Unfortunately high profit margins are a magnet for competition, so who wants to eat Visa s lunch? The main competitor is actually cash. The best thing about having cash as a competitor is that it doesn t fight back! It doesn t have a marketing budget to win you over. It s less secure, it s dirty. It s certainly not convenient and it s expensive for merchants to deal with. Let s think of some areas where cash is being displaced. If a small bag of pretzels isn t enough to get you to Toronto on a WestJet flight, you can now only buy food or drinks on board with a major credit card cash is no longer accepted. You might find yourself paying by phone more and more when parking, rather than feeding the meter. Or, tapping your credit or debit card at Tim Hortons to buy a coffee. Cash is being displaced all around us. MasterCard is obviously a major competitor, but the payments industry is generally a cozy duopoly. There are other competitors as well. For instance, SoftCard was a payments network funded by AT&T and Verizon, but even with these heavy backers they couldn t overcome the barriers to entry they shut down last year. What about these new digital wallets on your phone such as Apple Pay? We actually view these as a positive for Visa because they rely on Visa s payment network to execute a transaction. Put simply, Apple Pay needs Visa more than Visa needs Apple Pay. Now all of a sudden, we have over 2 billion Apple and Android devices that are capable of buying things or accepting payment using Visa s network. The way we pay is changing and we think the network effect can allow Visa to grow in ways that never existed before Odlum Brown Annual Address Page 8

9 Image source: Visa Inc. What does that mean? There s a network effect when the value of a good or service increases with the number of users. Think of , Google, or Uber. The more people who use it, the more useful it is it s a positive feedback loop. Visa s network connects users together in more than 200 countries to fast and secure electronic payments. It includes 2.9 billion payment cards that are accepted at over 36 million physical merchant locations, plus millions more online. It really comes down to this: the more cardholders there are with a Visa card, the more incentivized a merchant is to accept that form of payment. The more merchants that accept Visa, the more likely consumers and businesses want a Visa card. With the network effect, the strong get stronger over time, which leads to a wide and growing moat around Visa s economic castle Odlum Brown Annual Address Page 9

10 Now, it s great that Visa has a durable competitive advantage because of its growing network, but what about the sluggish economy? I should mention that we re not buying economies. We re buying businesses, and Visa has the capacity to grow in a slow growth world Odlum Brown Annual Address Page 10

11 There s still $16 trillion of cash and cheques used for commerce each year around the world in emerging markets, 80% of transactions are done with cash! We think electronic payments will continue to displace paper forms over time and, because of this, Visa should be able to grow its business much faster than the economy. That s exactly what s been going on. The world economy is growing at roughly 4%. Visa s business is growing almost four times this rate! 2016 Odlum Brown Annual Address Page 11

12 Source: S&P Capital IQ Shares of Visa have done remarkably well since the IPO in 2008 but this is because of the phenomenal underlying business performance as a result of Visa s secular growth and awesome profitability. So even today, we still think we re getting more value than what the stock price reflects Odlum Brown Annual Address Page 12

13 This isn t the most exciting quote, but it makes an important point. You likely have heard of Elon Musk. He s disrupting the auto industry with Tesla, the way we generate power with Solar City, and sending rockets into space with SpaceX. Elon Musk said, It s hard to break into a network once it s formed. This coming from the King of Disruption I think shows you how valuable a strong and growing network can really be Odlum Brown Annual Address Page 13

14 Let s wrap up and I ll give you the Twitter version. Visa earns a toll on global spending which makes it a terrific inflation hedge. Cash is being displaced by electronic payments that should allow it to keep growing in a slow growth world. The best part is: Visa s massive profits should be protected from competitors because its network keeps getting larger and stronger. It s a fantastic business! 2016 Odlum Brown Annual Address Page 14

15 So when it comes to investing, we think, that just like the company s tag line, Visa is everywhere you want to be Odlum Brown Annual Address Page 15

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