TECHNOLOGY

Card Network Systems

INITIATING COVERAGE REPORT

William C. Dunkelberg Owl Fund

February 18th, 2015
Nathan Eisenberg: Lead Analyst
neisenberg@theowlfund.com
Goutham Bollu: Associate Analyst
gbollu@theowlfund.com
Kyle McGarry: Associate Analyst
kmcgarry@theowlfund.com

MasterCard, Inc.
Exchange: NYSE Ticker: MA Target Price: $101.39
COMPANY OVERVIEW
MasterCard (MA) operates in the global payments industry
connecting consumers, financial institutions, merchants,
governments and businesses worldwide, enabling them to use
electronic forms of payment instead of cash and checks.
Geographically, MA operates in the U.S. (29.9%), Europe
(30.1%), Asia (29.1%), Latin America (8.0%), and Canada
(2.9%). The company uses a three-tiered business model: as
franchisor, processor, and advisor. As franchisor, the
company markets a portfolio of brands and products
worldwide, including MasterCard, Maestro, Cirrus and
MasterCard PayPass, facilitating commerce to a network of
more than 28.5 million acceptance locations around the
world; as processor, the company's streamlined and intelligent
approach to processing enables efficient commerce on a
global scale, as well as offering customized solutions that
deliver value through technology; and as advisor, through
MasterCard Advisors, the largest global professional services
firm focused exclusively on the payments industry, the
company provides strategic and operational solutions
covering the payments process from end to end.
INVESTMENT THESIS
MasterCard is currently trading at a 6.3% discount to its card
network services peer group 5-year P/E average. This is a
result of MAs greater international exposure than its peers.
Investors overreacted to the threat of negative foreign
exchange (FX) translation impacting MAs core business and
its reliance upon international opportunities to fuel doubledigit revenue growth. Finally, compression of MAs operating
margins in Q4 14 related to recent acquisitions caused a
short-term earnings weakness relative to MAs primary
competitor, Visa. However, MAs innovative mobile
payments platforms, fraud-reduction services and greater
international exposure make it the best positioned card
network provider to capitalize on strong global growth in
electronic payment volumes and secular decline in cash
payments. These services, in tandem with the macroenvironment tailwinds, will drive MA back to fair value at a
29.22x P/E and a dividend-adjusted return of 17.0%.

Sector Outperform
Recommendation: BUY
Key Statistics:
Price

$87.20

Return
Share O/S
(mm)
Market Cap
(mm)

17.0%
1,150
$100,200

52 Week Low
52 Week
High

$86.87

Yield
Enterprise
Value

0.73%

$88.32

$96,210

Earnings History:
Quarters

EPS

1Q14
2Q14
3Q14
4Q14

Revenue YoY

$0.73
$0.80
$0.89
$0.72

17.17%
15.11%
22.59%
36.28%

Price

0.80%
9.40%
-2.32%
0.91%

Earnings Projections:
Year
2014

Q1
$0.73

Q2
$0.80

Q3
$0.89

Q4
$0.72

Total
$3.14

2015E
2016E

$0.80
$0.98

$0.89
$1.07

$0.96
$1.14

$0.83
$0.99

$3.47
$4.17

2017E

$1.07

$1.14

$1.29

$1.25

$4.94

1-Year Price Chart

All prices current at end of previous trading sessions from date of

report. Data is sourced from local exchanges via CapIQ, Bloomberg
and other vendors. The William C. Dunkelberg Owl fund does and
seeks to do business with companies covered in its research reports.

Spring 2015
CATALYSTS & POSITIVES
Virtual Cards & B2B Payments
B2B transactions, still dominated by cash and check payments globally, have
begun to see diminishing relevance in light of secular electronic payment
adoption. This is providing significant opportunity for virtual card providers,
which offer the convenience of credit cards with improved security in processing
online payments. Virtual cards currently only account for around 2% of the $16.5
trillion global B2B transaction market, but thanks to innovation in bill payment
and banking platforms like MasterCards MasterPass, GlobalVCard, and Travel
Controller, businesses are expected to flock to the convenience, security, and
features provided by virtual cards. Recent B2B adoption and growth in MAs
virtual payment systems include:

One of the four largest Chinese e-Commerce firms and B2B retailer,
DHgate, adopted MasterPass toward the end of 2014 to process its
transactions, which handled over 5 million buyers in 2014 alone. DHgates
buyer volume is expected to more than double by 2017 as it connects U.S.
businesses with a growing Chinese e-Commerce export market. This also
reflects MAs opportunity to tap the worlds largest and underserved
economy in electronic payments.
Fleet card provider, WEX, expanded MA-branded virtual cards to ~5
million in 2014, nearly a 20% increase. This came after a 20% increase in
MA-branded cards from 13 to 14, as well.

These recent examples of virtual payment banking processing illustrate MAs

opportunity in a transformative time for the payments industry.

Risks

Increased Regulation: the payments

industry, specifically interchange fees,
is subject to significant and intense
global, legal, and regulatory which may
have material adverse impact.
Regulators have been seeking to
establish the authority to regulate
certain aspects of payment systems
such as MA. These regulations could
restrict interchange fees as well as the
types of products MA offers to
customers.

Governments: Governments in
countries such as Russia, Ukraine, and
India could provide preferential
treatment or protection to selected
national payments and processing
providers.

Security: Risks for payments and

technology companies have
significantly increased in recent years
in part because of the escalation of
security threats. The increased
sophistication of organized crime,
hackers, and terrorists poses an
ongoing risk for MA.

Tokenization
Tokenization, a platform developed jointly with other payment service providers,
serves as the security infrastructure that enables emerging payment platforms like
Apple Pay, Samsung Pay and digital point-of-sale (POS) transactions.
Additionally, MAs Digital Enablement Service is securitizing these mobile wallet
and device-based payment platforms. Apple Pay has seen remarkable growth
since its launch just six months ago, with 50% of all large U.S. retailers planning
to support it by the middle of 2016. Samsung Pay is expected to see similar
growth. We expect these emerging payment systems and digital POS transactions
to contribute incremental revenue growth to MA by the beginning of 2016.
International Focus
With 60% of MAs revenues derived internationally and continued expansion
from 40 countries in 13 to 55 in 14, MA is the global card network leader.
Exposure to the least saturated and fastest growing gross dollar volume (GDV)
regions is strategic to MAs long-term growth. MAs innovative payment
platforms and early positioning in underserved electronic payment markets will
drive network volume growth, allowing MA to grow its share of a rapidly
growing market.

Economic Moat

Network Effect: MA has built a

network that is widely accepted by
merchants around the world. MA
operates in a near duopoly with its
main competitor, Visa. As consumerspending ramps up in developing
networks, sheer transaction volumes
cement MAs position as a market
leader.

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INDUSTRY OVERVIEW
Cashless Payment
As spending trends shift away from cash and check
payment methods, credit cards, debit cards and prepaid
cards continues to grow in importance. This growth is
particularly strong outside of the U.S. (OUS) as cash still
accounts for roughly 85% of global consumer
transactions. Emerging economies are expected to
continue rapid adoption of cashless payment solutions.
Non-cash transactions have seen exponential growth in
the Asia-Pacific region.
Mobile Payment
Mobile payments utilize device-interconnectedness to offer on-the-go payment options. Mobile pay has seen impressive
growth thanks to widespread use of smartphones and improvements in security. Global mobile payments volumes grew
25% over the past five years to $325 billion in 2014. This is expected to more than double to over $700 billion by 2017
as more merchants accept mobile payments. The advent of mobile wallets and broad convenience factors are expected
to aid mobile payments in gaining further market share against cash transactions.
Apple Pay, Samsung Pay & Googles Softcard
Launched in October of 2014, Apple Pay marks a growing trend for tech firms entering the mobile payments market. In
February of 2015, Google acquired mobile wallet platform, Softcard. Google has since negotiated with AT&T, T-Mobile
and Verizon Wireless to pre-install Softcard on all Android phones sold in the U.S. Finally, Samsungs acquisition of
LoopPay will allow it to launch Samsung Pay sometime in the middle of 2015. While still largely U.S.-focused, mobile
payment platforms like these have also seen regional entrants in Africa. Additionally, the required fraud reduction and
security protection improvements payment processors need to host mobile payment platforms is expected in 1H 2015.
These innovations are expected to drive mobile payment adoption beyond the U.S.
European Payment Regulation
At the beginning of 2015, the EUs Committee on
Economic and Monetary Affairs agreed to cap
interchange fees on debit and credit card transactions
to 0.2% and 0.3% of total transaction value,
respectively. This multilateral interchange fee (MIF)
change is expected to be in effect by 2H 2015. The
MIF includes specific provisions for both three party
payment card schemes (such as: American Express,
Diners Club) and four party payment card schemes
(MA, Visa). While this legislation provides loopholes to the MIF cap for three party networks, it also requires them to
provide comprehensive EU coverage, a restriction that could likely squeeze these smaller card systems out of the EU
altogether. This will likely reduce competition from existing three party networks and squelch competitive entrants
offering four party networks further market dominance.

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TARGET PRICE

PEER GROUP IDENTIFICATION

MA is currently trading at a 6.3% to its card network

services peer group 5-year P/E multiple. We believe
MA will appreciate back to its peer group premium,
implying a P/E multiple of 29.22x. Multiplying this by
NTM EPS and factoring in a 0.73% dividend yield
gives us a projected return of 17.0%

Implied P/E Multiple: 29.22x

Valuation Price Target = $101.39
Projected Return: 17.0%

Visa (100% of FY 14 Sales)

o U.S.-focused card network service provider.
Total System Services. (70% of FY 14 Sales)
o Database management, analytics and business
applications.
Global Payments (58% of FY 14 Sales
o Electronic transaction processing and system
services

FINANCIALS
Revenue
Assessment Fees
These are fees that are charged to the bank which issued the card.
Assessment fees are based on the gross dollar volume for the year
and are also domestic only, where the issuing bank and the
acquiring bank are in the same country. The rates depend on
multiple factors such as the nature of the transactions and the
region of the issuer. These assessment fees grew at a 5-year CAGR
of 8.47% to a value of $3,967 million, which represents 41.88% of
net revenue. MA is losing ground to Visa in this regard, growing
2.29% slower compared to Visas 5-year CAGR of 10.76%. This disparity is due to Visas focus in the United States,
where it has 50% of the market with 53% of its revenues originating in the United States compared to MA where only
39% of its revenues originate domestically. MA has more of a focus on non-domestic assessment fee, which comes to
the company via cross border fees. Gross Dollar Volume, or GDV, is the measure of all transactions used by an
institution within a year and is used by MA to charge a cumulative fee. GDV has risen 9% overall, the most growth
coming from Asia/Middle-East/Africa at 13% growth and Europe at 9%.
Transaction Fees
MA acts as a transaction processing service for its customers.
MA authorizes, clears, and settles transactions made with its
network. The customers also use MAs network to transmit
financial messages between the issuing and acquiring banks.
Transaction fees make up 42.6% of net revenue, totaling $4,035
million and grew 20.13% YoY, outpacing Visas growth in the
same area by 8.31%. Some of the fees that make up the total
transaction fees include authorization, settlement, connectivity,
and switch fees, all on a per-transaction basis. What drives the
revenue for this segment is the total amount of transactions using
MAs network, which saw 12% growth YoY.

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Cross Border Fee
Transactions that occur from one country to another carry additional fees which also include currency conversion fees.
These fees are usually high compared to assessment and transaction fees and vary greatly based on the risk of
international merchants. Cross border revenue totals $3,054 million, representing 32.2% of net revenues. 2014 saw a
9.34% rise in cross border fee revenues, which outpaced Visas growth by 4.3%. The fee for this type of transaction has
historically been around 0.8% of the total transaction amount. If there are regulations in a block of countries placing a
ceiling on that fee, MA will only see significant drawback if the fee drops below 0.6%.
Other Revenues
These include acceptance development fees, warning bulletin fees, consulting and research fees, and others fees such as
penalties, hologram, and publications. None of these sub-segments dominant this section, which totals $1,688 million or
17.8% of net revenue. This is the only segment where MA generates more revenues over Visa, generating only $770
million. MA is also outgrowing Visa in this segment by 19.28% with MAs segment growing 26.82%. This shows us that
MA is able to generate revenues from means not directly tied to GDV, providing protection to our catalysts and macro
trends.
Rebates and Incentives
Rebates and incentives are paid to customers and merchants to help bolster card issuance and acceptance of MA cards.
These contra-revenues vary with the gross dollar volume. These rebates are given both on assessment and transaction
fees. MA saw this segment grow 11.18% to -$3,271 million, representing -34.5% of net revenue. MA and Visa saw nearidentical growth figures but Visa has a lower absolute value, totaling -$2,592 million. We believe that with increased
rebates and incentives, MA will be able to draw more card issuing,
which leads to both GDV and transaction volume growth.
Margins
MA has an adjusted EBITDA margin of 64.58%, which is above
Visas of 64.02%. MA saw EBITDA margin expansion of 7.53%
from 2013 whereas Visa saw a contraction of 81bps. The story
changes when we take a look at the operating margin, with MA
weighing in at 53.9% against Visas 60.6%, both companies saw very
slight margin contraction of less than 1%. MA underwent 8
acquisitions over the course of 2014, adding 25.61% more
employees than it had in the year prior, raising SG&A costs 16% to
$4,046 million in addition to a one-time restructuring charge of $54
million. We see this as a strategic play by MA and something that
isnt as appreciated as it should be. MA is investing for future
endeavors, positioning itself well in future market conditions. As we
move to the profit margin, MA and Visa decline at similar rates
from the operating margin. MAs profit margin increased 84bps
to38.18% from 2013 while Visa expanded its profit margin to
42.81%, a 53bps expansion. The disparity of the profit margin is due
to the reasons discussed previously.

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Debt
MA has debt principal payments of $500 million in 2019 and $1,000 in 2024. MAs total debt reaches $1,843.75 million
with $343.75 million in interest payments. MAs current debt/equity is 21.89%. Additionally, the company has an annual
interest payment of $22 million in 2015 and then $44 million through 2016-18 and then decreasing steadily from $39
million in 2019 and then $34 million through 2020-23 and then decreasing to $17 million finally in 2024. The company
also has an unused revolver credit line of $3000. MA has an interest coverage ratio of 106.38x, which shows that it is
more than capable of fulfilling its short-term debt obligations. Additionally, MAs current ratio is 1.59 and its quick ratio
is 0.79. MA also has an investment grade of an A. We believe debt is very low and in a position to expand or eye future
acquisitions.

Shareholder Returns
MA currently pays out a dividend of $0.44, a 12-month yield of 56bps. The
dividend is growing at a 3-year CAGR of 101.38% and YoY growth of 68.97%.
This dividend carries a payout ratio of 14.2%, compared to Visas payout ratio of
18.7%. This lower payout ratio gives the capacity for MA to grow it, giving
shareholders more dividends in the near future with higher yields to suit. MA is
also committed to return value to shareholders via its share repurchasing
programs. In December of 2014, the board of directors approved a $3.75 billion
buyback program. We believe that MA will deliver on its program, given that
the company purchased $3.225 billion in 2014 out of a $3.575 billion purchase
plan. This leftover allocation gives MA a total of $3.8 billion to repurchase. As
free cash flow increases we expect MA to increase its share repurchasing
program and for the company to complete its said plans.
Free Cash Flow
In FY2014, MA had a free cash flow of $3.2 billion with cash flow from operations of $3.4 billion and capital
expenditures of $175 million. FCF grew at a 5-year CAGR of 14.6% since 2010, but declined 18% in FY 14. This was
due largely to a 17.6% decrease in CFFO as a result of a 120% increase in prepaid expenses in Q4 14. Management did
not shed any light on this increase, however we expect prepaid expenses to return to historic levels moving forward.
Adjusted for this expense, CFFO was flat FY 13-14. On the whole, CFFO grew at a 5-year CAGR of 15% since 2010
as a result of net income growth and more efficient working capital management. CAPX increased at a 5-year CAGR of
23.4%. While CAPX is important to maintaining the physical component of MAs network infrastructure, it represents
only 25% of cash outlays in investing activities. Through 2018, we expect FCF to continue to grow at low double-digit
rates and CFFO to grow at mid double-digit rates owing to rapid international GDV growth. This maturation of MAs
cash flows will enable MA to return more to shareholders and continue expanding its network into more countries.

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Earnings
MAs EPS grew at a 19.29% CAGR since 2010, to 2.4 billion. 2014 top line growth came in at 14%, lower than the 5year average due to negative FX translation and a mixed economic environment. EPS growth was driven by an increase
of cross-border volumes of 19% and a 13% increase in gross dollar volume, on a local currency basis, and increase in
processed transactions of 11%. These factors were partially offset by an increase in rebates and incentives. Earnings are
expected to grow at a rate of 16.9% through 2018.
MA Comparables Analysis
Visa and MA operate in a near duopoly due to their network effect and strong brand recognition, with their combined
market share of 87.4%. Total System Services (TSYS) is a credit card processor, merchant acquirer and bank credit card
issuers and Global Payments (GPN) is a provider of electronic transaction processing services for merchants,
government agencies and multi-national corporations. While comparing MA to Visa is the most direct peer, MAs
international presence direct us to include internationally weighted comps.

Discounted Cash Flow Statement Assumptions

We are forecasting 2015 sales growth of 10.5%, in line with many analysts estimates. Following 2015, we continued sales
growth at low double-digit rates in 2016 and 2017. This is a result of expected incremental revenue from tokenization
and emerging payments support, as well as rapid adoption of electronic payments in emerging markets. From 2018 out,
we are projecting sales growth to step down from high single-digit rates to 6.5% in 2021, reflecting our view that MA
will remain a critical component of the global payments market while understanding that double-digit growth for a
maturing company is not feasible. All other assumptions were derived from long-term averages or management
guidance, e.g. plans to return capital to shareholders.
Valuation
MasterCard is currently trading at a 6.3% discount to its card network services peer group (Visa, Total System Services &
Global Payments) 5-year P/E average. This is a result of MAs greater international exposure than its peers. Investors
overreacted to the threat of negative foreign exchange (FX) translation impacting MAs core business and its reliance
upon international opportunities to fuel double-digit revenue growth. Finally, compression of MAs operating margins in
Q4 14 related to recent acquisitions caused a short-term earnings weakness relative to MAs primary competitor, Visa.

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APPENDIX

DCF Assumptions

MA to Network Card Services Peer Group

1-Year

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3-Year

5-Year

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MAs Historical P/E Graphs

1-Year

3-Year

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5-Year

10-Year

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Consumer Spending & Payment Companies Index

MasterCard & Visa Revenue Breakdown

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DISCLAIMER
This report is prepared strictly for educational purposes and should not be used as an actual investment guide.
The forward-looking statements contained within are simply the authors opinions. The writer does not own any
MA Incorporated stock.
TUIA STATEMENT
Established in honor of Professor William C. Dunkelberg, former Dean of the Fox School of Business, for his
tireless dedication to educating students in real-world principles of economics and business, the William C.
Dunkelberg (WCD) Owl Fund will ensure that future generations of students have exposure to a challenging,
practical learning experience. Managed by Fox School of Business graduate and undergraduate students with
oversight from its Board of Directors, the WCD Owl Funds goals are threefold:

Provide students with hands-on investment management experience

Enable students to work in a team-based setting in consultation with investment professionals.
Connect student participants with nationally recognized money managers and financial institutions

Earnings from the fund will be reinvested net of fund expenses, which are primarily trading and auditing costs
and partial scholarships for student participants.

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