On the surface, issuing credit cards seems like the worst business model imaginable. Lend money to people up front, so they can buy what they want to with it, then give them 30 days to pay it back without interest? How can anyone turn a profit doing that?
The State of The Grace Period
The answer is “Just wait for the 31st day. And beyond.” Tens of millions of cardholders do, incurring ever-growing balances and thus making Visa Inc. (V) one of the world’s largest and most profitable corporations. With a market valuation of about $133 billion and profit margins at a dumbfounding 42%, Visa has proven that extending credit to consumers and assuming they’ll be irresponsible is as gainful an industry as any.
Technically, Visa doesn’t even issue cards or lend money. Rather, the company’s primary business involves: a) allowing financial institutions to distribute cards bearing Visa’s invaluable and respected brand name to accountholders, and; b) charging merchants for the privilege of accepting said cards. The two complementary sides of the strategy deserve some exposition. (For related reading, see: Credit Cards: An Introduction and Understanding Credit Card Interest.)
Playing Both Sides
Bank X borrows money at some rate(s), and lends it out at higher rates, keeping the difference. That’s not news; it's the standard model that the banking industry has employed since forever. And while Bank X profits off business loans, mortgages and other relatively complex transactions, there’s still the more mundane matter of getting everyday consumers to become financially beholden. Enter Visa. Bank X then distributes its Bank X Visa cards to accountholders, who now have the convenience of not having to carry unwieldy wads of bills for every commercial transaction. (In the blunt language of new CEO Charlie Scharf, referring to accountholders and merchants, “Cash is the common enemy everywhere.”) The downside, for negligent accountholders, is that it can be harder to keep track of cumulative credit card charges than of dwindling physical currency in one’s pocket. So Bank X starts charging 14%, or 19% or 24% interest, and Visa ends up adding to its revenue total (which approached $12 billion last year.) (For more, see: How To Trade Credit Card Stocks.)
Why Retailers Sign On to Pay Up
On the other side, the accountholders need someone to buy from. When a merchant sets up to accept Visa cards, it typically pays somewhere around 1.5 to 3% of each transaction to Bank X, which in turn had paid Visa for the privilege of using its network. That 3% might sound like a lot, especially in a low-margin business such as grocery retail, but from the merchant’s perspective it’s better to get 97% of a transaction than to refuse credit cards, lose customers to competitors that accept credit cards and instead receive 100% of nothing.
The model is simple to understand. What makes Visa extraordinary is the speed and technological prowess with which it facilitates these exchanges. Worldwide, Visa processes more than a billion transactions a week, and as the outspoken Scharf states, “our business is people-light and technology-heavy.” Visa has a mere 7,500 employees, which is no more than the number represented by the Tacoma, Wash., local of the United Food and Commercial Workers union. Visa’s workforce is 1/300 the size of the workforce employed by Wal-Mart Stores Inc. (WMT). As a capital-intensive company, the revenues from data processing make up a huge portion of Visa’s receipts. Visa might not issue cards directly to cardholders, but the company obtains a piece of every authorization and every settlement, and charges for access to its worldwide network access. Visa has 2.2 billion cards in circulation, which last year carried $4.3 trillion in payments and, even more impressively, $2.6 trillion in cash volume. Those convenience checks and cash advances that can impoverish imprudent cardholders? They benefit Visa to the same extent. To quote Donald Trump in his capacity as a casino owner, “It’s a good business being the house.” (For related reading, see: How Wal-Mart Makes Its Money.)
Visa buys back its own stock aggressively, a billion dollars at a time. Excess capital is a good problem to have, and while Visa’s share repurchase program is extensive, it’s less important than Visa’s generous dividend payout (18% of net income), which itself is secondary to Visa’s organic reinvestment in the company, which totals billions of dollars annually.
The Bottom Line
In an imaginary world in which people bought only what they could afford, saved for large purchases, and didn’t overextend themselves, Visa and its competitors wouldn’t exist — or at least, wouldn’t exist in the elephantine form they do now. Most of today’s other giant corporations make their money by selling tangible, vital products or services: turn raw materials into cars, buy items from wholesalers and offer them at retail, dig oil out of the ground and refine it. Visa is unusual in that it what it’s selling is some manifestation of base human desires — personal convenience with a price. Even more oddly, that price is set by each individual customer. If you pay your Visa bill in its entirety every month, it costs your financial institution (and thus Visa) to accommodate you. They’ll lose money on the deal. But if you incur a balance, let it revolve, and add to it with each pay period, you’ll be contributing to a scenario whereby Visa’s stock price has not only tripled over the past three years, but remains well shy of an ambitious one-year target estimate. If you’re skeptical about investing in Visa, just remember that the road to a cashless society is one-way. (For related reading, see: How We'll All Be Amazon.com Customers Eventually.)