By Daniel Federgreen
Analyst
In recent years, the payments community has witnessed a fundamental change in the core business structure of MasterCard Worldwide, Visa Inc. and Discover Financial Services. Each has become a public, for-profit entity. Has this or will this affect the day-to-day function of the payments industry? Is there a reasonable way to measure this change if there is one?
Scottish economist and philosopher Adam Smith wrote in The Wealth of Nations (first published in 1776) that companies in the same market niche have competitive concerns, and antagonistic behaviors are only overcome when a mutual benefit, such as a monopoly or effective monopoly, is developed. He said, "People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices."
With the change in the legal entity status of three key players in the electronic payments space, MasterCard, Visa and Discover Financial Services, the question is, will this change modify in any manner the organizations' behavior in the marketplace, and will this behavior potentially represent a further effective monopolization of the marketplace? To shed light on this, I analyzed their merger and acquisition behavior both before and after their public offerings.
One of the critical questions that must be asked is whether the change in legal entity status has affected the merger and acquisition (M&A) activity of the three entities in question. And if so, how will this affect the behavior, and how will that potentially affect "business as usual" in the payments industry?
In addition, the change in legal status from nonprofit to for-profit removes a significant restraint on any organization's behavior: nonprofit organizations are restricted to limited purposes. These purposes, in many instances, are specific functions listed under the law. Further, nonprofits must refrain from entering markets not related to the mission of the organization. No such prohibitions exist regarding for-profit corporations.
Research indicates that for both for-profit and nonprofit companies with gross revenues less than $50 million annually, the rate of M&A activity is similar. However, when one crosses the $50 million annual sales level, the rates accelerate in favor of for-profits over nonprofits. The specific reasons for this are unclear; however, there is greater and growing asymmetric need for for-profit companies to show growth either organically or through the acquisition route.
I have analyzed the companies acquired by MasterCard, Visa and Discover Financial Services since they became publicly traded entities. I examined the prior five-year period to the conversion date and the subsequent time frame. The sources reviewed include corporate websites, the Mergent Online financial database, Securities and Exchange Commission filings and Alacra Inc., a business information source.
Nonprofit and for-profit companies have different objectives in developing their business strategies. A for-profit company needs to deliver continued top-line growth. Continued growth will typically indicate a for-profit company has solid plans for the future, and this will in turn raise the stock price for shareholders. One way for-profit companies can achieve growth is through merging with or acquiring other companies with proven track records.
In the five-year period before their initial public offerings (IPOs), MasterCard and Discover had minimal M&A activity, while Visa did not engage in any M&As until after its IPO. The acquisitions in this pre-IPO period can be categorized into customer services and infrastructure, with each company pursuing a different area.
Discover's only acquisition was of Pulse EFT. Discover improved its infrastructure in two ways with the acquisition. First through Pulse, Discover gained access to one of the fastest growing ATM networks in the nation, thus providing its original customer base with more convenient options to use Discover products.
Secondly, the acquisition doubled the transaction volume and number of cards in the U.S. market for Discover, thus minimizing the gap between Discover and the other players in the credit card market.
MasterCard's M&A activity prior to its 2006 IPO focused on improving its offerings to its customers. MasterCard acquired both TowerGroup and Watch Hill Partners. TowerGroup was a leading research and consulting firm focused on the global financial services industry and provided additional customer offerings to complement MasterCard's existing service lines.
MasterCard also strengthened its customer service thro-ugh acquiring Watch Hill Partners, who were recognized experts in improving customer relations to ensure that customers are retained.
Following the IPOs, MasterCard, Visa and Discover have all become more active in acquisitions. The acquisitions in this period can be categorized as involving e-commerce, infrastructure or fraud protection.
Visa engaged in the largest singular acquisition of the three companies with its $2 billion acquisition of CyberSource. CyberSource was a leading independent player in e-commerce, as fully 25 percent of all e-commerce dollars were transacted on its software platform. This acquisition gave Visa immediate access to this market.
MasterCard also increased its stake in the e-commerce market by acquiring DataCash Group, which offered a single interface to process payments securely.
Discover continued to expand its customer base with the purchase of Diners Club International Network, adding additional merchants who would accept Discover products as well as increasing its international presence.
Through two acquisitions, MasterCard also addressed infrastructure improvements. Through its purchase of Orbiscom Ltd. and Travelex's prepaid card program management assets, MasterCard sought technologies to develop programs that would increase the number of transactions on its card processing system, as well as accelerate MasterCard's expansion into the prepaid market.
The acquisitions after these corporations went public were not only larger in terms of purchase price, but they also were executed as part of the broader strategy of company diversification and growth.
A key question remains: will this increased pace in M&As continue? As these corporations seek investor dollars and as investors seek moderate returns with minimal risk, companies will need to turn more and more to acquisition. M&As enables a company to get immediate return on its investment compared with developing a new offering internally.
M&As, whether executed by a for-profit or nonprofit corporation, require thoughtful planning of corporate integration to receive the added value of any acquisition. The integration of these various acquired companies into the fabric of the purchasing entity is a significant challenge for any organization, including Visa, MasterCard and Discover Financial Services.
Areas such as business culture integration, synergistic maximization and platform alignment must be addressed. Clearly the most important and immediate item in a financial services relationship is platform integration. Just how much this might delay the full benefit of a merger and the cost of doing this is central to these decisions.
It is my belief that all three entities discussed have, at a minimum, greater flexibility and freedom to act in the broadest aspects of the M&A marketplace under the current status of for-profit, public companies.
Given this, as well as the singular predominance that these three companies have, the risk that they will further reduce competition through M&As is enhanced. Balancing this, however, is the clear ability of regulators to have greater impact upon and control of behaviors of public, for-profit companies versus private nonprofits.
Daniel Federgreen can be reached at exvala@gmail.com. He currently is employed in the corporate financial group of a Fortune 50 company.
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