Mastercard Incorporated (MA) Q3 2011 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Third Quarter 2011 MasterCard Earnings Conference Call. My name is Chantalay, and I will be your facilitator for today's call. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Ms. Barbara Gasper, Head of Investor Relations. Please proceed.

Thank you, Chantalay. Good morning, everyone, and thank you for joining us today, either by phone or webcast, for a discussion about our third quarter 2011 financial results. With me on the call today are Ajay Banga, our President and Chief Executive Officer; and Martina Hund-Mejean, our Chief Financial Officer. Following comments from Ajay and Martina, we will open up the call for your questions. This morning's earnings release and the slide deck that will be referenced on this call can be found in the Investor Relations section of our website, mastercard.com. The earnings release and slide deck have also been attached to an 8-K that we filed with the SEC earlier this morning. A dial-in replay of this call will be available for one week, through November 9. Finally, as set forth in more detail in today's earnings release, I need to remind everyone that today's call may include some forward-looking statements about MasterCard's future performance. Actual performance could differ materially from what is suggested by our comments today. Information about the factors that could affect future performance are summarized at the end of our press release, as well as contained in our most recent SEC filings. With that, I will now turn the call over to our CEO, Ajay Banga. Ajay?

Thank you, Barbara. Good morning, everybody. As usual, before Martina gets into the details of our results, let me start with some comments. In the third quarter, we saw net revenue growth of 27% or 24% on a constant currency basis. This helped fuel operating income growth of 31% and EPS growth of 43%. We're obviously pleased with our results this quarter, including our fourth consecutive quarter of double-digit volume growth, as well as the highest growth rate in process transactions since the IPO in 2006. Each region posted healthy volume growth with the strongest growth in Latin America and Asia-Pacific, Middle East, Africa. Volume growth in the U.S. of almost 14% was led by strong debit results aided by the roll on of business wins and double-digit increases in our commercial credit business. Despite persistently high unemployment rates and a weak housing market that has resulted in the low levels of consumer sentiment that we all read about, we are still seeing the consumer spend. Our U.S. consumer credit volume grew 4%, and debit volume grew about 22%. This is consistent, by the way, with our SpendingPulse data that shows retail sales growth x auto has remained for the most part between 8% to 9% year-over-year in the recent months. Certainly, some of this increase is due to inflationary pressures such as higher gas prices and food inflation, but it's still money that consumers are spending. However, the comparison will become more difficult starting in November as U.S. retail sales x auto were up by over 5% in November and December of 2010 versus last year's spring-summer period when the comparable number was only about 1%. Moving on to Europe. Our performance there is driven by healthy cross-border volume growth and new domestic processing businesses in the Netherlands. Given…

Thanks, Ajay, and good morning, everyone. Let me begin on Page 3 of the deck, which shows our reported results versus last year's third quarter. As you just heard, we had a terrific quarter. Net revenue grew over 27% driven by very strong volume and transaction growth across our base business, as well as the addition of new deals. Acquisitions contributed about 4 percentage points to this growth, resulting in a very robust top line growth rate of almost 24%, excluding acquisitions. Total operating expenses were up 23.1%, which included about 9 percentage points of expenses related to acquisitions. Therefore, expense growth, excluding acquisitions, was just under 15%. Foreign exchange contributed less than 4 percentage points to net revenue growth and just over 2 percentage points to operating expense growth. The FX impact is the same for growth rates with and without acquisitions. Operating income was up 30.9%. This resulted in an operating margin for the quarter of 55.1%, up from 53.6% in last year's third quarter. Bottom line, we delivered net income of $717 million, up over 38% and diluted earnings per share of $5.63, up almost 43%. Now on the next couple of slides, representing the operational metrics for the third quarter of 2011 compared to the same quarter a year ago. So if you go to Page 4, you can see that worldwide gross dollar volume or GDV was up 18.1% on a local currency basis or 23.4% on a U.S. dollar converted basis. This is the highest quarterly growth rate we have seen in more than 4 years. U.S. volume growth was 13.6%, and outside of the U.S., volume growth was 20.4% on a local currency basis, including about 25% growth in Latin America and Asia-Pacific, Middle East, Africa. Worldwide credit volume grew 14.9% on a…

Thank you, Martina. We're now ready to begin the question-and-answer period. [Operator Instructions] Operator?

[Operator Instructions] Your first question comes from the line of Bob Napoli of William Blair. Robert P. Napoli - William Blair & Company L.L.C., Research Division: I'd like a little update on Europe if I could. I mean, it's 1/3 of your spending and your slowdown -- your performance there in light of the circumstances is pretty impressive, and I'd like a little more color on what you're seeing there on a real time basis and imagine that some of these processing deals that you've won that's made the numbers look better than the market itself.

Bob, let me take this first. First of all, yes, we are seeing actually extremely good performance in Europe. When you look at our total GDV numbers and GDV growth numbers in Europe, it's over 17%. You see both from a credit as well as from a debit perspective, a double-digit growth there. You see double-digit growth almost 18% from a cross-border point of view, and then we're benefited in particular in the Netherlands by the deals that we did there on the transaction processing, which is 30% growth. So we have really not seen any significant impact in Europe given what's going on there from an economic point of view. In part, it is because all of the good work that our people are doing on the local ground in terms of winning agreements and implementing things, it's in part the secular trend going from cash and check to electronic forms of payments. And we'll be watching this situation very carefully going forward, but despite the turmoil, our business is performing well.

Your next question comes from the line of Chris Brendler of Stifel, Nicolaus. Christopher Brendler - Stifel, Nicolaus & Co., Inc., Research Division: Martina, the domestic assessments strength you pointed to obviously -- I was trying not -- as has been summed. Processing revenues were up I think 26% and transactions were up 20%. Is there any -- was there any pricing in there that drove the outperformance or is that currency?

Okay, can you repeat that question, please, because I didn't get everything? Christopher Brendler - Stifel, Nicolaus & Co., Inc., Research Division: The domestic processing increased this quarter. Revenues I think were up 26%, but processed transactions were up 20%. Was there any pricing in there? Or is it just currency that drove the outperformance?

What you have to look -- yes, domestic processing had a little pricing in there for sure, just a tiny little bit. It was about 2 to 3 percentage points, but what you have to compare is you have to compare the 25% increase on revenues to what we did from a U.S. dollar converted GDV number. And when you look at this, the numbers, except for that small price change, actually line up perfectly. Christopher Brendler - Stifel, Nicolaus & Co., Inc., Research Division: Okay, and just secondly on PIN debit in the U.S., do you have any plans to try to use your signature rails to process PIN debit transactions?

This is Ajay. And I'm not going to tell you what plans we have, but I'll tell you this. We can obviously do that. In fact, microprocessing in Europe right now is done off those rails, and so we actually have rail experience on that. But I'm not going to talk any more about our PIN debit plans other than what I talked about in my opening comments for what we're trying to do.

Your next question comes from the line of Julio Quinteros of Goldman Sachs.

Great. Ajay, can you just go back and rehash the strategy here on PIN debit? I mean, you outlined the 4 things that I think make a ton of sense in terms of how you're going about this. Maybe as opposed to rehashing all 4 of them. Just focus specifically if you can on the routing opportunity with both merchants and the merchant acquirers if you will.

Julio, I'm not going to add much more. We are working through the routing opportunities with selected merchants and acquirers. We've actually been signing a few deals with them. I'm just doing all this in a surgical, strategic way for those opportunities that make sense to us. I don't feel it's in my competitive interest to be publicly talking about which ones are signed and what my plans for the next quarter are. So I just don't want to go any further down that path, but you should just know all 4 of those things I talked about. That is retain our existing placement on the minority of our debit portfolios that are exclusive to us; second, get Maestro as the PIN debit brand on the back of competitor cards; third, keep converting competitive sick portfolios to MasterCard like we've been doing; and finally, work on resulting preference. We're working on all those 4 ideas with strategic, surgical opportunities, because the state is still complex and there's many moving parts. And there's still a lot of negotiations going on, and the issuers are looking for incentives. The merchants are looking for incentives. The acquirers are looking for incentives in a business that has trimmed revenue yields to start with, and so we want to make sure we do it well and smartly.

Your next question comes from the line of David Togut of Evercore Partners.

I apologize if you already addressed this and so was cutting over from another earnings call, but did you quantify any changes in U.S. debit volume growth since the new interchange regulations when it went in effect on October 1? At least, can you quantify any that might be specifically tied to that?

David, it's really far too early to be looking at any different change in trends. In fact, when I was talking earlier in my script, in my prepared remarks about processed volume, we really have not seen much of a change whatsoever in the United States, not on the debit volume, as well not on the credit volume but very similar to the third quarter. So I just suggest to you that it's far too early to be figuring out where that might go.

Your next question comes from the line of Glenn Fodor of Morgan Stanley.

Martina, you had your goal out there for operating margin of at least 50%, but I just want to get a sense of your appetite to flex around that target level over the near term. And secondly, looking out over the next 12 months or so, I mean how would you characterize it from an internal investment standpoint? Are we looking at heavier than normal amount of investments on the docket, about average, less than average?

Yes, Glenn, I'd be happy to talk about this. First of all, we put out the 50%-plus operating margin out there for a reason, and we put it out there because we are doing fairly significant investments in our strategic priorities, which we quote, e-commerce, mobile information services, what we do in the debit space and what we do in the prepaid space as well as in the commercial credit space. In addition to that, the numbers that you are seeing here, we have the acquisition expenses included, which will anniversary at one point in time, latest in the first -- at the end of the first quarter, I'd say, at the beginning of the second quarter of 2012. So you will see a couple of more quarters of this coming through. We are keeping flexibility from an operating margin point of view, primarily because we're looking into the future and what the economies, the growth economies might bring in the future. So of course, when we put our plans together -- and this is by the way no different for 2012 than what we would have done for 2011 as well as 2010. We are putting certain plans together to make sure that we can flexibly react. If we were to see some changes in the economic environment, it doesn't matter in which part of the region of the world. So you should expect us to have that kind of flexibility built in to future plans, too, as we do -- as we did this year and last year.

Glenn, the only thing I'd add is that as you heard Martina in her prepared comments, the fact that we are sticking to the concept of a minimum 50% even for 2011 when clearly for the first three quarters, we have done somewhat beyond that is because she has indicated that there are still expenses to come in the fourth quarter, maybe at a lower rate than what we saw in the third quarter but probably at a higher rate than would otherwise have been thought about. And I think those are the kind of indications we're trying to put our money back into our strategic initiatives. We've actually, from little, little things that we have hired this year close to 700 people into our company, and that's in addition to those we got through the acquisitions of Access Prepaid and DataCash. And by the way, of those 700, close to 350 are in the United States where people think that hiring is not going on, and so we're actually adding. And I think that's part of what we're trying to do with our business is to invest sensibly, but like Martina just said, they're very cognizant of the mixed signals that we are getting in the world economic system. Whether the signals are coming from confusion between macroeconomics and microeconomics, I don't know. But I just know that I'm getting these. It's not showing up in the business yet, and so every month, she and I are very conscious we need to keep some flexibility in the way we are constructing our expenses so we can react if we begin to see an impact on our top line. And remember that even for our top line, we are trying to indicate that the third quarter did have certain aspects to it that may not get repeated in the fourth quarter, but we remain in the perspective that says the second half is going to be higher than the first half. That part has not changed.

Your next question comes from the line of Jason Kupferberg of Jefferies. Jason Kupferberg - Jefferies & Company, Inc., Research Division: On the rebates for Q4, I guess historically Q4 is the highest quarter for that line. Do you expect that, that will be the case again this year and any quantification you could provide around that? And would just love any thoughts from you guys on do you think we'll see any new issuers join the Google Wallet initiative in addition to Citi at any point soon.

Jason, I really don't expect much change in the fourth quarter from what you see typically in our fourth quarter. You'll see a very normal fourth quarter from a trajectory, from a contra revenue trajectory point of view, so there's really nothing to call out in specific.

As far as Google is concerned, Jason, I would say that 2 things are happening: one, of course, the bunch of new merchants that we talked about in my remarks. But within the next few months, I think Google Wallet will open up to the other networks, which I believe is the right thing. I believe that open systems is the only way. I've been saying this for a while, that mobile payments will begin to acquire traction. I think that'll be networks as well over a period of time. I'm sure they'll open up to other banks as well. I just don't know what the timing of these specific things is.

Your next question comes from the line of Bryan Keane of Deutsche.

Super results, but I did want to dig down on the 0.4, which I think was on the debit strategy of winning routing preference for merchant and acquirers. I think that's the first time I've heard you talk about that, Ajay, and we obviously know Visa has kind of planned to incentivize merchants and acquirers. So I guess my question is won't that pressure some of your rebates and incentives going forward and how do we think about that? And then secondly, are you worried a little bit that you could lose some PIN share if you don't incentivize some of these merchant and acquirers now that Visa's put out this strategy?

Actually, it's not the first time I've talked about the routing preference and incentive. It's just that I'm sticking to my way of thinking about it, which is I don't plan to go out with a broad-based approach. I don't need to. I will do this selectively with certain merchants where I believe it makes a difference to the kind of volume that we get on our debit business. We are already been doing some of those even prior to the changes in the rule because we've been having relationships with selected merchants where we feel that they will either make a difference to reducing the use of cash or they will make a difference to the perception of how debit can be used. And that's sort of a new thing. And the difference only is you aren't seeing as big an impact on our rebates and incentive line as you may have seen with other competitors, but honestly, you got to ask them that question. I don't know why that is the case. Mine is what it is.

Yes, in fact, let me just add to it. Of our $110 million of increase in incentives in the third quarter, the vast majority is really related to volume performance, okay? It's only a small portion related to signing new agreements or renewing agreements.

Okay, so no additional expense to think about as we head into 2012 with the result of this?

Look. As Ajay said before, things are changing everyday. The market has to work through a dislocation that happened from the legislation, and we are going to have to work through that. So I'm -- we're not going to talk about 2012 at this point in time. This is only our third quarter results. Typically, we give you on the February call with our full year disclosure. We give you a typically a few words about the next year, but the situation is fluid, Bryan.

Bryan, think about what I said earlier. We're going to keep our flexibility going. I think among other things like the economic environment, I think similar to that, this whole debit environment is still moving around. And I don't want to give you thoughts about something I don't have fixed right now directly for next year. It would be a mistake in guidance to give you. I don't want to do that.

Your next question comes from the line of Craig Maurer of CLSA. Craig J. Maurer - Credit Agricole Securities (USA) Inc., Research Division: Just a quick question on Brazil. I was curious if the end of exclusivity and the opening up of those systems down there added any to -- anything to your growth rate and if we should think about any type of grow over effect from that.

Craig, that's a great question. Actually, when Redecard existed earlier in its original form and the predecessor was yellow, which was the Visa-based acquiring scheme existed in its earlier form, actually, the distribution for this yellow predecessor was wider than the distribution for Redecard in its predecessor form. And so in fact, the opening up of that market effectively expanded the distribution for MasterCard to the same level as that of all the other competitors. Now it did that for others too, but it actually helped us in that sense. Mind you, I'm not talking about a 50% extension. I'm talking about way south of that number, but it did help. Should you be thinking about that in a lapping sense? It start as a significant amount. I think the bigger issue in Brazil in a lapping sense is the Itaú processing, which lapped in September, and the second issue of course out there is Brazil's economy and how well it holds up, and I mean that constant guidance that comes around Brazil saying doing well on commodities, struggling on industrial production, so we keep an eye on that as well. But I would say I wouldn't factor a great deal in my mind at least of the lapping caused by the removal of exclusivity.

Your next question comes from the line of Darrin Peller of Barclays Capital.

You process and actually handle the authorization and settlement in about 5 or 6 countries, and I think you highlighted today new processing in Brazil and Netherlands, which I think you may have discussed before. But that's obviously continued to contribute to growth, and I think these types of transactions really boost your revenue yield per transaction longer term. So can you just comment on that for a minute? I mean have there been any further changes in the landscape, maybe SEPA or others that really might incrementally continue to open up the opportunity to process more transactions around the world versus just the brand transactions?

Seeing your transactions and processing them is always useful for a company like ours not just for what we get as a revenue directly from it. For what it gives us is the ability to sell other value-added products based on what we see in those transactions. And so all of the effort we do with them inControl or a fraud management capability or behavioral scoring through Advisors, all that does get enhanced when we see transactions. So I believe that's what we'd like to do. Now we're trying our best to improve our position in that space across the world. I think SEPA, clearly, as we've talked about does provide a degree of opportunity there, and in fact, our progress in SEPA over the last, I'd say, few months and few quarters has actually shown some of that. Transactions in SEPA up and beyond are the ones that we have seen and up beyond 100%. In fact, our processing of domestic transactions grew 180% in the third quarter of 2011 and have grown 113% year-to-date. Now it's on a small base, and Europe takes -- it's an evolution. As you can see in the newspaper right now, Europe's not a revolution although it feels like that on the roads of Greece. But I'd say to you that's what we are trying to do. Yes, SEPA and the payment systems directive does provide opportunities in Europe. Yes, there are opportunities like that in other countries around the world, as domestic schemes that were created over time begin to find that the economics of staying up to date with the technology investments required to be that way no longer make sense, and they start coming to players of scale to say, while you've got the scale across 200 countries, why am I redoing it in every country? That's the principal way in which we get into these processing transactions. It's very important to us. It's a constant effort. It's a slow effort.

Okay, that's helpful. Just one quick follow-up. Conversations progressing with banks regarding debit pricing, especially given now with the U.S. banks. Primarily, you're tracking their debit usage fees that many had planned to instate. Can you comment on the course of action you think these banks might take to take advantage of -- or really just try to replace the debit interchange revenue now?

They've been -- I would tell you that the amount of noise made on the media of about one particular aspect of what they're trying to do is what the media chooses to do, but they've been doing things with the taking away of free checking accounts for a while. They have done things with different fees. They have looked at their rewards on debit cards. They're looking at every line of cost in their system. If you think about it, it's a fair amount of revenue that is moving from them to some of the retailers over this period of time, and they're going to try to find ways to make sense. I don't know what they're going to do. I don't know yet, but I know what they're trying to do is to look at every single line item from the cost of running a branch to the cost of rewards to checking accounts and also they had looked to recently at debit card fees and looks like that one got away for the time being.

Your next question comes from the line of David Hochstim of Buckingham Research.

I wonder -- could you give us an update on what's happening with China and with your relationship with China UnionPay and how much cross-border volume in China is affecting the APMEA numbers?

No, I'm not going to give you specifics on China's cross-border volume, but it's healthy and growing. I would say on China UnionPay, our relationship carries on from where it was for the last few quarters. We are now at the mobile payments gateway trial. We have done that. It's complete. They're actually moving towards commercial production off that. Eventually, the plan is for us to help them increase their acceptance overseas while CUP will help us increase acceptance for our brand in China. But it's not just about increasing acceptance. It's based on getting revenue from their acceptance for them and for us, so those are the kind of things we are looking through with them. We continue to work with them on this cross-border outside of China relationship. As you know, domestically, the market is still a controlled market with China UnionPay being in a monopoly position and with us and competitors, all of us not being allowed to play there, and that's an unfortunate situation.

Okay, and again, I guess, asked earlier, but in Europe, just to be clear, have you looked at the sort of same customers over time? There's no change in spending behavior?

At this point in time, we are really not seeing any significant changes, David.

Your final question comes from the line of Sanjay Sakhrani of GIC (sic) [KBW]. Sanjay Sakhrani - Keefe, Bruyette, & Woods, Inc., Research Division: So Martina, just a quick clarification on Europe. What is the growth rate x that add in Netherlands? And kind of when does it lap into next year? And then just separately, I was just wondering if you guys had any thoughts on Durbin's request for an FTC study on the small bank debit interchange exemption.

Okay, let me take the first one. Ajay will take the second one. But really where you see the Netherlands showing up in a big way is in the transaction processing numbers, which are very, very healthy in Europe. I think I said, 30% plus at this point in time. It's in the volume numbers as well as in the cross-border numbers that I was quoting for Europe. You are not really seeing a significant impact from the Netherlands, so this is very good across all of the countries. And remember this is not just Western Europe. There's a healthy portion of Eastern Europe in there.

And Sanjay as far as the second part of it is concerned, I continue to believe that once the law is the law, we will ensure that we implement it to the best of our capability. And in that law, the banks below $10 billion are entitled to a differential interchange from those above, and I'm determined to implement that with the full force of what I can do. So whether Senator Durbin wants to investigate it one way or the other, it's his call and I think it’s his prerogative. But I'm just determined as a company to do what's right. And now the law is the law and that's what we're going to do.

At this time, I would like to turn the call back over to Ajay Banga for closing remarks. Please proceed.

So let me leave you with just a few closing thoughts. We've delivered really good results year-to-date due not only to strengthen our base business across all 5 of our regions but also driven by volume and transactions from new deals. We remain watchful of macroeconomic trends around the world. We are always ready to react as Martina was saying in response to a question. If you see those trends going in a direction that begins to impact our business, as we discussed in our investor meeting, we believe that global PCE will continue to grow over time. There will be ups and downs by country, ups and downs by year, but in the meantime, we continue to invest and execute at a very local level to drive acceptance in new categories, displace cash and bring the benefits of electronic payments to more people and more institutions. Cash is not free. It costs up to 1.5% of GDP for a Central Bank to print it, secure it and distribute it, and it comes at a cost to banks. It comes at a cost to merchants. It comes at a cost to consumers. We will continue to push innovative products into the market that drive efficiencies and growth for all the stakeholders, and in turn, I believe, this will drive MasterCard share and long-term revenue growth. So once again, thank you for your support for our company. Thank you for your time today, and I look forward to seeing some of you again over the next few months.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a wonderful day.