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Visa IPO Brings Value, For Now

Kevin Kelleher

Visa starts trading Wednesday, and judging from the low valuation that underwriters accorded the stock as it heads out the gates, it's likely to find a grateful market awaiting it.

The credit-card titan priced its shares at $44 apiece late Tuesday in an offering that will raise $17.9 billion. There are several good reasons for investors to take to the stock -- which I outlined on Tuesday -- and now I'd like to flip things around and look at some potential concerns.

These aren't factors that will necessarily weigh down shares, but they're important for shareholders to keep in mind as they watch their investment:

1) Visa doesn't consider you a customer. If you have a Visa card and use it every day, you might be seduced into the invest-in-what-you-know mantra of yore.

But Visa's primary customers are banks -- the banks that issue your credit and debit cards, and the banks that handle merchant transactions. You are simply a cardholder -- at best a customer of Visa's customers.

This matters because Visa is treating its primary customers very, very well. As Laurie Kulikowski pointed out, $10.2 billion of the company's IPO proceeds will go to redeem shares held by member banks such as JPMorgan , Bank of America BAC, Citigroup , and Wells Fargo . You cardholders get bubkes.

(Interestingly, Visa's underwriters include financial giants such as JPMorgan, Bank of America, Citigroup and Wells Fargo. Self-dealing, anyone?)

Those payments have been a powerful incentive for banks to keep Visa as a client. Once they're paid out, the incentive vanishes. That doesn't mean members will be jumping ship, but it does open up the possibility.

2) Legal issues aren't going away. Another $3 billion from the IPO money will be put in an escrow account to provide for legal settlements Visa will make to American Express, and possibly Discover. That's on top of the $2.7 billion in litigation provisions last year.

But Visa's prospectus warns that amount may not be enough. The so-called "retrospective responsibility plan" to shield new shareholders from legal-settlement costs "may not adequately insulate us from the impacts of settlements of, or judgments in, the Discover lawsuit." And it may not shield it from "other pending or future litigation."

Lawsuits are attracted to Visa. Over the past five years, Visa has paid out $4.3 billion in litigation provisions, or 28 cents on every dollar of revenue it's brought in.

Incidentally, between the $10.2 million in member redemptions and the $3 billion in legal money put in escrow, Visa will only have $4.7 billion in cash from the IPO. That's still quite a stockpile, but it's not as large as some investors might think from just reading the headlines.

3) The economic backlash. Visa has said the last two recessions haven't really slowed it down, and that its debit-card business has broadened its exposure to counter-cyclical purchasing.

True enough, but this recession could be much nastier than the last two. And unlike the previous recession earlier this decade, which hurt business spending but was supported by consumer spending, a recession this time around could hurt the consumers that Visa depends upon.

And let's say consumers rely more on credit cards as their other income resources dry up. That could lead to headlines about regular folks crushed by credit-card debt. Of course, Visa isn't really exposed to consumers who can't pay their credit bills. But it is exposed to a backlash that could lead in turn to new regulations protecting consumers.

Such laws may already be on the way. As the New York Times recently noted, "In both the Senate and the House, bills have been introduced to eliminate some of the worst of the fee practices, as well as the ability of credit card issuers to, for instance, impose retroactive interest rate charges."

4) Visa will be volatile. That's good or bad depending on your situation, but if you're an individual investor who likes steady gains, you might not like the bumpy ride.

The good news is that the volatility is likely to be on the upside. Underwriters priced the deal at a value attractive compared to that of rival Mastercard: Visa's $37.6 billion valuation at the offering is only 7.7 times 2007 revenue, a bit higher than Mastercard's current ratio of 6.8.

But now look at the profit level. Visa posted a $861 million loss last year, but excluding the $2.7 billion litigation provision it had a $1.8 billion profit -- the IPO valuation is 21 times that figure. Assuming Visa's projection of 20% earnings growth, the IPO is 17 times estimated 2008 earnings. Mastercard is 37 times 2007 earnings and 28 times 2008 earnings.

Visa's post-offering float of 447 million shares will be several times larger than Mastercard's. That should absorb some speculative enthusiasm, but it could also lead to smaller percentage gains and lead some investors to conclude that Visa is underperforming its chief rival.

Again, this is certainly not bad. But it's something to watch. The volatility could swing to the negative side at any moment.

5) Revenue growth will slow. According to projections in Visa's own prospectus, its core market will see slower growth in the next several years.

Global purchases through credit and debit cards grew 14% between 2000 and 2006, and are expected by the Nilson Report to slow to 11% compound annual growth rates through 2012.

There's certainly less room for growth in its home market, where growth will slow to 8% through 2012. Are there consumers with good credit in the U.S. who want a Visa card but don't have one? Probably, but not that many.

Visa has proven adept at finding new areas of revenue growth -- debit cards are a good example. Its dominating share of online purchases will help. But new growth may be harder to find. A focus on affluent customers sounds nice, but could expose it more to an economic recession.