Motley Fool Hidden Gems Investing - The War on Cash, Revisited

Episode Date: December 3, 2023

Matt Frankel and Jason Moser, our resident Fintech Fools, caught up to talk about the payments space, how it's changed this year, and what they’re keeping an eye on come 2024. They discuss: The state of the “War on Cash” Embedded finance And two “toll booths” that aren’t going away anytime soon Tickers discussed: V, MC, PYPL, SQ, PINS, MQ, FOUR, MELI, UBER, DASH Host: Jason Moser, Matt Frankel Producer: Mary Long Engineer: Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

From morning hockey with a cup of coffee to Timbits and road trips, Tim's and Canadian Tire have always gone together. Now it's official. You can now earn Canadian Tire money at Tim's. Link your Triangle Rewards and Tim's Rewards accounts to earn twice with every Tim's run. Terms and conditions apply. Visit timhordens.ca slash triangle for details. Warren Cash Basket of MasterCard, Visa, PayPal, Block, and Equal Waitings.

The inception date of July 24th, 2017 is worth noting. This basket is still up 130% versus the market's 105%. So even with this pullback, specifically, I mean, I look at companies like Block and PayPal. Even with the pullback in companies like those, the basket is still outperforming. I'm Mary Long, and that's Jason Moser, a lead advisor here at The Fool and our go-to guy when we want to talk the war on cash. As we close out the year, we'll be bringing you some industry-focused style episodes, where a couple analysts get together to discuss standout stocks in a given industry.

Today, Jason is joined by Matt Frankel to tackle the world of payments. Let's go ahead and just start this show off with, let's call it the big four, Matt, the war on cash basket. We get questions about this basket all the time. People are very interested in these companies. It's something we've talked about for many, many years. As a reminder for listeners who may not be as familiar, we're talking about in specific Visa, MasterCard, PayPal, and Block. Those are the four companies that make up the official war on cash basket. Though, hey, listen, we encourage all listeners, hey, get creative.

Make the war on cash basket that's right for you. It doesn't have to be those four, right? We've even talked about a war on cash basket part two on these shows before. But Matt, we're going to kick it off with these four specifically. And I want to start with the two big toll booths, right? Visa and MasterCard, because these are the ones that are always just in your face, so obvious, and yet some folks will say, these are companies that are headed the way of the dodo bird. Crypto and Web 3.0, they're going to obsolete these networks. But I tell you, to this point, Matt,

it really doesn't feel that way at all. Yeah, we haven't revisited the war on cash basket in quite some time. We looked like mad geniuses for the war on cash basket in around 2021 for a while there. Now it's doing okay, but it's kind of come back to earth a little bit. But you mentioned Visa and MasterCard, and I don't want to get into what I think crypto is going to do or not do because it's not that long of a show. But my short answer is both of these businesses are not going anywhere. We can kind of cover them in one swoop because I'd say they're like 95% the same company. It does feel like this is kind of a Lowe's Home Depot situation, When you cover one, you kind of cover the other. They're a little bit different,

but they're the two that really rule the roost. Yeah. One's 30% bigger than the other, kind of like a Lowe's Home Depot situation. The numbers look pretty similar. If I look at the most recent quarter, both of them grew revenue by the exact same amount, up 11%. Earnings were up 22% at Visa and 24% at MasterCard. Payment volume is enormous at these companies. Between the two of them, they have, just doing the quick math in my head here, they have $22 trillion of annualized payment volume between the two of them. And it's roughly split 50-50 between the U.S. and international. There are 4.26 billion Visa cards in the world between credit and debit cards, 3.26 billion MasterCards. These are massive, massive payment networks. They are not going

anywhere. And what a lot of people don't realize is that the other companies we're going to talk about like PayPal and Block, as well as a lot of these fintech startups and a lot of the crypto companies. It's not an either or, right? Visa wants companies like Block to do well, because guess what? Those little cash cards have a Visa logo on them. They want these companies to do well, these fintech startups. It's a win-win situation. I call Visa and MasterCard the ultimate war on cash stocks, because whatever fintechs win the battle, Visa and MasterCard win too. Well, they've done a very good job, I think, through the years of finding new avenues or ways into that payments value chain. I think you make a very good point there,

in that you've got a lot of these newfangled fintech companies, they're doing neat things. We'll talk about embedded finance to an extent here in a little bit as well. Well, but they all rely on those rails at one point or another, right? I mean, you're seeing attempts at disruption there. You see things like FedNow and whatnot trying to basically invent new sets of rails to give more choices, more options, quicker transmission of money, finances. But it all really does, it seems to boil down to the fact that these are two businesses. these rails in Visa and MasterCard are just inexorable parts of the value chain here when it comes to payments, no matter what the company. Yeah. And it's also kind of worth mentioning that

Visa and MasterCard don't have their hands in some areas of finance yet, especially person-to-person transfers, which PayPal and Block are both known for. That's a massive opportunity there. But yeah, you're right. There are the rails. It's not a complete duopoly. You have American Express and Discover in the U.S., and in a lot of foreign markets, Visa and MasterCard are not the dominant players like they are here. If you go to some parts of the world, credit card acceptance isn't even that widespread yet. I've lived in a few of those places. Right. You don't want to go backpacking through certain parts of Latin America and not have cash. It doesn't really work out that well in a lot of cases. But they're very mature and

profitable businesses, very profitable. They have net margins that would make pretty much any other company jealous. But they're not mature to the point where they don't have any room to grow. There's a lot of international opportunity. I mentioned the person-to-person payments. There's business-to-business transfers that are very prevalent that no one's really figured out how to make money off of yet. But they are definitely the rails and they're not going anywhere. I'm glad you mentioned earlier that we look maybe a little bit more like geniuses with this War on Cash basket, maybe a couple of years back. Obviously, the performance was significantly higher. It is worth noting, this War on Cash basket of MasterCard, Visa, PayPal,

Block in equal weightings, the inception date of July 24th, 2017, it's worth noting, This basket is still up 130% versus the market's 105%. So, even with this pullback, specifically, I mean, I look at companies like Block and PayPal. Even with the pullback in companies like those, the basket is still outperforming. Let's go to PayPal, because I think this is a really, you know, this is an interesting story from a number of angles, right? I mean, PayPal, you talk about a business with so much potential, but one that's clearly going through some growing pains. There's new leadership. Hopefully, there's new renewed focus there.

But Matt, why is the market so glass half empty on PayPal these days? Well, you mentioned the new leadership, and that kind of is one of the things that I'm excited to see if their growth strategy is a little bit more, like you said, focused. Their growth was very disjointed for a while. I don't know if you remember when they were trying to acquire Pinterest. I do. Well, I mean, it seems like it goes back to that phrase, everything app, right? They wanted to be this super app in doing everything for everyone. And you know what? It doesn't feel like culturally, at least on this side of the world,

it just doesn't seem like that's what consumers want. And I mean, I'm a big Pinterest shareholder, so I'll take it. But I was sitting there scratching my head, like, what are they going to do with it? Yeah. Like, you know, they were going to buy them out for $70 a share. It's also worth noting. Yeah. So it was a very disjointed growth strategy. I would call it kind of all over the place. Some of their acquisitions certainly made sense. Like, Honey definitely made sense as an acquisition, whether or not they overpaid for it's another conversation yeah um you know a lot of companies overpaid in 2021 2022 for acquisitions just based on the valuation environment at the time it's not that they management made bad decisions and the other thing is paypal had these very ambitious

growth targets that it looked during the pandemic years like they were going to meet without any issue. For one, they have about 430 million active users right now. Their CEO, this was only a couple of years ago, said, we're going to hit 750 million users in just a few years. Clearly, that's been walked back a little bit since then. The strategy has definitely shifted from, we're going to hit 750 million in a few years, then we're going to go on to a billion, and we're just going to go from there. Now it's gone to, we have 430 million good users, let's figure out how to maximize them. The question is, can PayPal extract any more value out of its current user base? Venmo in particular has been very slow to monetize, I would say. But the numbers look

better than the stock price might lead you to believe. PayPal's growing, not maybe as the market wants it to. The user base is actually declining a bit. But the users that they have, they're doubling down on, they're more engaged. Total payment volume is up 15% year over year. that's outpacing inflation so this isn't just inflation driven uh revenue is up eight percent year over year non-transaction non-transaction expenses which has been a big focus area there's down 12 year-over-year despite higher payment volume that combination 20 earnings per earnings growth of year-over-year um they're really engaging their their members better the average Active PayPal account makes 56.6 transactions per quarter. That's 13% higher than a year ago.

They're doing a great job of engagement. This is an absolute cash machine. This is a profitable business. A lot of people think of PayPal as a tech company, which in a lot of minds translates to unprofitable. They have roughly $15 billion of cash on their balance sheet. they generate over $5 billion of free cash flow annually, which right now they're putting it all into buybacks. I was going to say, we talk about how companies reinvest this capital, this cash flow. PayPal is really making a big effort here buying back a lot of these shares right now. Clearly, they see at least some value in where the share is right now. Yeah. They've retired 5% of their shares in the past year. They've spent

$5.4 billion in buybacks during that period. Essentially, all their free cash flow is going into buybacks right now. Now, my hope is that they find some bolt-on acquisitions that could drive value. That's the preference. It's kind of like Warren Buffett says, our first priority is figuring out how to maximize our current business. Then we'll worry about buybacks and things like that. But that tells me that they see a real deep value here if they're not doing anything else with their money. I mentioned they have a lot of cash on their balance sheet, so that gives them a cushion to spend their money on buybacks and still be able to pursue acquisitions or whatever if they arise. But this is a very cheap business. It trades for less than, I think,

less than 15 times forward earnings, like 12 times for a while there. And if you had told me that was going to be PayPal's valuation a couple of years ago, we would have both thought that was kind of a silly statement to make. It definitely seems like a bit of an overreaction to the downside there. I mean, I'm not saying that the market was necessarily rational, you know, in 2022 either. But yeah, it does feel like given, I mean, this is a company in fundamentally a very good position, right? I mean, good financials, I mean, playing into a market where there are clear and obvious tailwinds that are not abating. So yeah, then it's going to really just kind of boil down to new leadership. Seems like new leadership is some focus there trying to sort

of pull back from that super app aspiration and really just dig down into what they do really well, which could work out very well for the company. I mean, again, these companies go through growing pains all the time, right? It's never a straight line up. And speaking of never a straight line up, I mean, let's look at Block here because this is another really interesting story to follow here right the fintech formerly known as square uh now now it's block and it's it's got square it's got cash app it's got these crypto aspirations with bitcoin it's got title you know and music streaming i mean i'm not exactly sure what the focus there so we talk about paypal and maybe that we're a little bit relieved that it looks like this

company's getting getting some focus back i think it's a fair question to ask at least with block i mean, is this a company that is losing focus? As you know, I've been a Block shareholder for the long haul. Me too. I'm right there with you. I bought two days after the IPO. I've ridden Block from $9 a share all the way up to $280 a share and back to where it is now. So I've been a fan of this company for a long time. The last time I saw you in person, we were interviewing Block co-founder Jim McKelvey. Oh, yeah, that's right. Yeah, that was a fun interview. So their growth strategy over the past few years, I could also describe, kind of like PayPal's, it's like all over the place. But they weren't just talking

about making acquisitions that didn't make sense. They actually did a couple. You mentioned Tidal, which I'm not really sure what the point of that was. Now, that felt like either he was appeasing Jay-Z, trying to kind of get tight in that club, or maybe this was just like a gamble on NFTs, which clearly that had been working out so well. But any which way you cut it, I just don't see the logic in that deal. But thankfully, they didn't pay an arm and a leg for Speaking of paying an arm and a leg, I'm glad you just used that phrase. I knew where this was going. They also acquired Afterpay, which made sense. That is definitely a fit in the business, not for $29 billion.

That was a lot. Thankfully, it was an all-stock deal. As their stock went down, the essential price they paid for the acquisition went down as well. I think it would be something like $6 billion if you look at their current stock price. Stop doing that, focus. That's my point with Jack Dorsey. The first line of his recent shareholder letter really made me smile. It said, quote, we've been quiet lately because we've been focused. If you think about it, you really haven't heard any news from Block lately. You've heard a lot from PayPal, the new CEO, the management shakeup, the strategy shift, you really haven't heard much from Block. They're really focusing their efforts and

they're doing a lot of things that are very non-Jack Dorsey-esque in the sense that, number one, they're really focusing on controlling costs. He's generally a growth at all costs type of guy. They capped the number of employees they're going to have. They implemented a $1 billion buyback program, which that's the first time I've ever heard the words buyback and block in the same sentence. Their business, unlike PayPal, their business is still growing very, very rapidly. Gross profit was up 21% year-over-year in the last quarter, Cash App is still growing, the payments ecosystem is still growing. The Afterpay integration actually looks like it's adding significant value to the business. But there is a long way to go

when it comes to reaching profitability. Out of the four we've talked about so far, this is the least profitable by a long shot. Now, they could be very profitable today if they would stop pumping so much money into growth, rein in their expenses. I mentioned that's just now becoming a priority. They're a little late to the party with that. I mentioned they did a $1 billion buyback authorization. That's not even going to cover their stock-based compensation for the year. That's just really to offset it. Their share count is not going to go down even if they buy back a billion dollars worth of stock. Things like that really need to be brought under control for this to really return to the level it was at before.

Yeah, I think that makes a lot of sense. I mean, I appreciate you bringing up the buy-now-pay-later stuff, because I think in the very beginning stages of that market, I think we all probably looked at it, at least with the healthy dose of skepticism. I mean, it seems ultimately like BNPL is more or less just credit card in a different name, right? But when you look at it, I mean, clearly, consumers are looking at that more and more as an option, and retailers are looking at that more and more as an option. And so, I said it before, if it's something that enables consumers to spend and enables retailers to sell, then it's a value, right?

And if you look at the Adobe Analytics, they're talking about for Cyber Monday alone, BNPL is going to grow nearly 19% to close to $785 million in sales. I mean, it's clearly an option that consumers are gravitating more and more towards. And so, even if Block overpaid, which is obviously something that's debatable, but I think we probably would all agree they paid a lot, maybe that is something that does pay off down the road. look at the tailwinds in that market. Maybe it is something that ends up paying off. Matt, I wanted to dig into a few other companies in this space, companies that we'd like to follow

sort of tangentially, ones we don't get to talk as much about, but companies that probably many listeners are very familiar with. We wanted to start with Marketta. I think that's a nice segue from Block into Marketta, because Marketta and Block, they're kind of joined at the hip, aren't they? Yeah. Well, Block is their biggest customer, specifically the Cash App by far. Marketta is a payment card infrastructure provider, is the best way I could describe them. In addition to being the company that provides the technology behind the Cash App card, they also do things like they provide cards for Uber. If you ever do an Instacart grocery order, they're the company that allows your credit card to be used in-store without you physically being

there with your card, so that your shopper can buy groceries on your behalf, things like that. They provide the technology behind these things. Cash App makes up a big, big part of their revenue. It was a huge sigh of relief for investors when Cash App renewed its contract this year. That was up to expire. I think it's now renewed. That would have been a nail in the coffin. I think that's renewed through 2028, I believe. Yes, four additional years, I believe. As a result, the company reset this year. The renewal rates, as is rather common when you sign a new contract, the initial rate goes down, but you agree to four more years. You saw their revenue declined by 43% year-over-year, but that doesn't tell the story

about how the business is going. That's just because the Cash App rates went down quite a bit. If you look at the numbers, the payment volume through Marketo's platform is up 33% year-over-year. So they say, start judging our growth again in the third quarter of 2024. That'll be one year after the cash app renewal. So you'll see like kind of year over year comparisons of revenue that make, they're really apples to apples comparisons. High gross margin business, 67% gross margin. They have up $1.3 billion in cash. So they don't really have to worry about being profitable just yet. It's only a $3 billion market cap company. So that's a lot of cash on hand. And on an adjusted basis, they're on the verge of profitability, but their growth has been

very, very impressive. I'd like to see them continue to diversify their revenue away from Cash App. But really impressive business, and it's a technology that is very much needed and is going to be increasingly needed as those type of businesses really expand. Yeah, I suspect you're right. And I mentioned embedded finance earlier in the show. I mean, That really is what Marketa is. It's embedded finance. It's bringing those finance capabilities into apps that aren't necessarily fintech companies. You mentioned Uber, DoorDash, companies like that that rely on drivers or delivery drivers going in there and picking up something and needing to charge it to a card, then gets charged to the individual

consumer buying the product or whatever. But that embedded finance market, it's an interesting one. and it really is growing as we see the mobile economy, the digital economy, the gig economy continue to grow. It does feel like there's a lot of opportunity there for Marquetta, and it was very good news to see them continuing that relationship with Block, because I have a feeling that that should pay off down the road. Matt, Shift4 Payments, this is not a business I'm as familiar with, one that you follow. What does Shift4 do, and what do you like about them today? They do payment processing and software for businesses. They're specifically concentrated in restaurants and hotels. They're the actual consumer-facing software terminals and things

like that, that you'll see when you go to pay for a hotel stay or things of that nature. Pretty big and successful company, a little over $5 billion market cap, bigger than Marketa, and profitable on a gap basis. They have a 6% net profit margin in the past 12 months. It's a really successful business so far, very strong growth. Payment processing volumes growing 36% year over year, 23% revenue growth. They get a percentage of transaction volume and some software revenue, things like that. Over the past five years, they've grown at a 48% annualized rate, sustained over four years, including in the slowdown, they're still growing. Their main focus is restaurants and hotels. They've expanded that quite a bit in the past

couple of years. Stadiums and sporting venues are a big, big focus area for them. They recently acquired a company called Appetize that gets them into a lot more sports venues. I believe, If I remember correctly that you're a golfer, I'm sure you've heard of Pebble Beach Resorts. You remember correctly. You remember correctly. Pebble Beach Resorts is a recent big win of theirs that added Shift4 as their payment processing partner. And nonprofit organizations are another big vertical of theirs, like Habitat for Humanity uses Shift4 as their payment software. So, interesting, kind of a software play on the payments industry. Well, finally, Matt, one that most

listeners are probably pretty familiar with, may have heard of this company, MercadoLibre. It's what we talked about on occasion here. It's not just a marketplace. Matt, this really is a fintech play as well. How does MercadoLibre continue to gain share? Because it really feels like they have just got everything going in the right direction. Yeah. They keep building out their ecosystem and it's really impressive. Their profitability really has gotten much, much better in the past couple of years too. If I'm looking at some of these growth numbers, I'm thinking like, what slowdown? On both sides of their business, you have the e-commerce platform, merchandise volumes up almost 60% year-over-year.

It's not just inflation because, let's be fair, they operate in some countries where inflation is way high. Argentina, inflation is over 100% right now. That's such a bad deal, what we've got going on here, right? It puts ours into perspective. But the number of items sold on the platform is up 26% year-over-year, so it's not just inflation. On the payment side, total payment volume on the Mercado Pago is up over 120% year-over-year. What a slowdown. If you look at their numbers, you would have no idea that's going on. Their credit business is doing well. Mercado Credito is doing well. Forgive my terrible Spanish accent. My high school Spanish teacher would be very upset

at me right now. But their credit portfolio is growing and performing to expectations. On the bottom line, they're very profitable. It's really rare you find a company growing revenue at almost 70% year-over-year with great bottom-line profitability. They have an 18% operating margin. It's a powerhouse business. I'm not surprised it just recently hit a 52-week high, one of my largest investments, and I'm sure a lot of people listening and people at The Fool could say the same. For good reason. People always throw around, this is an early-stage blank, but this really is like an early-stage Amazon, PayPal, all rolled into one. Sounds familiar, sounds familiar, Matt. Well, listen, that's a lot of FinTech in a short

amount of time, we're going to leave it there. But hey, thank you for making some time for us this week. Yeah, thanks for having me. It's always good to get back together with you for a fun episode. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Mary Long. Thanks for listening. We'll see you tomorrow.