Motley Fool Money - 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

This episode is brought to you by Indeed. Stop waiting around for the perfect candidate. Instead, use Indeed sponsored jobs to find the right people with the right skills fast. It's a simple way to make sure your listing is the first candidate C. According to Indeed data, sponsor jobs have four times more applicants than non-sponsored jobs. So go build your dream team today with Indeed. Get a $75 sponsor job credit at Indeed.com slash podcast. Terms and conditions apply.

Warren Cash Basket of MasterGar Visa, PayPal, Block, and equal weightings. The inception date of July 24, 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 and 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, right? The war on cash basket. We get questions about this basket all the time. People are very interesting in these companies. I mean, 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 kind of the ones that are always just kind of in your face so obvious. And yet some folks will say, you know, these are, these are companies that are headed the way the Dodo Bird, right? 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, right? When you cover one, you kind of cover the other. They're a little bit different, but they really are kind of, they're the two that really

rule the roost. Yeah, like one's 30% bigger than the other, kind of like a Lowe's Home Depot situation. And the numbers look pretty similar. Like, 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% of 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. Wow. And it's roughly split 50-50 between the US and international. There are 4.26 billion visa cards in the world between credit and debit cards, 3.26 billion master cards. 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? You know, 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 sorts of avenues or ways into that payments value chain. I mean, I think you make a very good point there in that you've got a lot of these sort of newfangled FinTech companies. They're doing neat things. We'll talk about embedded finance to an extent here in a little bit as 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 Fed now and whatnot, trying to basically get 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, they 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, you know, some parts of the world, credit card acceptance isn't even that widespread yet. Yeah. I've lived in a few of those places. Right. You don't want to like, you don't want to go backpacking through like, you know, certain parts of Latin America and not have a, and not have cash. Like, it doesn't really work out that well in a lot of cases. Yeah. But these aren't, they're very mature and profitable businesses, very profitable.

You know, they have net margins that would make pretty much any other company jealous. 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. You know, 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. performance was significantly higher than it. It is worth noting. This Warren Cash basket of Master Guard Visa, PayPal, Block, and equal weightings. The inception date of July 24, 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'd 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, me, 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, 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. You know what? It doesn't feel like culturally, 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. 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 years ago, said, we're going to hit 750 million users in just a few years. That's a lot. 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 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, it 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. Revenue is up 8% year-over-year. Non-transaction expenses, which has been a big focus area there, is down 12% year-over-year, despite higher payment volume. That combination, 20% earnings growth year-over-year. They're really engaging their members better.

the average active PayPal account makes 56.6 transactions per quarter. That's 13% higher than a year ago. So they're doing a great job of engagement. This is a 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 to 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. I mean, PayPal is really making a big effort here, buying back a lot of these shares right now. I mean, clearly they see at least some value in where the share is right now. Yeah, I mean, 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 buyback. 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. So, but that tells me that they see a real deep value here if they're not doing anything else with their money. And I mean, and I mentioned they have a lot of cash on their balance sheets. So that gives them a cushion to, you know, 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 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 in 2022 either. But yeah, it does. 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 it, 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, this is another really interesting story to follow here, right? The FinTech formerly known as Square, now it's Block, and 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'm not exactly sure what the focus there. So, when we talk about PayPal and maybe that we're a little bit relieved,

that it looks like this company's 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 bought two days after the IPO. I've written 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 McElvey. 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 title, 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 didn't work it 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 leg for it. Speaking of paying an arm and a leg, I'm glad you just used that phrase. I knew where this was going. So they also acquired after pay, 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. So 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. It's kind of 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. And 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. And 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 cost type of guy. They cap 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's still growing. The payments ecosystem is still growing. The afterpay integration actually looks like it's adding significant value to the business.

But, you know, 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, rain 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. So their share count's not going to go down even if they buy back a billion dollars worth of stock. So 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 to bring it 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, right? And retailers are looking at that more and more as an option. And so, you know, I said it before. Like, if it's something that enables consumers to spend and it enables retailers to sell, then it's a value, right?

And if you look at the Adobe Analytics, right, they're talking about for Cyber Monday alone, BNPL's 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. I mean, you 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 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. We wanted to start with Marquetta. And I think that's a nice segue from Block into Marquetta, because Marquetta in 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. So Marquetta is a credit card infrastructure or 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. So they provide the technology behind these things. Cash app makes up a big, big part of their revenue.

So it was a huge sigh of relief for investors when Cash App renewed its contract this year. That was up to a huge. expire. I think it's now renewed through. Yeah, that would have been kind of a nail in the coffin. I think that's renewed through 2028, I believe. Yeah, four additional years, I believe. And as a result, the company kind of reset this year. The new renewal rates, as is rather common when you sign a new contract, the initial rate goes down, but you agree to four more years. So 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 Marquetta'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 either I mentioned, embedded finance earlier in the show. I mean, that really is what Marquetta is. It's embedded finance. It's bringing those finance capabilities into apps that aren't necessarily fintech companies, right? You mentioned Uber, right, DoorDash, companies like that that rely on, you know, drivers or delivery drivers going in there and picking up something and needing to charge it to a card so

then gets charged to the individual consumer buying the product or whatever. But that embedded finance market. It's an interesting one. It really is growing as we see sort of the mobile economy, the digital economy, the gig economy continue to grow. It does feel like there's a lot of opportunity there from Roketa. 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, shift for payments. This is not a business I'm as familiar with, one that you follow. What does Shift 4 do? And what do you like about them today? So they do payment processing and software for businesses. They're specifically concentrated

in restaurants and hotels. And it's just kind of like the one of the, they're the actual consumer facing like 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. So bigger than Marquetta and profitable on a, you know, gap basis. They have a 6% net profit margin in the past 12 months. So it's a really successful business so far, very strong growth. Payment processing volumes growing 36% year every 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, like sustained over four years, including, you know,

in this slowdown, they're still growing. So their main focus is restaurants. and hotels. They've kind of expanded that quite a bit in the past couple 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 correct. Pebble Beach Resorts is a recent big win of theirs that added shift four as their payment processing partner. And nonprofit organizations are another big vertical.

There's Habitat for Humanity uses shift for 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, Mercado Libre. It's what we talked about on occasion here. It's not just a marketplace. Matt, I mean, this really is a fintech play as well. How does Mercado Libre continue to gain share because it really feels like they have just got everything going in the right direction. Yeah, and they keep building out their ecosystem and it's it's really impressive. Their

profitability really has gotten much, much better in the past couple of years too. And I mean, 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. And it's not just inflation, because let's be fair, they operate in some countries where inflation is way, you know, Argentina, inflation's over 100% right now. Yeah, that's such a bad deal what we've got going on here, right? It kind of puts ours into perspective.

But the number of items sold on the platform is up 26% every year, every year, so it's not just inflation. On the payment side, total payment volume on Mercado Pago's up over 120% year over year. You know, what slowdown? They're really, you know, 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. And on the bottom line, they're very profitable. It's really rare you find a company growing revenue at almost 70% year every year with great

bottom line profitability. They have an 18% operating margin. Wow. So 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. And for good reason, it's just a, you know, people always throw around, this is, you know, an early

stage blank. But this really is like an early stage Amazon, PayPal, all rolled into one. 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.