Baird Discusses Impact of EMV Technology Shift and Apple Pay on Card Processing Industry

NEW YORK, Feb. 9, 2015Baird, an employee-owned international capital markets, private equity, wealth and asset management firm, will host its annual Business Solutions Conference in New York City Feb. 24-25. The conference will bring together institutional and private equity investor attendees to hear presentations from executives representing more than 65 public and privately held companies across a range of sectors including Information and Education Solutions, Facility and Industrial Services, Financial Technology Services, Human Capital Services, Information Services, Marketing and Professional Services.

David Koning

As a preview to the conference, Baird Senior Research Analyst David J. Koning, CFA, who covers Business Process Outsourcing, shares his thoughts on the opportunities and challenges facing the card processing industry.

With the October liability shift deadline looming for EMV technology, will the shift be what the industry needs to guard against future high-profile security breaches and how are card processing companies preparing? 

First of all, EMV cards do offer additional security, which will be good for the industry. For example, EMV card are widely used in Europe, where Visa Inc. (V) Europe has reported that fraudulent volume is about 4-5bps. In contrast, fraudulent volume is generally a bit above 10bps in the U.S. EMV cards are very difficult to copy when compared with a magstripe card, and when a consumer is required to use a PIN, the transaction becomes even more secure.

The payments industry is very focused on helping banks and merchants get ready. Card issuer processors like Fiserv, Inc. (FISV) and Total System Services, Inc. (TSS) are helping their clients mail out new EMV enabled chip cards. The big banks started sending these out several months ago, and the smaller banks have just begun. In our recent survey of 65 smaller financial institutions, approximately 65% expect to issue EMV cards in the next 12 months. The merchant processors are helping ensure that merchants have terminals that can accept EMV cards. Many of the large merchants have these terminals in place already, though most still use the swiping function at this point versus asking consumers to insert their cards.        

What impact has the launch of Apple Pay late last year had on the mobile payments industry and what is your outlook for 2015?

Apple Pay is still in its early stages, and the reality is that a very small percentage of transactions are being done via Apple Pay given that 1) it requires a consumer to have an iPhone, 2) it requires that the merchant can accept Apple Pay, and 3) it requires the financial institution associated with the payment card to have adopted Apple Pay as a way to use the card. Even if a consumer has all of those lined up, he or she might still choose to swipe a card. Yet the launch of Apple Pay is interesting, because it is the first widespread mobile payments rollout. The Starbucks mobile app has also been very effective, but it can only be used at Starbucks. It remains to be seen whether there will ever be one mobile solution that is ubiquitous. The great thing about Visa and MasterCard Incorporated (MA) is that almost every adult has one of their cards, and almost every store accepts them. Until there is a ubiquitous mobile payments solution, it is hard to know if we will see widespread adoption.

Are you concerned about the impact of geopolitical tensions on the payments space? 

Geopolitical tensions like economic issues in Russia have had a mild impact on Visa and MasterCard. While cross-border spending can be affected for short periods by impacts like weather or health events, the biggest geopolitical issues for payments generally revolve around regulatory impacts and fears that regulators may reduce the fees networks, banks and acquirers can charge. The good news is that none of these has had overly material impacts over time. The diversity of income streams throughout payments is another offset.

In light of ongoing debate over the future of bitcoin, what role do you think cryptocurrencies in general might play in the future?

We are somewhat skeptical to whether Visa and MasterCard would ever include cryptocurrencies within the basket of currencies it will process for consumers. Given significant volatility in price and some security fears, we believe cryptocurrencies will largely be isolated to a smaller group of users over time. There are simply too many good reasons to use a government-backed currency, and access Visa and/or MasterCard for consumer protections and rewards.

How closely should investors in payments companies be watching volatility in the currency space? 

Currency is worth paying attention to given that the dollar has appreciated pretty rapidly against many other well-transacted currencies. MasterCard indicated that fx could have a mid-single-digit impact on 2015 revenue growth and Visa has indicated an approximately 2% impact on F2015 revenue growth. Underlying trends remain pretty solid, however, and are much more important than currency trends, which are transitory.

Can you share your thoughts on frontier markets as growth opportunities for payments companies and their possible future impact on the sector?

We will likely see a lot of new payment card programs in emerging markets over the next several years, but they will likely have a minimal impact overall. For perspective, large countries like Japan, Germany, France, South Korea, Russia, and Australia in their entirety are generally in the 2-3% range of Visa and MasterCard’s revenue. While emerging market initiatives may not have a big financial impact individually, a program like the MasterCard/Net1 UEPS welfare debit card program in South Africa can be great for consumers, as it can offer a much safer way to transact and a less-expensive account, and even be linked to mobile phones for certain types of payments. Over a long period of time, the collective impact of these types of programs could become more material.

About David J. Koning

David J. Koning, CFA, is Baird’s senior analyst covering Business Process Outsourcing. Prior to joining Baird in 2002, he was an equity analyst at Holland Capital Management and a commercial lender and commercial credit analyst at Comerica Bank. David received a BA in Mathematics and Business from Calvin College and an MBA with a concentration in Finance from the University of Chicago.

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About Baird

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