Tuesday, March 4, 2008

The Appeal of Visa's IPO

by:Anne Kates Smith, Senior Associate Editor,
Kiplinger.com Sunday, March 2, 2008

There certainly are high hopes resting on the initial public offering of credit card giant Visa Inc. The stock is expected to start trading March 19 or 20 under the proposed symbol V, at anywhere from $37 to $42 a share. With 406 million shares being offered, and an option for underwriters to peddle another 40.6 million, Visa could rake in $18.8 billion in what would be the biggest U.S. IPO ever.
If it goes as planned, such a mega-deal could kick start the stalled IPO market, which is running at the slowest pace since 2003, according to Thomson Financial.
More than a dozen Wall Street firms involved in the underwriting could share about $500 million in fees. Plus, the deal calls for Visa to buy back some $10.2 billion worth of stock now in the hands of its bank customers. That would boost the banks' beleaguered balance sheets and give them an opportunity to share in the appreciation of their remaining stakes. Of Visa's stakeholders, J.P. Morgan could see more than $1 billion from the deal, while Bank of America stands to gain more than $500 million.
But what's the attraction for Main Street investors, given the present turmoil in the financial sector? The chief attraction is that Visa isn't part of the turmoil.

Unlike American Express and Discover Card, Visa isn't the one lending money to cash-strapped consumers whose homes are worth a fraction of what they once were. Visa simply collects the fees every time someone swipes a Visa credit or debit card. And that happens way more often than it does with MasterCard, Visa's only true competitor.
Visa handled 44 billion transactions in 2006, compared with 23 billion handled by MasterCard (and just 4.5 billion by American Express), according to The Nilson Report. In dollar terms, that amounted to $3.2 trillion for Visa, dwarfing MasterCard's $1.9 trillion.
The shift from paper to plastic is still in the early stages, especially in developing countries, Visa says in its prospectus. It says that Nilson forecasts global transactions to grow at an annualized rate of 11% through 2012, with particular strength in Asia, Latin America, the Middle East and Africa.
For fiscal 2007, which ended September 30, Visa generated operating revenues of $5.2 billion. Stripping out some one-time litigation charges (more about that later) and adjusting for taxes, Visa's net income topped $1 billion. That would pan out to be about $1.31 a share, says Nick Einhorn, an analyst at Renaissance Capital, an IPO research outfit that also runs a mutual fund that invests in new issues.
Business may be great, but even Visa acknowledges substantial risks to investing in its shares. Chief among them is a pile of lawsuits. Since 2005, merchants have filed some 50 suits for alleged overcharges. Discover and American Express sued, charging Visa with anticompetitive practices. Visa will plunk $3 billion into an escrow account after the stock offering to cover the cost of settlements or judgments -- but only time will tell if that's enough.
Other risks include increasing regulatory scrutiny -- especially in matters of consumer privacy and identity theft. This could boost costs for the company. Another potential risk is further consolidation in the banking industry, which could shrink the market for Visa cards.
As it is, only a few financial powerhouses account for a significant share of Visa's revenues. Its five biggest customers represented 23% of revenues for fiscal 2007. J.P. Morgan Chase accounted for 9% alone.
But companies always belabor the risks in a prospectus. Investors will likely give as much credence to the performance of MasterCard shares since their debut in the spring of 2006. Since closing at $46 on the first day of trading, MasterCard ( MA) is up more than 300%. It closed at $191.19 on February 27, down 2.4%. Analysts expect MasterCard's earnings growth to approach 20% annualized over the next three to five years.
Assuming a comparable growth rate for Visa, the stock at $39.50 a share (the mid-point between the expected offering price of $37 and $42) would trade at 25 times estimated 2008 earnings of about $1.58 a share -- dead even with MasterCard's price-earnings ratio of 25. If you're bullish on MasterCard -- and many experts are -- there's no reason not to feel the same way about Visa.
The good news for IPO fans is that, with an offering this size, there's a good chance that your broker will have some shares for you, if you want them.
Before you make the call, though, remind yourself that MasterCard came out of the gate much more modestly priced -- with a P/E in the mid-teens instead of the mid-20s. Plus, some analysts who love the business think that MasterCard's shares are due for a breather. So expecting the same kind of meteoric gains for Visa may be just too much wishful thinking.