Judge Rejects Visa and Mastercard Settlement. Should Investors in the Stocks Worry? | The Motley Fool

A federal judge recently rejected an antitrust settlement between Visa (V -1.54%), Mastercard (MA -0.36%), and merchants over interchange, or swipe, fees. The proposed settlement was largely considered a win for the two credit card processors at the time.

Let’s look at the original settlement, what happens next, and what long-term impact the situation could have on the stocks of Visa and Mastercard.

Settlement rejected

Back in March, Visa and Mastercard agreed to a settlement with retailers to an antitrust class-action lawsuit that began back in 2005. The merchants alleged that the two credit card processors colluded with card-issuing banks to inflate interchange fees and prevent them from directing consumers to cheaper options.

Interchange fees are the fees charged to process a credit card transaction. The fee takes into account the convenience of immediately processing the purchase without payment delay as well as covering security and fraud costs. Fees can also vary depending on such factors as transaction size, whether the card is swiped or manually entered, and the type of rewards program attached to the card. While the credit card processors set the fees, the card-issuing banks collect the fees.

According to the National Retail Federation, the average swipe fee for credit cards is 2.24%, although they can reach as high as 4% for some premium reward cards. Debit card swipe fees, however, are much lower, as most are capped by federal law. Note that with debit card fees, however, the issuing bank is not extending any credit and is just letting the buyer withdraw money from a deposit account.

As part of the settlement agreement, Visa and Mastercard denied any wrongdoing but agreed to reduce their swipe fees by 4 basis points for the next three years and for them to be an average of 7 basis points lower over the next five years. The settlement also allowed merchants to direct customers to cheaper alternatives and impose surcharges for using certain cards. I actually saw this in action recently from a small burger chain that added a 3% surcharge for using a credit card, while there was no charge for using a debit card.

The settlement was largely viewed as a major win for Visa and Mastercard given the small fee reduction and temporary nature of the fee cap. Visa said that 90% of the merchants that agreed to the settlement were small businesses. Large retailers, however, spoke out against the agreement.

The next step is likely a trial or perhaps a revised settlement on less favorable terms.

The impact on Visa and Mastercard

Overall, I wouldn’t expect much impact from this news on the long-term prospects of Visa or Mastercard. Although the two companies set the interchange fees, it is banks that collect the fees. While a less favorable settlement could initially lower the fees banks pay the companies and temporarily hurt revenue growth, I would expect any further reduction in fees to largely affect the bank-issuing card companies more than Visa and Mastercard and for their earnings to feel little impact given their scale and the flexibility of managing expenses in their models. Meanwhile, banks will likely react by reducing their credit card reward programs, limiting the impact on them as well.

Outside of China, Visa and Mastercard have a near duopoly on the credit card processing market. Meanwhile, they both benefit from the secular global shift away from cash toward electronic payments, particularly in emerging markets, as well as increased cross-border spending and general inflation.

From a valuation perspective, Visa trades at a forward price-to-earnings (P/E) ratio of 27 times with Mastercard having a forward P/E of nearly 32 times. That is toward the low end of the historical averages for both stocks.

MA PE Ratio (Forward) data by YCharts

Both Visa and Mastercard are great growth stocks trading at reasonable valuations. Mastercard has been increasing its revenue a bit more quickly over the past few years, although the revenue growth last quarter for the two companies was very similar at about 10% for both. Adjusted net income growth was also similar at 17% for Visa and 16% for Mastercard.

I like both stocks at current levels and would use any dip from the settlement news to scoop up shares. Given how similar the companies’ last quarter results were, I slightly prefer Visa given its cheaper valuation.