Mastercard has multiple characteristics that should draw investors’ attention. First, despite the evolution in the payment space, we think a wide moat surrounds the business and view Mastercard’s position in the current global electronic payment infrastructure as essentially unassailable. Second, Mastercard benefits from the ongoing shift toward electronic payments, which provides plenty of opportunities to utilize its wide moat to create value. Digital payments, on a global basis, surpassed cash payments just a couple of years ago, suggesting that this trend still has a lot of room to run, and we think emerging markets could offer a further leg of growth even if growth in developed markets slows. Finally, Mastercard is something of a tollbooth business, and the company is relatively agnostic to smaller shifts in the electronic payment space, as it earns fees regardless of whether payment is credit, debit, or mobile.

Mastercard is not without issues in the near term. Cross-border transactions, which are particularly lucrative for the networks, came under heavy pressure due to the fallout from the pandemic and a reduction in global travel. We expect a full recovery, but this could take a few years. From a longer-term point of view, we think it is likely that smaller and more regional networks are building out additional capacity for cross-border transactions, which could eat into growth a bit in the coming years, but we haven't seen a material effect yet. While this situation bears watching, Visa and Mastercard’s global networks remain unparalleled, and we think this will remain the case for many years to come.

In the near term, we see the state of the economy as Mastercard’s biggest risk. A downturn in the economy would slow overall growth, as Mastercard’s revenue is sensitive to the volume and dollar amount of consumer transactions. The company has already seen growth decline significantly due to the pandemic. But we don’t see any industry trends that will impede Mastercard’s ability to maintain double-digit growth in the coming years, and the company looks poised to continue to modestly outperform its larger peer, Visa.

Payment networks such as Mastercard benefit, unsurprisingly, from a network effect. The more consumers that are plugged into a payment network, the more attractive that payment network becomes for merchants, which, in turn, makes the network more convenient for consumers and so on. In our view, this dynamic explains why a handful of networks have come to dominate electronic payments over time, and at this point, Mastercard has reached essentially universal acceptance in most developed markets. While the network effect is the initial and primary driver of economic moats in the space, the highly scalable nature of payment processing leads to sizable cost advantages for large payment networks, which further cements their competitive positions. For the dominant payment networks with global footprints, such as Mastercard, the network effect and resulting cost advantage is strong enough to lead to a wide moat, in our view.

Mastercard’s origin lies in the formation of the Interbank Card Association by a group of banks that acquired Master Charge in 1969 and adopted the company’s current logo. In the decades since, Mastercard has been one of the largest beneficiaries of the ongoing shift toward using electronic payments. During fiscal 2020, the company processed close to $5 trillion in purchase transactions. Visa, meanwhile, processes roughly twice as many transactions as Mastercard and leads it in terms of market share in every major global region. However, Mastercard has a similarly commanding lead over any other network and is the only other company with a truly global presence. Mastercard’s global market share for credit and debit cards has been estimated at 29% and 24%, respectively, a level that dwarfs competitors outside of Visa. We don’t believe that building a new network with a comparable size and reach is realistic over any foreseeable time line and view Mastercard’s position within the current global electronic payment infrastructure as essentially unassailable.

Mastercard has translated its dominant competitive position into an enviable level of profitability. Operating margins (using net revenue) in 2020 were 53%, and margins have generally trended upward over time due to the scalability of the business. Further, given the relatively asset-light nature of the business, returns on invested capital are very high, averaging over 150% over the past five years.

We are increasing our fair value estimate to $337 per share from $320 due to time value since our last update and some adjustments to our assumptions. Our fair value estimate equates to 41.5 times projected 2021 earnings, adjusted for one-time expenses. While revenue declined in 2020 due to the coronavirus and that issue bled into the first quarter of 2021, secular trends and improving share should allow Mastercard to maintain strong growth rates over the next five years. We project net revenue to grow at a 17% compound annual growth rate. In part, this growth rate hinges on depressed revenue in 2020 and the bounceback that we expect to occur over time. But we believe Mastercard can maintain low-double-digit growth even in the back half of our projection period. We think growth will be increasingly fueled by international markets, and Mastercard's mix leaves it relatively well positioned. While margins have held roughly level recently and were pressured in 2020, we think the company can achieve some modest margin expansion over time, and we project operating margins (based on gross revenue) to improve from 35% in 2020 to 40% by 2025. We assume the increase in client incentives as a percentage over revenue slows a bit, following fairly strong increases in recent years. Our long-term margin assumption is about 2 percentage points higher than the prepandemic level. Given the company’s history of fines and one-time charges, we include ongoing one-time costs roughly in line with historical averages in our projections, but these costs are excluded from the margin levels above. We use a cost of equity of 9%.

Mastercard’s revenue is tied to the amount and volume of consumer purchases, which creates macroeconomic sensitivity. Cross-border transactions are highly lucrative for Mastercard, making the company very sensitive to any swings in these types of transactions. Both Visa and Mastercard have paid substantial fines historically related to the oligopolistic nature of the industry, and we see legal and regulatory risk as intrinsic to the business model, given merchants’ desires to lower fees. While Visa's and Mastercard’s positions in the current electronic payment infrastructure are largely set, the payment industry continues to evolve in ways that could reduce their volume or profitability. Some governments have shown a preference for local payment networks, which could freeze Mastercard out of certain markets and impede the value it drives from its global network.

We see the company's largest environmental, social, and governance risk as data security. Any company involved in processing payments has potential exposure to breaches in its systems.

Our capital allocation rating for Mastercard is Standard. In our opinion, the company’s balance sheet is sound, its capital investment decisions are fair, and its capital return strategy is appropriate. We have a generally favorable view of the management team at Mastercard, but we believe the company's wide moat and favorable secular trends have been the primary driver of its strong historical results.

Ajay Banga served as the company’s CEO from 2010 until the end of 2020, when he moved to the chair position. Michael Miebach, who has been with the company for 10 years and previously served as chief product officer, replaced Banga as CEO. We like that Miebach has held leadership positions in the company across geographic regions, as we expect more of the company’s growth to come internationally over time. Still, given that the company has turned to a company veteran for the CEO role and Banga remains as chair, we don’t expect any major strategic pivots as a result of this change. We would view staying the course as a wise move for Mastercard.

While we attribute the company’s strong historical performance primarily to the wide moat that surrounds the business and secular tailwinds, it is notable that Mastercard has been outperforming Visa in terms of growth in recent years. This suggests management is effectively exploiting the growth opportunities the company has in front of it. Further, we like that management has been hesitant to commit to increasing operating margins over the short term. We believe the company still has significant growth opportunities, and the nature of the business requires reinvestment through the income statement. We think focusing on near-term profitability targets could hamper long-term value creation, and management is right to maintain flexibility on this score, although we think the scalability of the business model will allow for margin improvement over time.

While Mastercard has completed some acquisitions during Banga's tenure, they have generally been small and sporadic. We think the company’s competitive position argues against aggressive M&A, and we are pleased that management has shown discipline in this regard.

Management returns the bulk of Mastercard’s profitability to shareholders. Over the last five years, dividends and stock repurchases equated to 99% of free cash flow. We appreciate the company’s diligence on this front; the dividend has roughly doubled over the past four years.