The End of Cash?

As fewer and fewer Americans use cash to make purchases large and small, the big winners will be Visa and MasterCard. Plus: Why VeriFone Systems could climb 35%.

The U.S. Bureau of Engraving and Printing produced 8.4 billion notes last year, including a record three billion hundred-dollar bills. Yet even while cash in circulation is growing, it is becoming increasingly marginalized for retail transactions. This year, greenbacks will account for an estimated 29% of U.S. retail payments, according to McKinsey & Co., down from 36% a decade ago.

And among the wealthy and the upper-middle class, cash is almost extinct in the U.S., having given way to credit and debit cards. McKinsey says that cash comprises just 2% of point-of-sale payments for households earning more than $60,000 a year.

Credit cards and debit cards each make up about 30% of all retail transactions.

Cash's disappearance has been slow but inexorable. Upscale merchants are doing away with cash registers in favor of hand-held devices, like the ones that are ubiquitous in Apple stores. Web-based retailers don't take cash at all. And on the highways, even toll booths are fading. Waiting in the wings is a generation of kids that have grown up with debit cards, prepaid cards, and iTunes accounts. The ATM is now as foreign to teenagers as bank tellers were to their parents.

By 2020, McKinsey forecasts cash payments could drop to 26% at the "point of sale," a category that encompasses both physical stores and e-commerce. Most of that spending will come from poorer Americans who don't have bank accounts and people who want to keep their purchases hidden. For those groups, cash will never go out of style.

Thirty years from now, if recent trends continue, cash could fall to just 10% of U.S. retail purchases.
Having already vanquished checks, the two big payment networks, Visa (ticker: V) and MasterCard (MA), are even more focused on displacing cash. The dominant forces in electronic payments, they've spent years laying the digital rails that connect banks to merchants. As those rails get busier, the companies are more profitable. Their stocks are the best play on the cashless society.

A wave of relative upstarts is beginning to garner attention, particularly as so-called digital wallets take hold. The eBay (EBAY) unit PayPal, Google (GOOG) Wallet, and Square are all plays on the digital wallet, essentially a locker of personal-payment data stored either in the cloud or on smartphones. The wireless carriers are also fighting to get into the game by controlling the secure chips that are becoming common in smartphones.

Visa and MasterCard have their own answers to the digital wallet, called V.me and PayPass. And when it comes to routing transactions, Visa and MasterCard will continue to sit between the merchants and the banks. For all the hype, the digital wallet does little to alter the massive infrastructure that has been built around credit and debit. PayPal and Square are new interfaces, but they're just skin deep -- basically "a new way of initiating a good old-fashioned card transaction," says Gareth Lodge, an analyst for Celent, a financial-services research firm.

With some three billion cards between them, Visa and MasterCard will continue to exact a toll on the majority of card transactions, be they credit, debit, or prepaid. "The opportunity ahead of us is even larger than it was over the past 50 years," says Jim McCarthy, the global head of product for Visa -- not least because transactions in much of the rest of the world are still dominated by cash.

"All day long, we're still competing with cash," adds James Anderson, MasterCard's senior vice president for mobile and emerging payments. "We've got plenty of running room."

American Express (AXP) and Discover Financial Services (DFS) also benefit from the shift away from cash, but their networks are far smaller, and they're not pure plays. AmEx and Discover provide financing to their customers, so they have the risks more typically associated with financial services. Visa and MasterCard are simply networks; they have no credit risk. Their revenue comes from fixed per-transaction fees, service fees based on transaction size, and fees for cross-border transactions. On a $100 transaction, Visa and MasterCard make about 10 cents.

There's little risk that Visa and MasterCard will be replaced anytime soon, either. In addition to laying the physical infrastructure, the companies have spent decades building awareness with banks, merchants, and customers, much of it gained through famous ad campaigns. The slogans are embedded in our national conversation. "There are some things money can't buy. For everything else there's MasterCard." And "Visa: It's everywhere you want to be."

"It's the trust that exists between [Visa and MasterCard's] rails and the banking institutions that allows them to reach into customers' banking accounts and subtract money," says Chuck Akre, founder and chief executive of Akre Capital Management, which has large positions in both Visa and MasterCard.

The banks like that status quo. They take most of the fees that flow through the card networks, Akre adds. "The banks, in effect, are the protectors of MasterCard and Visa's domain."

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