Judge rejects Visa and Mastercard settlement. Should stock investors be worried?

A federal judge recently threw out an antitrust settlement between Visa (V -1.54%), Mastercard (MA -0.36%), and merchants on exchange or sliding 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 Visa and Mastercard stock.

The solution was rejected

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

Interchange fees are fees charged to process a credit card transaction. The fee takes into account the convenience of immediate purchase processing without payment delays, as well as covering security and fraud costs. Fees may also vary depending on factors such as the size of the transaction, whether the card is swiped or manually inserted, and the type of rewards program attached to the card. While credit card processors set the fees, 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 be as high as 4% for some premium rewards cards. Debit card swipe fees, however, are much lower, as most are limited by federal law. Note that with debit card fees, however, the issuing bank is not providing any credit and is simply allowing the buyer to withdraw money from a deposit account.

As part of the settlement agreement, Visa and Mastercard denied any wrongdoing but agreed to lower their swipe fees by 4 basis points over the next three years and to average 7 basis points lower over the next five years . The deal also allowed merchants to steer customers to cheaper alternatives and impose additional fees 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 seen as a big win for Visa and Mastercard given the small fee reduction and the temporary nature of the fee cap. Visa said 90% of the merchants that agreed to the settlement were small businesses. However, major retailers spoke out against the deal.

The next step is likely to be a trial or perhaps a revised settlement with less favorable terms.

Impact on Visa and Mastercard

Overall, I wouldn’t expect much of an impact from this news on Visa or Mastercard’s long-term prospects. Although the two companies set the exchange fees, it is the banks that collect the fees. While a less favorable settlement may initially lower the fees banks charge companies and temporarily hurt revenue growth, I would expect any further rate cuts to heavily impact the card companies that issue banks more much more than Visa and Mastercard and that their profits have little impact. given their scale and the flexibility of managing expenses in their models. Meanwhile, banks are likely to respond by scaling back their credit card rewards programs, limiting the impact on them as well.

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

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

MA PE (Forward) ratio data according to YCharts

Both Visa and Mastercard are great growth stocks that trade at reasonable valuations. Mastercard has grown its revenue slightly faster over the past few years, although revenue growth last quarter for the two companies was very similar at around 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 settlement news to pick up shares. Given how similar the companies’ last quarter’s results were, I slightly prefer Visa given its cheaper valuation.