Javier Hernandezj.hernandez54@umiami.

edu

Investment Research

4/29/2013

BUY
Price Target: $581-$622
Stock Overview:
Price Current
52 Wk % Chg 52 Wk Range Curr. Vol. 15d Avg Vol.

[MasterCard] (NYSE: MA)

MasterCard, Inc. is a global payments solutions company mainly focused on transactions processing of credit, debit, and other forms of electronic payments programs.

Investment Thesis:

MasterCard, Inc. is greatly undervalued compared to its peers In this report we used direct and indirect valuation as well as a discounted cash flow model. The multiples used were P/B, P/E, EV/S and EV/EBITDA MasterCard is the second largest credit card company after Visa and is globally diversified as well as a leader in emerging payment systems MasterCards stock has increase ever since they settled their Eric Gonzalez dispute with merchants and may still not have reached its fair e.gonzalez39@umiami.edu market price Political risk stemming from increased regulation of the financial sector may pose a threat to the valuation
305-218-9426

$539
9.72% $389.9546.9 0.381M 0.518M $66,174.6 $61,183.6 126 1.001 Buy 24.44x 21.19x 9.54x 23.66x 14.51x 8.22x N/A

Size
Mkt Cap (mil) Ent Val (mil) Shares Outs (mil) Beta

Valuation
Mean Recomm. P/E FY1 P/E P/Bk P/CF EV/EBITDA EV/Sales Div Yld

Financials
$66,174.59 Sales (mil) 16.4% 5yr Sales Growth 59% Gross Margin 5,552.05 EBITDA (mil) $3,619.47 Earnings (mil) 20.5% 5yr Erns. Grwth 0 Debt Price 0% Leverage $199.03 Latest $2,052 Cash (mil) 37.24% 1 Yr Chg (%) $2,948 OCF (mil) $128-227$2,852 52 FCF Wk Range (mil) 2,289,151 Curr. Vol. 10d Avg Vol. 1,000,796 $12,674.80 13,555.48 769.7

5-year Historical Price Chart

Size
Mkt Val (mil) Ent. Val (mil) Shs Out (mil)

Source: Bloomberg,1.35 Yahoo Beta

Valuation
P/E FY1 P/E P/Bk P/CF P/Sales 7.61x 25.6x 2.56x 6.26x 2.12x

Company Description
MasterCard, Inc. is a global payments solutions company mainly focused on the transaction processing of credit, debit, and other forms electronic payments programs. They generate revenues by charging fees to their customers for providing transaction processing and other payment services.

MasterCard charges the Issuer and Acquirer based on: Gross Dollar Volume (GDV), transactions processed, and international transactions processed.

Competitor Firms & Headlines

Competitors Based off purchase volume the industry leader is Visa followed by MasterCard and American Express.

Visa operates in the same manner as MasterCard whereas American Express business model allows them to also play the role of Issuer.

Headlines MasterCard MasterCard, Visa, and several banks settled a merchant price-fixing lawsuit for $7.25B. Visa will be required to pay $4.4B and MasterCard is required to pay $790MM towards the settlement. As a part of the settlement both companies have agreed to lower their fees by 10 basis points for eight months. (NBC News, 2012) MasterCard and Telefonica launched a joint venture called Wanda, a mobile money service that provides a mobile wallet for consumers in a dozen Latin American markets. (MasterCard Press Release, 2012) MasterCard defies Debt Crisis as Europeans boost card spend. While under pressure from France to cut card payment fees, consumers are increasingly using credit/debit cards. (Bloomberg, 2013)

Visa

According to J.P. Morgan, Visa would benefit from buying Visa Europe Ltd. This report was released after it became public that Visa is looking into acquiring Visa Europe. (Bloomberg, 2013) Visa Inc. has been named one of the most ethical companies by Ethisphere Institute. (4-traders, 2013) Visa announces retirement of John Partridge as president effect March 31, 2013. (Reuters, 2012)

American Express American Express boosts dividend and plans buyback worth around $800MM. (Bloomberg, 2013) American Express passed the stress test. (Motley Fool, 2013) American Express Company and Morgan Stanley announce new co-brand cards. (Reuters, 2012)

Macro-Oriented Industry Analysis

Political: In many developed nations there is increased pressure from governments and politicians to bring down interchange fees charged by Visa and MasterCard. The Durbin Amendment as a part of the DoddFrank Act lowered swipe fees charged to merchants by the credit card companies. This has caused great political pressure (and subsequent anti-trust lawsuits) by politicians to force the credit card companies to permanently lower the interchange fee. Smaller governments however are huge proponents of credit cards because it allows them to track how cash is being exchanged. Many nations that have problems with tax evasion have turned to credit card companies in order to find creative solutions to their problems. Other countries such as China, Russia, and Ukraine have created laws protecting domestic payment service providers limiting competition in those nations. While most international transactions are processed by the credit card company, China Bank handles all cross border transactions involving their credit cards.

Economy: Consumer spending is a large driver of revenue for credit card companies. As a result of the economic woes in Europe and North America consumer spend growth has decreased. In addition, the credit card companies charge high fees off processing international transactions. The bad economy has caused international travel to decrease hurting the credit card companies. Social Change: MasterCard is engaged in a war on cash. Currently, 85% of the worlds transaction takes place via cash. India and Brazil have large populations without bank accounts, despite the growing middle class. As society becomes more and more accustomed to increased technology, electronic payments should benefit greatly. Technological Change: The next wave of electronic payment is NFC, where MasterCard is an industry leader. They have branded their PayPass tap n go system better than Visas payWave and American Express ExpressPay. MasterCard is currently using PayPass to tap into mobile point of sales (POS) as well as entering the online click-and-pay space. MasterCard launched a joint pre-paid mobile wallet venture with Telefonica in Latin America. Currently, PayPal is attempting to join the other credit card companies and compete in the mobile POS market. Environment: The payments processing industry does not pose any environmental threats. Legal Challenges: MasterCard and Visa both just settled a $7.25B merchant class action litigation that temporarily reduced the interchange fee they charged merchants for the next 8 months creating a drop in revenue. In addition, the settlement forced both Visa and MasterCard to modify their no-surcharge rule that disallowed merchants from adding an additional fee to credit card purchases. As of now there havent been any corporations adding surcharges, but a change in policy may make credit cards less desirable to the consumer. Merchants are also concerned about the cost of accepting new payment systems and payment devices. There may be upcoming litigation and regulatory proceedings regarding the cost of NFC expansion. International Developments: Growth in Asia/Pacific and Latin America has led revenue growth for the credit card companies. Visa and MasterCard both plan to launch massive advertising campaigns in Brazil during the World Cup. MasterCard has also expanded Priceless saCities in Latin America, a campaign targeting wealthy individuals. International markets are very important for MasterCard seeing as 61% of its revenues come from outside the United States. Currently in Venezuela, corporations are not allowed to take money out of the country. With the death of Hugo Chavez this law may change and it will be interesting to see how that affects investments and spending coming in and out of the nation.

Micro-Oriented Industry Analysis

Buyers Bargaining Power- High A significant portion (24%) of MasterCards revenue comes from the companys five largest customers. Currently MasterCard has had to greatly increase its contra-revenue expense in the form of incentives and deductions in order to secure new business and maintain old relationships. In addition, MasterCard has undergone several pricing changes in the past few years in order to maintain its competitiveness against Visa and MasterCard. Suppliers Bargaining Power- Low MasterCard has its own networks in nearly all countries with Mexico and China being the exceptions. For the most part, they do not really have suppliers. Threat of New Competition- Medium-Low The two most significant products MasterCard can offer are its global acceptance and its brand. It is very difficult for a new competitor to enter the space. PayPal is currently trying to enter the in-person payments processing space. Square and other Smartphone based electronic payment services are also trying to enter the payments space. For MasterCard, Square represents both a threat and an opportunity seeing that MasterCard also collects interchange fees from Square transactions when using MasterCard branded cards. Threat of Substitutes- High For cardholders, there is very little differentiation between credit cards and most people use credit cards interchangeably. Rivalry among existing competitors- High The payments space is very small and while MasterCards biggest competitor is cash sales, in markets like the United States they are constantly battling Visa and American Express for market share. There is also a lot of competition for talent among the companies and it is common to see many employees jump from one firm to another.

Economic Moat MasterCard can currently process transactions faster than any other network (1.7 times faster than Visa) and is currently the only payments solutions company that provides triple-layer protection over credit card transactions. In addition, MasterCard has great brand reputation as a result of their Priceless campaigns.

Future Opportunities & Growth

Opportunities MasterCard is positioned as a global leader in NFC mobile payments. According to Frost & Sullivan they expect 53% of phones to be NFC enabled by 2015. Juniper expects NFC transactions to reach $74B by 2015. MasterCard has new innovative technology on the way that may shake up the way payments are transacted. The prepaid debit card market has proven successful in Latin America and may do well in other markets. Wanda and other mobile prepaid technologies can be expanded into to other markets CEO Ajay Banga has been named one of the top CEOs by Fortune and has turned the company around since joining in 2010.

Growth Currently 85% of the worlds transactions are cash. MasterCard has started what they call a War on Cash and expects significant growth just by convincing more consumers to switch to credit card transactions. As emerging markets develop, the underserved banking population may begin switching over to credit cards. During their investors conference call both the Chief Financial Officer, Martina Hund-Mejean, and the Head of International Markets, Ann Cairns, mentioned their desire to build the company through acquisitions of smaller firms whose technology they can integrate with theirs

Business Risk
Company Firm Specific Risk MasterCard Rising ContraRevenue will be a concern for the firms profitability in the long-run Large FX risk since most of the revenue is made outside the U.S. Merchants slow to adapt to new technology Top five customers account for 24% of revenue Tax changes on bringing in foreign income Visa Funds set aside for settlements may not adequately cover cost Current pending lawsuits would lead to substantial damages Agreement with Visa Europe forces Visa to pay for all legal claims outside of Europe Failure to maintain interoperability between Visa & Visa Europe American Express Adverse capital and credit conditions may affect liquidity Reduction in credit rating could affect cost of funding Exposed to significant government regulation and supervision Cardholders must pay credit card balance in order to recognize revenue

Industry Risk

Interchange fees and acceptance practice are under intense regulatory scrutiny worldwide Information breach or anything affecting the transaction network Increased competitive pressure has lowered prices Little differentiation between the firms in the industry Consumer spending growth has slowed Recent settlements allow merchants to add a surcharge to credit card purchases

Competitive Summary
Visa is in a very strong position as they have the largest market share in the most profitable market (U.S.). MasterCard however is uniquely positioned in the global landscape and should see plenty of opportunities in emerging payments. While MasterCard does compete against Visa and American Express their greatest growth will come from the decreased use of cash as consumers worldwide begin to adopt credit cards as a preferred payment system.

Quality of Earnings & Corporate Governance

Quality (Comparability) of Earnings Revenue Recognition Depreciation vs. Capex EBITDA Growth Rate YoY EBITDA Growth: Smooth or Volatile Capitalized Expenses? Deferred Tax Liabilities Operating Leases: describe Restructuring Charges Target AGR, OBJ, CON Dep. < or > or Capex 5 Year CAGR % Assets % Assets, both accts. % of Revenue % of Revenue MA OBJ < Capex 28% Smooth 1% -1% 0% N/A V OBJ <Capex 38% Smooth 1% 5% 1% N/A AXP OBJ <Capex -4% Volatile 1% -2% 0% N/A

All of the firms have similar methods of revenue recognition where they recognize revenue only when the service is delivered, the price is fixed, and collection is reasonably certain. All firms are growing Capex faster than depreciation American Express has seen volatile earnings. They operate as an issuing bank so they were faced with much more regulation than MA or V. Visa was the only firm with a tax liability instead of a tax benefit. Operating leases to rent out office space were used by all three firms but they werent significant expenditures.
MA 0% N/A 5% 0% 9% N/A 5% 16% V N/A N/A 13% 0% 33% N/A 32% 4% AXP N/A N/A 11% 0% 2% N/A 0% 15%

Other Financial Characteristics that Can Impact Value Minority Interest Asset: identify and compare market to book Minority Interest Claim: identify and describe claim Unfunded Pension Liability: Employee Options: in or close to the money claims Goodwill Goodwill writedown: describe Other Intangible Assets: Describe Cash & Near Cash items

% of Assets % of shares % of Assets % of Assets % of Assets

Unfunded pension liabilities make up a significant expense on V and AXP book. Goodwill are a significant portion of V assets. Intangible assets are a significant portion of V assets. Intangible assets include trademarks, patents, and customer relations. MA has a significant amount of cash.
MA 51.79 Exc, Ab Avg, Avg, Fair, Poor fair exc abv av exc N N V 51.79 poor abv av abv av exc N N AXP 51.79 abv av abv av abv av exc N N

CGQ CGQ Components: Scaled in Favor of Shareholders 1) Compensation 2) Board Characteristics 3) Audit Characteristics 4) Takeover Defenses Earnings Restatements? Switch Auditor?

Y or N Y or N

All three firms had the exact same CGQ score. MA has Ajay Banga who has been recognized as one of the top CEOs. All three firms have great auditing practices and are large enough to avoid being takeover targets.

Target or Acquirer
MasterCard has increased its number of acquisitions in the past few years including a major acquisition of Data Cash for $488.45 million back in 2010. In the past year they have acquired six different companies including purchasing a larger stake of iZettle AB, a smartphone payments processor.

Sources & Uses of Cash

Source MasterCard generates the majority of its revenue from processing payment transactions. It has a wide variety of billing events that it can charge both issuers and acquirers that are all related to how the transaction was processed. In addition, MasterCard has its own consulting practice called MasterCard advisors that helps customers find creative solutions to their payments processing problems. Uses In order to gain new business MasterCard must provide incentives for banks to issue cards with the MasterCard brand. They often provide kickbacks and other incentives to banks that can effectively spread the use of their credit cards. MasterCard also offers incentives for merchants who join their MasterCard network and make investments in new payment devices.
Firms MA V EBITDA/REV 57% OCF/EBITDA 70% FCF/EBITDA 68% AXP 63% 13% 7% 37% 95% 86%

American Express numbers may not be comparable because they also have a banking practice. MasterCard has a much larger cash position than Visa on a relative basis.

SWOT

Valuation
Direct Equity Valuation After sorting through the data there were six other companies with similar business operations to MasterCard Worldwide.
Name Discover Financial Services Fidelity National Information Services Alliance Data Systems American Express Fleetcor Technologies Visa MasterCard Worldwide MCAP$ 22.03B 11.32B 7.81B 72.26B 5.88B 104.29B 63.11B Tdebt$ $20013M $4558M $2891M $62287M $647M $M $M Debt/Mcap 97% 45% 40% 98% 15% 0% 0% Ent Val$ $38920M $15513M $9788M $112944M $6025M $99115M $58680M Current Rev$ $8984M $5841M $3641M $33808M $708M $10720M $7391M Hist Growth in Rev (Home Curr) 4% 3% 15% 5% 36% 13% 10% Est. Rgrowth 2013 (Home Curr) GP% EBITDA% N/A 30% -8% 32% 31% 4% 42% 31% 17% N/A 57% -6% N/A 53% 15% N/A 34% 8% N/A 31% 12% Est. Rgrowth 2014 (Home Curr) 4% 5% 8% 10% 11% 12% 12%

Sorting the companies through estimated 2013 and 2015 revenue growth rate had the highest correlation between the companies. In addition, Price-to-Earnings and Price-To-Book stood out as the most reliable metrics.
P/E P/B P/OCF P/FCF 2013 0.987462 0.714016 0.537192 0.419725 P/E P/B P/OCF P/FCF 2014 0.643346 0.849364 0.673575 0.601883 P/E P/B P/OCF P/FCF EBITDA% 0.127189 0.19026 -0.11893 -0.21299

Using regression analysis, MasterCards data was plugged into the equation in order to come up with the P/E and P/B multiples.

Credit Card Industry P/E

35.00 30.00 25.00 P / E 20.00 15.00 10.00 5.00 0.00 -10% -5% 0% 5% 10%

y = 60.878x + 17.363

15%

20%

Rev. Grth 2013 Est.

The regression trend line shows that MasterCard should trade around a P/E multiple of 25x and a P/B multiple of 8x. From the charts it is clear that P/E is far more correlated than P/B so we assigned a weight of 95% to the P/E multiple and a weight of 5% to the P/B multiple.
Stock Price 2013 Low Range 390 $ 87 610 $ 52
Stock Price 2014 Low Range 511 $ 113 696 $ 109

Metric P/B P/E

$ $

High $ 476 $ 662

Metric P/B P/E

$ $

$ $

High 624 804

Using analysts estimates of 2013 and 2014 earnings per share and book value per share the multiples were used to create a range of possible values for MasterCard. After assigning the weights the resulting range was $599-$652 for 2013 and $686-$795 for 2014. Indirect Valuation Using the same correlation matrix as before, EV/EBITDA was more correlated with estimated 2013 revenue growth than EV/S. As a result the weights were 80% and 20% respectively.
EV/EBITD EV/S A 2013 0.672648 0.91058 2014 0.640219 0.859581 EBITDA% 0.082419 0.238132

Using the same regression analysis the resulting multiples for MasterCard was an EV/S multiple of 6x and an EV/EBITDA multiple of 15x.

Using a constant cash and diluted shares figure the same high-low range was created for 2013 and 2014.

Metric EV/S EV/EBITDA

$ $

Stock Price 2013 Low Range 427 $ 14 602 $ 33

High $ 441 $ 635

Metric EV/S EV/EBITDA

$ $

Stock Price 2014 Low Range 463 $ 34 661 $ 73

$ $

High 498 734

Using analysts estimates of 2013 and 2014 Sales and EBITDA the multiples were used to create a range of possible values for MasterCard. After assigning the weights the resulting range was $560-$580 for 2013 and $620-$680 for 2014.

Discounted Cash Flow

MA Inputs Revenue EBITDA EBITDA Margin Depreciation and Amortization Other Non Cash Adjustments Changes in Non-Cash NET Working Capital (Pluses are Sources, Minuses are Uses) Includes Short Term Debt Capex Less Disposals Net Capex 2007 4067.6 1229.15 30% 97.64 2% -332.43 -8% -81.24 -2% -81.59 0 -81.59 -2% 2008 4991.6 23% 2060.35 41% 112.01 2% -310.54 -6% 865.67 17% -75.63 0 -75.63 -2% 2009 5098.68 2% 2408.23 47% 141.38 3% 408 8% -633.74 -12% -56.56 0 -56.56 -1% 2010 5539 9% 2905 52% 148 3% 148 3% -445 -8% -61 0 -61 -1% 2011 6714 21% 3677 55% 194 3% 699 10% -115 -2% -77 0 -77 -1% 2012 5 Yr. 7931 CAGR 18% 14% 4187 Average 53% 46% 230 3% 279 4% -320 -4% -96 0 -96 -1%

655.64 9.00% 9.50% 10.00% 10.50% 11.00%

$ $ $ $ $

6.50% 1,009 843 725 637 568

$ $ $ $ $

Equity Value 6.25% 933 $ 792 $ 688 $ 609 $ 546 $

6.00% 870 747 656 584 527

$ $ $ $ $

5.75% 816 709 627 562 510

$ $ $ $ $

5.50% 770 675 602 543 494

Based off the DCF Model, MasterCards share price should be $656 in 2013 with a possible range between $562- $688.

WACC Estimate

Based on the previous information I decided to use Bloombergs estimate for WACC because it was a more conservative number than either plain-vanilla CAPM or the Fama-French Model.

Common Inputs
Risk-free rate Equity-Risk Premium Beta Tax Rate Cost of Debt Kd 3.70% 5.78% 1.001 32%

Notes
Based on Bloomberg's rates on 10-year US Treasuries Based on Aswatch Damodoran's calculated risk premium Based on Bloomberg's Raw Beta estimate Based on Value Line's Income Tax Rate

0.00% MasterCard does not have debt outstanding

Cost of Equity
I. Capital Asset Pricing Model Inputs Risk-free rate Equity-risk Premium Beta CAPM Ke II. Fama-French Model Inputs Equity Risk Premium SMB Premium HML Premium FF Ke

3.70% 5.78% 1.00 9.49%

5.78% SEE MA PRICE TAB FOR CALCULATIONS 1.90% 1.90% 7.55%

Wacc Calculation
Tax Rate Kd Ke Debt Equity Shares Outstanding Current Price Total Weights % Debt %Equity WACC 32% 0.00% 9.49% 0 65970 124 532.02 65970 Used the highest number.

From Value Line. In Billions Bloomberg as of 4/24/2013 In Billions

0% 100% Bloomberg uses an ERP of 8.43%, using a WACC of 10.1% 9.49% a more conservative number

Results Using both the direct and indirect equity valuation method as well as using a discounted cash flow model the 2013 valuation range is $580-$630 and the 2014 valuation range is $650-745.

2013

2014

Conclusion
The findings from the DCF are in agreement with the findings from the trading comps valuation. MasterCard appears to be in a unique position to achieve double-digit gains. For this reason I believe MasterCard is a buy.

Reconciliation While the 2013 range of $600-$660 would represent double-digit gains from its current market price of ~$510 there is significant concern about upcoming litigation and upcoming regulatory action. While many analysts believe that the worst legal troubles are behind MasterCard it has taken awhile for the stock to catch up. MasterCard is uniquely positioned in emerging markets and is considered a leader in the technological advancements of the payments space. If MasterCard is able to avoid further regulatory scrutiny then the companys stock is positioned for great capital gains.

Appendix DCF Spread Sheet

MasterCard WorldWide
Operating Assumptions Current Sales
Sales Growth

Current Share Price 2013 $ 7,931 $ 4,187 509 3,678 1,174

$540 2014 9,041 $ 14% 4,701 52% 452 5% 4,249 47% 1,445 34% 2015

DCF Share Price 2016

$655.64
2017 12,701 $ 11% 6,224 49% 635 5% 5,589 44% 1,900 34% 2018 13,972 10% 6,706 48% 699 5% 6,008 43% 2,043 34%

EBITDA
EBITDA Margin

D&A Plus other non-cash adjustments

As a % of Sales

EBIT
EBIT Margin

Taxes
tax rate

10,217 $ 13% 5,211 51% 511 5% 4,700 46% 1,598 34%

11,443 $ 12% 5,721 50% 572 5% 5,149 45% 1,751 34%

Firm's Free Cash Flow EBIAT Non-Cash Adjustments Less Capex Capes as a % of Sales Changes in NWC Changes as a % of Sales Unlevered Free Cash Flow Discounting of Annual Cash Flow Discount Period (Mid-Year Convention) WACC (Bloomberg) PVLS Factor Present Value of Free Cash Flow to the Firm Continuing Value: H-Model Exit Year FCF Short-Term Growth Rate Transition Years Long-Term normal Going Concern Value Discount Factor Enterprise Value: Present Value of Free Cash Flow Present Value of Going Concern % of Enterprise Value Enterprise Value

$2,504 509 (1,788) 187 $1,412

$2,805 452 (90) -1% (362) -4% $2,805

$3,102 511 (102) -1% (409) -4% $3,102

$3,398 572 (114) -1% (458) -4% $3,398

$3,688 635 (127) -1% (508) -4% $3,688

$3,965 699 (140) -1% (559) -4% $3,965

1 10% 0.95 2,674 $

2 10% 0.87 2,689 $

3 10% 0.79 2,678 $

4 10% 0.72 2,642 $

5 10% 0.65 2,582

$3,965 0 5 0.06 108,545 0.62

$ $

$13,265 67,398 84% 80,663

Adjustments LT Liabilities 0 Preferred Stock 0 Minority Interest (12) Unfunded Pension Liabilities (92) Executive Options 0 Legal Claims 0 Cash 2052 Long Term Non-Operating Assets 0 Hidden Assets 0 Implied Equity Value $ 82,611 Diluted Shares Outstanding 126 Implied Share Price $ 655.64