Tag Archives: sustainable competitive advantage

VISA Q1 2017 Earnings, harvesting market growth, ploughing and sowing for the future

2-4-2017.  VISA Q1 2017 (2-2-2017) earnings call was led by Alfred Kelly Jr., who became CEO, replacing Charlie Scharf on 12-1-2016.  Al Kelly graduated from Catholic, Christian Brothers affiliated Iona College, in Westchester, NY, with undergraduate and MBA degrees. He worked in the Reagan White House as manager of information systems (using DOS, or Windows 2.0?) from 1985 to 1987, then held a range of important roles at American Express for the next 23 years.  He has been on the VISA Board of Directors since 2014 and therefore played a role in approving the current strategy. 

In the earnings call, Kelly noted that VISA strategy will remain as is, in a seamless transition with the previous CEO. He noted VISA has a talented leadership team; strong relationships with issuers clients, acquirer clients and merchant clients. It is important to learn about and address their business needs while reducing friction in and enabling digital payments. VISA is in an industry with strong growth. In developing markets, middle classes and governments are demanding payment digitization. In developed markets, ecommerce and mobile payments are displacing checks and cash. VISA is a leader in payments technology and constantly supports innovation in ecommerce and novel forms of payment digitization.

I will address the overall strategy of VISA, which describes how VISA fills a key criterion of an Eternal Company investment: the ability to extend its competitive advance into evolving new markets, in a separate post.

Following is a summary of Q1 2017 financial results.  Rev and EPS exceeded expectations as accelerating business more than offset exchange rate shifts.  GAAP Q1 rev up 25%, EPS 7%. Adjusting for the non cash gain in Q1 2016 from writing off the VISA Europe put, adjusted EPS up 23%.  Payment volume growth increased 1-2 % in most geo regions. Cross border payment growth accelerated 2% from 10-12% globally excluding VISA Europe. Including VISA Europe impact, they accelerated 10%.  Process transaction growth accelerated 15 from 12-13% driven by India and US.

Did not issue 2$ Billion in debt as panned to finance VISA Europe acquisition as well as other costs. VISA has 8$ Billion offshore, will await Trump plan for corporate tax reform which may well allow cash efficient cash repatriation. Until then, used commercial paper issuance to fund stock buyback and operating cash needs.

The only region with reduction in growth was Latin America, due to Brazil. 

The integration of VISA Europe is proceeding and will continue throughout 2017. Europe represents meaningful growth opportunities, with large opportunities to displace cash.  Plan to advance digital payments by rolling out tokenization, VISA Checkout, and supporting digital wallets.   VISA continued to focus on local market priorities alongside client engagement. The vast majority of VISA payments volume in Europe remain under contract and is therefore protected in the short term.

The deliberate process of consultation of VISA Europe staff was completed later than expected. New hiring, investment to integrate technology with that of the international VISA system are adding expenses as planned.   As cost reductions are realized and Europe clients access global VISA capabilities,  earnings will accrete and value will be realized for shareholders, as planned since the takeover was announced.  Equity dilution related to the purchase is being offset by accelerated share buybacks. 

In India, Aggressive demonetization measures pushed by the government resulted in doubled transaction volumes but little revenue growth. Responsive to request by the Indian Government, VISA charged no fees for processing through 12-31-2016.  VISA regards this as an opportunity to expand the network and acceptance internationally, focusing on building customer awareness and merchant acceptance 

Kelly articulated “So.. when you consider the economics of the investment we will make in India, plus conservative pricing, it will not drive much profit this year. But this is a great year to make sure we do everything we can in one of the two largest population countries in the world to get as good a position as we can to help us over the next decade. “

I would like to make two observations on this lovely sentence.

1. It prioritizes strengthening the company competitive advance for the long term over short  term profits

2. the nature of the VISA business supports long term investments such as the one mentioned because of its competitive advantage.  The VISA services introduced into the developing India market will still be indispensable in 10 y.  As long as VISA continues to support successful innovations in payments, while nurturing and strengthening its network security and reach, it will undoubtedly maintain its relevance and dominance in the market. 

 

 

 

Essential Criteria of an Amateur Investor investment.

edited 4-4-2016
1.  Sustainable Competitive advantage defending or growing market share in its specific market.  This is the sine qua non of our investment choices and the foundation of our approach to investment.  The company with a competitive advantage is rare.  It is marked by the ability to increasingly attain returns on investment above its cost of capital, and above those of its competitors.  A competitive advantage might be made durable by low cost/high volume leadership among competitors; barrier to market entry of competitors; product differentiation/switching costs to customers.  The company with a sustainable competitive advantage sells an indispensable product.

2. No competitive advantage truly lasts for ever. Hence, a related critical facet of the competitive advantage feature is that management consistently anticipates or reacts to changes in the market or competitive landscape by finding profitable ways of extending the company’s competitive advantage into new markets that are tangibly related to its current markets. That is, the company adapts and evolves to perpetuate its competitive advantage by extending it into the evolving new markets.

3.  Evidence of devotion to shareholders by its capital allocation, manifested in the following ways
stock buybacks to reduce share count
avoiding excessive dilutive stock compensation
obtaining good returns on investments in acquisitions
aligning reward and performance of management and employees to reward shareholders and long term company performance
allowing shareholders to have voting power commensurate with their stock ownership.

4  Common stock of publically traded company based in U.S. or other relatively transparent legal environment with respect for property rights, at least 10 years old.

5. The investment worthy activities of the business are demonstrated in the record of its past and present achievements, not in the hoped for future.

6.  quantitative evidence of ability to obtain returns on investment above cost of capital, such as low debt level, growing free cash flow, high free cash/revenue, high gross margin, high ROE and ROI.

Microsoft: leveraging and extending its competitive advantage into the future

My approach to investing in individual companies starts with identifying the rare companies with a sustainable competitive advantage.  While the existence of a durable competitive advantage is manifested in quantifiable features of the financial statement, the ultimate judgment of whether the current competitive advantage will last for the foreseeable future is qualitative, relying on an understanding of the nature, competitive environment and history of the business.

To adapt to an ever changing future, vigilant companies make trial investments in new related markets. The longest lasting companies are those who finally invest only in those areas in which they can maintain a competitive advantage, and hence continue to earn better than average returns on investment for the foreseeable future.   Many companies watch their once impregnable advantage decline as events shape history’s final judgment.  For example, Kodak was dominant in photographic film and in the 1970s had a 90% market share.  It then participated in the invention of digital photography and had the opportunity to integrate its own digital photo technology into PCs in the 1980s.  But Kodak did not pro-actively build a new basis for market dominance in the new markets.  Competitors caught up and passed, Kodak faded and finally filed for Chapter 11 Bankruptcy in 2012. It turns out that rare companies do the work to create bridges to future franchises, using their current market dominance to shape and outcompete in new markets.  Microsoft (MSFT) is such a company.

For the past 10 or 12 years, Microsoft has frankly been unloved by the fashionable tech media, and increasingly by the professional investing crowd.  Under this surface air of decayed greatness is an irrepressible, tenacious organism that adapts by thrusting into new territories, taking root only in areas in which it may extend its competitive advantage, and then proceeding to compete as if its life depended on it.

Recently, MSFT has put in motion a few approaches to increase its competitiveness, and these are now beginning to bear fruit.  These include low balling the price of its Windows OS;  developing its applications for cross platform markets;  partnering with 3rd party software/platform providers that may be competitors; and transitioning its market dominance to the cloud.

MSFT has used these strategies before. For example, in the early 1980’s Multiplan, the predecessor of Excel, was coded for a software emulator that would be interpreted for different OEM PCs. Thus it was sold to more than a hundred different OEMs selling to businesses, in an ultimately successful end run around Visicalc, which had locked up the retail market.  When MS-DOS was released in 1981, it was virtually given away to OEMs building IBM PC clones for a flat fee.  Clearly, MSFT viewed this as a race to sell applications (also including the programming languages that comprised its main business) as opposed to the OS.

For a vivid account of early Microsoft history and the tale of how a couple of intelligent, determined youngsters, who thought out of the box and had the courage to act on their convictions, created what would become one of the most formidable companies in history, read the splendid Hard Drive: Bill Gates and the Making of the Microsoft Empire
by James Wallace and Jim Erickson.

As announced in April at Build 2014 conference, Windows is now free to OEMs for smartphones and devices of screen size 9 inches or less, and windows now has lower processor and storage requirements. While Windows still has roughly 90% market share in PCs, the overall variegated market of computing devices has vastly increased in the last 10 years, so that Windows has less than 20% market share of that wider universe.  There are large markets for MSFT software.

OEMs have responded vigorously to this overture. For example, more than 11 (up from 3) signed up for Windows phone in the first quarter of this year.  It is important to note that since android OEMS must still pay license fees to MSFT, a $0 Windows Phone license costs them less than Android.

A lower cost Windows opens up markets on devices, as in the past, to Microsoft apps. These include both consumer oriented apps such as Xbox music, video and games, productivity apps including office 365, and services to manage devices for businesses. Over 2 years ago MSFT began writing a version of Office for iOS. When finally released in late March, it was  downloaded almost 30 million times in less than two months.  CEO Satya Nadella has articulated the vision of “Cloud First, Mobile First”, and that Microsoft will focus on “platforms and services”.  From the vantage point of BYOD, this means that businesses will use MSFT productivity applications on popular devices, on the respective different platforms, and manage mobile devices with MSFT Cloud based subscription services such as Microsoft Intune.

A third way MSFT is increasing competitiveness is by partnering with competing software service and platform providers. For the past 2 years, because there is demand for services from other providers in the public cloud, Windows Azure has increasingly accommodated services on 3rd party platforms running on Linux or from other providers such as Salesforce, SAP, Oracle and many, many others. This has produced a hockey stick upshift in Azure revenue growth.  See here for more on how Microsoft is levering its market dominance in productivity applications and services to gain market share in the Cloud, from which it wields the Cloud First, Mobile First strategy.