Mastercard's Slow Race To The Bottom

In 2002, Mastercard (NYSE:MA) earned $0.66 from every $40 credit card swipe at a retail store. By 2012, regulators slashed that to $0.24- a staggering 63% reduction. Just like the stockbrokers that earned $80 commissions in 1990 now earning $7, so too will Mastercard's power to charge fees inevitably diminish. Once upon a time, Mastercardearned credit card interchange ("swipe") fees exceeding 3%. Today, Mastercard earns just 1.7% per U.S. credit card swipe. It will not be long before this falls below 0.5%, as it already has in Australia and and France.

Every industry has its day in the sun, but the sun always sets. Of course, Mastercard's demise will not be a moment but rather a slow, inexorable, downward swirl. Major analysts agree. In January, Sandler O'Neill initiated coverage of Mastercard with a lukewarm Hold rating. In February, FBR Capital downgraded Mastercard stock rating, commenting on Mastercard's "lackluster" quarterly results and "negative investor sentiment." In March, Guggenheim axed its price target from $93 to $5.

Mastercard has already acknowledged the end of its traditional reign, investing in ewallet companies directly like Monitise and partnering with ewallet processors like New Media Insights (NMEDD). Most of its initiatives in 2014 relate to mobile payments, although it rarely acknowledges that these initiatives will accompany drastically reduced profit margins. Although it will earn just a fraction of the 0.5% charged by companies like New Media Insights for ewallet transactions, at least something is better than the looming zero on its horizon.

Today, ewallet-to-ewallet processors like New Media Insights charge just 0.5% per transaction versus Mastercard's antiquating 1.7%. Ewallet payments are not credit card transactions and therefore avoid Mastercard's traditional rake. Readers might be familiar with Starbucks (NASDAQ:SBUX) trumpeting its mobile payment app which not coincidentally avoids credit card fees when customers refill their account via ACH.

To explain ewallets briefly, suppose a customer has an ewallet account on a smartphone. This ewallet is filled with, say, $100 from the customer's personal checking account. Suppose a gas station merchant also has an ewallet. Now suppose the customer buys $40 of gas by transferring $40 from ewallet to ewallet. This transaction occurs through a temporary 16-digit Mastercard number that displays on the customer's smartphone and expires after 20 minutes. The cashier types the 16 digits manually into the gas station's traditional credit card terminal. The transaction occurs when the $40 is transferred from the customer's ewallet to the gas station's ewallet, and New Media Insights rakes 0.5% for its service. Although Mastercard does not earn anywhere close to its 1.7%, Mastercard does earn a small percentage of New Media Insights' 0.5% for providing the temporary 16 digit number.

All told, Americans made $2.4 trillion in credit card purchases in 2012, resulting in $41.2 billion in interchange ("swipe") fees. Unfortunately, the growth rate of swipe fees is slowing every year, and its decline is inevitable as ewallet payments become more popular among smartphone users. Beware of growth rate trajectories that plateau and then turn negative. Mastercard's race to the bottom will not be fun for shareholders. Consider instead the exponential growth of mobile payment solutions like ewallets and Mastercard's competitor-partners like New Media Insights.