Cash is history. How to profit from the digital-payment future.

  • By Daren Fonda,
  • Barron's
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Sometime back in March, the Federal Reserve began quarantining cash bills arriving from Asia. The move was meant to protect Americans from the coronavirus, but it wasn’t entirely necessary. Cash usage was already at an all-time low. Covid-19 has just hastened the decline, with Americans at first stuck at home and now still wary of the close proximity required for the physical exchange of bills. The volume of ATM cash withdrawals tumbled at least 12% in the second quarter, according to Wall Street research firm MoffettNathanson.

Digital payments have ably filled in, and those cash withdrawals are unlikely to return. In fact, the rise of digital payments is one of the few Covid-19 trends all but guaranteed to last long after a vaccine. And that creates significant opportunities for a host of tech-focused payment companies.

“Because of Covid, consumers don’t want to touch anything, and it’s creating a virtuous cycle for us,” says Mastercard president and incoming CEO Michael Miebach.

It’s not just that the physical economy is getting nudged online. Consumer and business behavior is shifting, perhaps permanently. Millennials who loathed cash before the pandemic are now even more likely to “Venmo” one another cash for last night’s pizza and beer. Millions of seniors, stuck at home, are going cashless for the first time. Retail stores and restaurants are developing online sales channels, while governments worldwide are shifting to cards for disbursements to consumers and businesses. Outside the U.S., India’s transition to a cashless society is accelerating, while Sweden is closer to becoming the world’s first cashless country. One of the hottest start-ups in Silicon Valley these days is Stripe, a payments technology company valued at $36 billion.

None of these trends have been lost on Wall Street. Digital payment stocks like PayPal Holdings (PYPL) and Square (SQ) have been some of the best performers in 2020, pushing their valuations to extremes. The elevated prices could pressure the stocks in the near term, keeping further gains muted. But for long-term investors, there’s still time to jump in.

“The stocks may breathe a bit from here, but we’re still likely underestimating the amount of e-commerce and digital banking shifts that will happen,” says Lisa Ellis, who covers payments for MoffettNathanson.

Cash represented 26% of all U.S. consumer payments in 2019, according to the Federal Reserve’s latest Diary of Consumer Payment Choice. That’s down from 31% in 2016.

The Fed updated the study this May, noting that consumers were holding on to more cash as a result of the pandemic, but few of them were spending it. Some two-thirds of respondents said that they had made no in-person payments from March 10 through early May, meaning cash isn’t changing hands.

As cash’s share of payments continues to fall, PayPal looks unstoppable. The stock, at a recent $176, fetches a steep 39 times 2021 earnings. But growth estimates are rising, and analysts keep hiking their price targets. Positive earnings revisions are more likely than negative ones, says Ellis, who expects the stock to gain 25% over the next year to $220 a share. Square is also capitalizing on digital payment trends, but its valuation poses an even higher hurdle. Following a 133% gain this year, the stock trades at 121 times estimated 2021 earnings.

The giant card networks, Visa (V) and Mastercard (MA), may have more upside over the next few months; their stocks are up less than 15% this year, well below their average annual gains of 25% to 30%. The card networks are seeing lower transaction volume due to the pandemic. Earnings estimates have fallen, pushing up near-term multiples. But the card networks are getting a boost from the decline of cash, and, as the connective tissue of the payments system, their networks are gaining in value. Both Visa and Mastercard are also expanding into high-growth areas such as peer-to-peer, or P2P; business-to-business, or B2B; business-to-consumer, or B2C; and cross-border remittances.

“Higher consumer demand is resulting in more merchants offering electronic payments, and with more transactions, there’s more demand for data analytics and cybersecurity,” says Mastercard’s Miebach.

Meanwhile, there are behind-the-scenes payment processors that get less attention but remain just as vital to the future of payments. Fidelity National Information Services (FIS) and Global Payments (GPN) both made major acquisitions last year: Fidelity National bought Worldpay, and Global Payments merged with Total System Services—adding scale, global reach, and diversified product lines. Both firms now handle payment processing for card issuers while also connecting traditional and online retailers to card networks and banks, a business known as merchant acquiring.

Both Fidelity National and Global Payments trade around 27 times 2020 earnings—far below multiples for pure-play e-commerce stocks like PayPal or Square, and at least a 33% discount to Visa and Mastercard.

Dave Ellison, a manager of the Hennessy Large Cap Financial fund, has shifted his portfolio away from traditional financial-services stocks into the payments and financial-technology, or fintech, space.

“These companies are positioned to continue to grow and take share in an industry where the alternatives are becoming less attractive,” he says.

Ellison, a longtime investor in bank stocks, says that he has soured on financial-services models that rely on deposits and lending. “I like the companies that are moving money around, rather than buying and selling money,” Ellison says. “Big Tech will continue to poke at payments. They all have the ability to write the code and do the algorithms. If you’re a small or midsize bank, you have no chance.”

While fintech valuations are rich, the multiples reflect the scarcity value of high-growth businesses in a low-growth climate. “ Amazon.com has been expensive for 23 years, and it has worked out,” Ellison says.

Another growth driver: the “silver tech” generation of older Americans going cashless for the first time, as Covid-19 changes habits. PayPal says that this demographic is now its fastest-growing user base—with considerably larger transaction sizes and purchasing power than those of younger generations. “There has been a massive adoption of e-commerce and mobile payments, and it has come with tremendous growth of new users,” says Deutsche Bank analyst Bryan Keane, who has a Buy rating on PayPal and a $234 target.

Barron’s recommended Mastercard, Visa, and PayPal in a May 2019 cover story. All three have outperformed the S&P 500 index.

The trends we identified have only accelerated. With more people working from home, more purchases are being made online. Where physical transactions are happening, they increasingly rely on contactless methods, including credit and debit cards with wireless chips built in.

The convenience of those methods is one more incentive for consumers to drop cash. The shift to contactless cards increases the number of transactions per card by 20% to 30%, according to a J.P. Morgan report. Meanwhile, grocery stores, restaurants, and other businesses trying to retain customers amid social distancing are taking orders online and offering curbside pickup, where cash simply doesn’t work. E-commerce sales from businesses to consumers should grow 10% over the next year, the bank says. There is plenty of room for growth, since U.S. online shopping is still only 8.9% of total retail sales (versus 23% in China).

Indeed, one of the hottest e-commerce stocks this year is Shopify (SHOP), a platform for small businesses to create online storefronts, track sales, and provide fulfillment services. Shopify, which charges monthly fees, is riding the e-commerce surge, having doubled revenue in its most recent quarter to $714 million. However, at 394 times next year’s estimated earnings, the stock’s multiple is unforgiving, and its $105 billion market cap makes it larger than e-commerce firms eBay (EBAY), Etsy (ETSY), and Wayfair (W) combined.

Investors can use payments stocks to play the same trends underlying Shopify’s success. And Covid-19 has actually created a buying opportunity, relative to the rest of tech, at least.

Even as the scales tilt to e-commerce, weakness in consumer spending at physical locations is pressuring transaction volumes on card networks. Both Visa and Mastercard are expected to report revenue declines this year, their first annual declines as public companies.

Payment processors are also under pressure because of weakness in bricks-and-mortar retail. While payments volume is taking a breather this year, it should reaccelerate in 2021. And the addressable market is enormous: Digital payments worldwide totaled $15.7 trillion in 2019 out of $33.2 trillion in total consumer sales.

In the U.S., digital payments accounted for 68% of all retail purchases, rising steadily for years. Tack on business transactions, peer-to-peer exchanges, and other types of payments, and the market grows further.

Gary Norcross, CEO of Fidelity National, says that a structural shift to electronic payments has been nudged ahead a few years by the pandemic. “We’ve seen a significant decline in the use of cash,” he says.

The digital pure play

PayPal is the clearest winner in the digital shift. The company added a record 21.3 million accounts in the second quarter, up 137% over the prior year, and ended the quarter with 346 million active accounts. “The world has accelerated from physical to digital across multiple industries,” CEO Daniel Schulman said recently. “Merchants are embracing a digital-first strategy, and these...are durable and meaningful tailwinds.”

PayPal, a pioneering online payment service that grew up with the rise of eBay, has expanded into cross-border money transfers with Xoom; it has taken a leading role in peer-to-peer with Venmo, exceeding 60 million accounts; and it’s signing up more online merchants via its Checkout button, which has a 79% share of the top 500 online retailers. Amazon Pay is No. 2 at 14%.

Wall Street expects PayPal’s earnings and revenue to both rise 20% this year, with sales hitting $21.3 billion. Analysts expect similar growth in 2021. The stock is up 68% in the past 12 months to a recent $181.

“The sustainability of their extraordinary growth is the key controversy on the stock,” says Ellis at MoffettNathanson. But PayPal remains one of her top picks, partly because PayPal continues to develop new revenue streams. One such area is Hyperwallet, PayPal’s instant-cash platform used by companies like Uber, DoorDash, and Etsy to pay independent contractors or vendors.

Bank of America analyst Jason Kupferberg recently reiterated his Buy rating on PayPal shares, noting that elevated e-commerce trends are persisting, and that the company is capitalizing on the shift to digital payments.

Operating margins are rising, he says, and he remains bullish, given PayPal’s “significant scarcity value and accelerated structural benefits related to the pandemic.” His $235 price target implies a multiple of 38 times estimated 2022 adjusted earnings.

The card networks

Visa and Mastercard are broader plays on the global economy, so their businesses haven’t seen a boost from Covid-19. Visa reported a 70% decline in cross-border travel-related revenue in August, compared with last year, but says it’s now seeing “encouraging signs” where borders have reopened. Analysts expect revenue to fall 5% at Visa and 7% at Mastercard this year.

The slowdowns should be temporary, though. A recovery in the global economy and travel should lift card transaction volumes next year. Ellis estimates that payment transaction volume will grow 14% in 2021, well above its average 10% growth rate from 2012 to 2019.

Visa is also capturing new payment flows in areas like P2P, and expanding services to banks, such as analytics and advanced security. The company should benefit from its acquisition of Plaid, a financial network that links customer bank accounts to apps like Venmo and Robinhood, for stock trading. Ellis is particularly upbeat on Visa Direct, which powers peer-to-peer apps like Square’s Cash App and cross-border money transfers.

Ellis says that Visa Direct is “extraordinarily disruptive” because it’s replacing checks, cash, and wires.

“For most of our history, money flowed one way—from the consumer to merchant,” Visa Vice Chairman and Chief Financial Officer Vasant Prabhu told Barron’s. “Now, we can do merchants paying you, disbursements from businesses or governments to consumers, cross-border remittances, and medical and insurance payments. We’ve seen some extraordinary growth in those areas with Visa Direct, and we think this is a significant opportunity for a very long time.”

Ellis values Visa’s stock—which recently traded at $205—at $250, or 37 times forward earnings, a modest premium to the current multiple of 35. That price/earnings ratio looks steep compared with the broader market, but it’s in line with Visa’s historical premium, supported by the company’s steady profit growth, averaging 19% a year, with operating margins around 70%.

Mastercard should benefit from similar dynamics, along with a strong push into business transactions and other payment flows.

CEO-elect Miebach says Mastercard’s cross-border e-commerce revenue has held steady. Europe is leading the way in a travel-and-entertainment recovery, and he sees modest improvements as travel recovers globally.

“People will want to make up for lost time to see customers and family,” Miebach says. “We believe travel will be a huge driver for us, but it will take some time.” He adds that Mastercard will stay acquisitive in areas like open banking, real-time payments, and cybersecurity. None of these businesses are as profitable as processing card transactions, but “the idea is not only to acquire a capability but also to drive scale and global reach,” he says.

UBS analyst Eric Wasserstrom likes the stock for those drivers, along with Mastercard’s potential to expand margins. The company invested heavily for years in services, diluting margins. But as these businesses scale up, that margin pressure should diminish, he says. It won’t happen overnight, but Mastercard’s 59% operating margins are well below Visa’s. “Mastercard in the near term will grow more quickly with improving margins,” he says.

He has a price target of $367, or 8% above the stock’s recent close.

The payment processors

If there’s a bargain bin in the industry, it’s the payment-processing stocks. Fidelity National, known as FIS, and Global Payments are in a revenue slump due to the retail slowdown, especially among small businesses and restaurants.

Before the pandemic, investors were counting on the stocks getting a lift from merger synergies, a valuation and margin boost from paying down debt, and ongoing acquisitions. The cost synergies appear intact, but the growth story has been put on hold, says Ellis.

But FIS and Global Payments remain a key technology backbone for banks and merchants, generating steady processing revenue, and the merchant-acquiring business should pick up with an eventual revival of retail.

FIS should regain momentum with its Worldpay deal. The $48 billion acquisition vaulted FIS, traditionally a bank-processing company, into merchant-acquiring and e-commerce and gave it a larger international presence. Worldpay processes 40 billion transactions annually in 120 currencies. Payments for Disney +, the new streaming service, now go through FIS. CEO Norcross says the company won the Disney business in part because of Worldpay’s global platform and e-commerce capabilities.

“When you’re launching in multiple regions of the world, complexity plays into how you simplify the experience for the customer,” he says. “This is where FIS differentiates itself.”

FIS is seeing a pullback in transaction volumes among small bricks-and-mortar retailers. But Norcross says that April was the “low-water mark” and that there are bright spots, including grocery, fast-food, and pharmaceutical spending. “As we come out of the pandemic, we’ll see transaction volumes recover to pre-Covid levels and increase well beyond that,” he says.

FIS is also generating growth with banking services; it’s shifting to a cloud-based platform to help small and midsize banks compete against larger rivals and digital upstarts.

“They’re signing up banks in the middle of the Covid crisis, which is impressive,” says Canaccord Genuity analyst Joseph Vafi, who has a Buy rating on the stock.

FIS is expected to lift revenue 8% next year to $13.7 billion, according to consensus estimates. Cost savings from the Worldpay merger should help boost earnings before interest, taxes, depreciation, and amortization, or Ebitda, 17%, to $6.2 billion. Vafi sees the stock hitting $178, up from a recent $149.

Global Payments had its own big merger last year, buying Total System Services for $25 billion. The deal adds scale and makes Global Payments an end-to-end processor for merchants and banks. The firm now counts 1,300 financial firms as clients, up from about 500 premerger. The company recently partnered with Amazon Web Services to distribute and sell payment services on a cloud-based platform. “We and Amazon are tied at the hip,” says Global Payments CEO Jeffrey Sloan. “We think the partnership triples the size of our addressable market.”

Global’s U.S. merchant acquiring revenue fell 14% in the second quarter as small businesses closed and sales dried up with the pandemic. But Global Payments isn’t as exposed to hard-hit areas like travel and entertainment as the card networks, limiting its declines somewhat.

About 60% of Global Payment’s revenue is fueled by corporate technology spending that has held up well, compared with consumer transactions.

“We’re in a healthier place than we could have imagined,” Sloan says. “We’re seeing a continual recovery, and we haven’t seen any impact from hot spots in the U.S. or markets globally that are open.”

Evercore ISI analyst David Togut calls the stock a top pick and recently raised his price target to $253, 40% above the stock’s recent close of $181. Citigroup analyst Ashwin Shirvaikar isn’t as bullish, maintaining a $207 target, but he calls the stock attractive at 22 times estimated 2021 earnings. Revenue growth could beat forecasts, particularly if a new stimulus package comes through for small merchants.

Ultimately, though, it all comes back to cold hard cash. “Will it return post-Covid?” asks FIS CEO Norcross. “If the answer is no, it will be a significant tailwind for the entire industry.”

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