Warren Buffett and his new Berkshire Hathaway (BRK.A)(BRK.B) investment manager Todd Combs have in common a proclivity for credit card stocks, though their purchases were made under different circumstances and of different companies. Combs’ choices, Visa (V) and MasterCard (MA), also had dramatic run ups in market value that contributed to the greater than 26% return Buffett lauded Berkshire’s two new managers for in his 2012 annual letter. (See more about how they did it here.)
Buffett and American Express (AXP)
American Express is one of what Buffett called Berkshire’s “Big Four” stock holdings in his annual letter. It is also old, dating back to 1991, at $300 million initially. But Buffett’s original investment reads like a prototype of more recent Bank of America (BAC) and Goldman Sachs (GS) capital infusions to ease distress. In 1991, American Express was suffering from the results of a failed attempt to expand into a full-fledged financial services conglomerate and needed cash. Buffett gave it to them in exchange for preferred stock with an 8.5% dividend and the right to convert it to common stock at $33 to $37 per share. The CEO at the time called Buffett’s move a “vote of confidence” in the company.
The stock was automatically exchanged for 14 million common shares when it did not reach the specified price range by August 1994. By that time though, the investment had grown to $385 million, along with three additional $26.5 million annual interest payments, providing Buffett with a 64 percent return, according to a 1995 New York Times article.
In the following year Buffett bought more common stock, controlling 9.8% of the company’s outstanding shares by 1995. As of the fourth quarter of 2012, Berkshire holds 151,610,700 shares of American Express in total, or 13.72% of the company, making it the largest institutional equity owner of the company.
Buffett’s first dealing with the company dates back even further. The new Buffett biography, “Tap Dancing to Work: Warren Buffett on Practically Everything,” unearths this anecdote from a 1995 article in Fortune:
“Warren Buffett loves to tell a parable about the stock market's irrationality. It was 1963, and a scandal involving fake inventories of salad oil at a small subsidiary of American Express drove down the price of Amex shares. How bad a problem was this? To find out, Buffett spent an evening with the cashier at Ross's Steak House in Omaha seeing if people would stop using their green cards. The scandal didn't seem to give any of the diners indigestion, so Buffett seized the opportunity to buy 5% of the company for $13 million. He later sold his holding for a $20 million profit.”
The two instances suggest that Buffett believes in the power of American Express’ business to charge through short-term setbacks. He didn’t, however, buy any new shares when the company’s stock plunged to 10-year lows during the financial crisis of 2008 and 2009:
More recently, the more exclusive credit card has been increasing in popularity. It experienced more purchase volume in 2011 than MasterCard for the first time since MasterCard was known as MasterCharge in the 1960, according to The Nilson Report. In a year in which all four major card brands had purchase volume increases, American Express’ increased 13.4%, versus 6.1% for MasterCard.
American Express’ share of U.S. purchase volume also increased to 26.3% in 2011, its third consecutive year of increases and up from 19.9% in 1999.
As a result of the company’s recovered capital strength from 2009, the Federal Reserve allowed the company in March 2012 to instate a capital distribution plan, which included an 11% increase to its dividend rate, from 18 cents to 20 cents per quarter, and repurchasing up to $4 billion of its shares in 2012 and an additional $1 billion worth of shares during the first quarter of 2013. The shareholder-friendly buybacks are part of what prompted Buffett to say in his annual letter that his ownership interest in American Express is “likely to increase in the future.”
MasterCard was the second-largest holding at Todd Combs’ Castle Point Capital Management LLC before he joined Berkshire in October 2010. It appeared in Berkshire’s portfolio shortly thereafter, at 216,000 shares in the first quarter of 2011, to which it added 189,000 shares the next quarter, for a total of 405,000 shares. Since the purchases, MasterCard’s market price has approximately doubled. Shares are $528.87 per share on Tuesday afternoon.
Since Ted Weschler joined Berkshire in early 2012, and Visa appeared in Berkshire’s portfolio in the third quarter of 2011, Todd Combs likely purchased this company as well. He started with 2,291,708 shares for $87 per share on average, and increased the holding to 2,865,009 shares the next quarter for $94 per share on average.
In the second and third quarter of 2012 he reduced the stake to 1,555,459 shares for $119 and $129 per share on average. The market price for Visa shares is $160.29 on Tuesday afternoon.
Visa and MasterCard are market leaders, dominating the top two market share percentages in the U.S. credit card market and have the two largest payment networks.
Both are also benefiting from significant headwinds at this time. Global credit card transactions rose 12.1% in 2011 over the previous year, to $135.33 billion. The number of credit, debt and prepaid cards being used also increased 12.4% to 6.54 billion, with Visa and MasterCard seeing the second and third-largest increases, up 3.9% and 8.9%, respectively.
The credit card industry from 2011 to 2016 is expected to increase to 238.99 billion purchase transactions, an increase of 89.31 billion from the 149.68 billion purchase transactions in 2011. Growth in the U.S. is estimated to e 44%, with the largest growth coming from emerging markets, such as 105% in Asia/Pacific, 99% in the Middle East/Africa, and 97% in Latin America, according to The Nilson Report.
The benefits are reflected in Visa’s fiscal first quarter 2013 results reported Feb. 6, Visa announced revenue of $2.85 billion, compared to $2.55 billion the previous year, and net income of $1.29 billion, a 26% increase over $1.03 billion the previous year. It expects net revenue growth in the low double digits for fiscal 2013. Visa also reported 9% year-over-year payments volume growth and accelerated international expansion. The company has a $1.5 billion share repurchase program it announced in the fiscal fourth quarter of 2012, along with a 50% quarterly dividend increase.
Similar, MasterCard on Jan. 31 announced a 10% fourth quarter net revenue increase to $1.9 billion, and an 18% net income increase to $605 million. The results excluded a U.S. merchant litigations charge that hit in the fourth quarter of 2011. Its processed transactions also increased 20% to 9.2 billion, and gross dollar volume was up 14% on a local currency basis.
For the full-year 2012, MasterCard repurchased 4.1 million shares for about $1.7 billion, and had $440 million remaining under its repurchase program.
In spite of the steady growth, about 85% of transactions around the world still involve cash, leaving vast room for market expansion for all three of the companies.