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Introduction
Visa’s (NYSE:V) bullish case maintains great return potential, but it recently cracked in a way we can’t ignore. In an article titled “European payments: The European Commission welcomes the initiative by a group of 16 banks to launch a European payments initiative (EPI)”, the European Commission describes an initiative that poses a vital threat to Visa and Mastercard (NYSE:MA) in the European market. The recent trends in the payments industry surely call for exposure to digital payments players. However, I would choose PayPal (NASDAQ:PYPL) over Visa due to lower regulatory risks and bigger upside potential.
Last year, the European Central Bank (ECB) expressed its concerns about the dependency on non-European players for two-thirds of non-cash payments. The ECB saw the risk that the payments market would not be fit to support the EU single market, and this initiative seems to be tacking this very issue.
This initiative aims to create a unified payment solution for consumers and merchants across Europe, encompassing a payment card and a digital wallet and covering in-store, online and person-to-person payments as well as cash withdrawals.”
“Prices will differ from one bank to another, but the infrastructure will be pan-European.”
ECB, 2nd July 2020
The “infrastructure” of the quote above is currently powered by American giants Visa and Mastercard, which could soon see their market shrink. The European payments system is expected to start operating by 2022, at which point, Visa and Mastercard will lose a significant portion of their European market. Visa has long been aware of how European regulation had the potential to affect its business overseas. The increasing scrutiny and regulation of the payments industry got Visa worried about interchange fees, operating rules and risk management procedures, but a change to the whole payment infrastructure is a problem of a different nature.
In their annual report, Visa warns about government-imposed restrictions on international payment systems that may prevent them from competing against providers in certain countries, including significant markets such as China, India, and Russia. Europe could soon end up being added to this list. Likely, Visa will continue to operate in the region through its subsidiary Visa Europe. Visa Europe’s card scheme has recently emerged from ECB analysis as the only card scheme that broadly met the definition of a European card scheme. However, the European initiative could translate to major European banks issuing cards through the new card circuit, leaving Visa and Mastercard with the short end of the stick.
Last year, Visa’s volume originating from European cards was roughly 20% of all Visa Credit and Debit volume. Cross-border volumes, where the card-issuing country is different from the merchant country, will also get significantly affected should the new European cards not fall under the Visa brands.
Digital Payments Trends Are Increasing
The positive news is that the digital payments market is in growth mode now more than ever, and this digital payments market is still relatively small compared to the payment market overall size.
According to the ECB, 76% of all transactions in the euro area are carried out in cash, amounting to more than half of the total value of all payments. In the US, cash remains the most frequent method of payment, representing roughly 31% of consumer transactions.
Due to the COVID-19 pandemic, cash is losing its appeal faster than ever. The fear of bacteria-spreading banknotes is adding to the clear benefits of digital payments, such as increased storage efficiency, faster payments (think contactless), and decreased risk of cash robbery. The shift to digital payments is therefore accelerating, and the biggest beneficiaries are card providers such as Visa and Mastercard, but also digital wallet providers such as Square (NYSE:SQ) and PayPal in the US, and Revolut in Europe.
PayPal Offers An Alternative With Bigger Upside
PayPal is an established global brand in the payment industry. Compared to Visa, PayPal is not a credit card network. Instead, it generally acts as a processor or a gateway connecting to Visa or Mastercard’s network to facilitate payments. However, PayPal’s business reach is growing, and it is now building a strong ecosystem aiming at connecting digital wallets, with physical stores, with online stores, and even with discount finder Honey, creating a true omnichannel experience.
The digital wallets market is getting bigger, with research pointing at a $7.5 trillion market by 2024. With PayPal mobile and Venmo, PayPal is well-positioned (together with Square’s Cash App) to become and remain a major player in this new growing industry.
If you own Visa and want to maintain exposure to the digital payments industry, PayPal is a great alternative. Although the shift to a cashless society will benefit Visa more directly, regulations are less likely to affect PayPal, while almost certainly significantly affecting Visa and Mastercard’s business in Europe. Should the digital wallet industry continue its exponential growth, PayPal could also be set for greater upside.
Conclusion & Takeaway
I remain bullish Visa due to the growth in digital payments, but its long-term global growth could be hindered by existing and upcoming European regulations. A related play, PayPal, could equally benefit by digitalization trends but offers greater upside due to digital wallets and its omnichannel evolution. Should I pick one for the long term, I would choose PayPal.
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