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By William Patalon III
Money Morning/The Money Map Report
The Visa Inc. (V) initial public stock offering is already going to be the biggest IPO in U.S. history.
Now it's also poised to be the hottest IPO investors have seen in years.
Late yesterday (Tuesday), just hours before the massive credit-card processor are scheduled to start trading today (Wednesday), industry experts say that strong demand induced underwriters to price the stock at $44 a share.
That's $2 a share higher than the even the very top of the projected range of $37 to $42 a share. And it means the offering raised a U.S. record $17.86 billion – even without the over-allotment provision of 40 million shares that would boost the proceeds by $1.76 billion.
IPO expert Louis Basenese says that some experts are suggesting that investors employ the indirect approach by purchasing shares of the downtrodden banks that are underwriting the deal.
And while it's true that those banks will control a hefty chunk of Visa stock after the offering is finished, this strategy is still a bad idea, according to Basenese. Agreements will keep the banks from converting their "Class B" shares to "Class A" shares for years. And that lockup period could actually be lengthened by any pre-IPO litigation that the agreement says must be settled before the shares can be converted so investors who played this hand can profit.
"Stay with the 'Class A' shares," says Basenese, an IPO expert who is the editor of the investment newsletters The Hot IPO Alert and The Takeover Trader.
Details of the Deal
The San Francisco-based Visa originally filed to sell 406 million "Class A" common shares at $37 to $42 apiece, for proceeds of $15 billion to $17 billion. Even that would have easily leapfrogged the largest U.S. IPO to date: The $10.6 billion stock offering for AT&T Wireless, which occurred in April 2000.
By boosting the price to $44, the over-allotment provision would boost the total proceeds to $19.62 billion. That would actually push the Visa deal up near the biggest global IPO of all time, the October 2006 IPO of the Industrial & Commercial Bank of China, or ICBC, which raised $19.1 billion – or nearly $22 billion when the over-allotment provisions were fulfilled.
If the Visa deal is oversubscribed, the fallout could be highly bullish. Currently, the stock offering is.
"If the Visa IPO does as well as everyone expects, comes out on schedule and is oversubscribed as I believe it will be, it could have a huge impact on the stock market in general and the IPO market specifically," Basenese said.
Basenese says that, according to his calculations, Visa's shares could be worth $80 by the end of this year – and perhaps more, if all goes according to plan.
It could even revitalize the U.S. IPO market, which has been enduring one of its toughest stretches in years.
Ending the "Manic" Market for IPOs
At a time when U.S. investors are losing confidence in stocks, a rejuvenated IPO market could play a key role in rejuvenating the major indices.
A year ago, when stocks were soaring to new record highs, private-equity deals, leveraged buyouts and big corporate mergers were helping fuel a lot of the advance. Investors were willing to pay up for stocks, reasoning that they had a good chance of bailing out with a handsome windfall if their company was "taken out" by a hedge fund or a buyout artist.
But hedge funds, private-equity players and even corporations looking to get leaner and meaner are only aggressive about these deals themselves when there's an easy way to "cash out." And that "cash-out" strategy means there has to be a healthy IPO market. A private equity fund buys a company that's stumbling a bit, but still has a good business, taking it private. They invest some capital, and devote some management attention to the firm. Two years later, they sell the revitalized company to investors via an IPO that sends the company's stock rocketing skyward on its first day of trading as a newly public company.
And everybody's happy.
When the IPO market stalls, however, those buyout deals slow to a trickle, and the market's former record advances come to an end.
"Weakness in the overall stock market translates into the IPO market," Jay Ritter, professor of finance at University of Florida, told Reuters in an interview. "The IPO market tends to be hypersensitive to movements in the broader market … and this hypersensitivity tends to make the IPO market somewhat manic depressive."
With the Standard & Poor's 500 Index down more than 11% so far this year, underwriters remain wary of bringing new stock deals to the market. In January and February alone, 30 U.S. IPOs were withdrawn or postponed, reports IPO data provider Dealogic. Globally, during that same two-month stretch, more than twice than many IPO deals were shoved onto the back burner.
The spiraling global credit crisis has only made matters worse. In January and February, IPO hopefuls around the world shelved stock worth $21.4 billion, which was almost twice the value of the new
shares that actually were issued, according to data from Thomson Financial.
Globally, 92 IPO issuers raised just $12.2 billion in the year's first two months – the worst start to the year since 2003.
And the role of the United States in the IPO market continues to slip, as the biggest deals getting done continue to come from other markets abroad. Of all the IPOs issued globally in January and February, only 7% emanated from U.S. companies, down from last year's still-lackluster 33%.
"We are off to our worst start for IPOs in the United States since 2003," Richard Peterson, director of capital markets at Thomson Financial, told Reuters. "There have only been nine deals priced so far this year and there hasn't been a deal priced in the past two weeks."
According to the Securities and Exchange Commission Form S-1 filings, there are 186 companies that have already filed to go public and that are now waiting on the sideline, including 58 that have filed this year, said Basenese, the IPO newsletter editor.
The Visa deal could help break up the logjam. Indeed, the fact that it's been moved up is highly positive and means the deal is probably a good one for investors, he said. His reasoning: In all his years covering the IPO market, he's yet to see the underwriters move up a poor IPO deal.
Not everyone believes this will help the U.S. IPO market.
David Menlow, president of IPOfinancial.com,. This is a singular seismic event that is not going to re-ignite the market as far as instill confidence or bring more deals into the system."
Francis Gaskins, president of IPODesktop.com, agreed, stating that this IPO is "a unique, one-time event. All eyes will be on Visa and then it's over."
But even if that's the case – and the IPO doesn't re-ignite the U.S. stock-offering market – Visa's shares can still be a profitable play for investors.
The Keys to the Deal
According to Basenese, the Visa deal is one of the better IPOs to come down the pike in some time. For one thing, the company is the market leader, dwarfing its rivals in terms of both transaction volume and total transactions [See accompanying chart].
Chart 1: Visa the Giant
As the largest processor of retail payments the world, Visa Inc. dwarfs its rivals. It accounts for 60% of the debit-card transactions in the U.S. market – a four-to-one advantage over rival MasterCard. As the chart demonstrates, it is also bigger by total transactions and total volume.
Sources: The Hot IPO Trader, Money Morning.
Visa is an electronic payments network that focuses on retail transactions. It actually acts as a facilitator of global commerce, enabling money and information to move among banks, retailers, consumers, businesses and even government entities.
There are three basic points investors need to understand – especially with the chaotic credit markets investors now face, Basenese says:
- Visa is not a credit-card issuer.
- It's not a lender.
- And it's not exposed to consumer-credit risk.
The bottom line: Visa is simply a transaction-processing company that collects a fee based on the number and dollar value of the transactions that it processes, he said. In short, this is a financial-services company whose shares investors can snap up with confidence and a feeling of safety, since there aren't any worries that another credit-crunch-related catastrophe could obliterate its business and send its shares into the ground overnight, Basenese said.
Investors have been eager to grab shares in Visa's offering as shares of the much-smaller rival MasterCard Inc. (MA) have more than quadrupled in value since the company went public in May 2006. MasterCard shares have largely been untouched by the stock-market turmoil generated by the ongoing credit crisis and closed yesterday (Monday) at $201.52, down $7.13, or 3.42%. They are down 11% from their 12-month high of $227.18.
A Profitable Profile
With a public company, at the end of the day, it's always about earnings. And Visa is poised to deliver profit growth. In its latest quarterly report, Visa generated $1.49 billion in revenue and $430 million in profits [excluding one-time events]. Company managers are conservatively projecting that profits will advance at a 20% clip.
But with his own analysis, Basenese uncovered three catalysts that will help Visa boost its profit-growth rate up to the 30% to 35% pace. Those three key catalysts:
- No Chinks in its Armor: To generate profits, a company has to have strong sources of revenue. And Visa does. In fact, Basenese says there's "not a weak spot in this company's revenue mix." Sales are increasing at healthy, double-digit rates across all business segments and in all geographic markets.
- Killer Cost Controls: Since 2003, the total number of transactions Visa processes have soared 61%, but costs have increased only 12%. And since the company's VisaNet payment-processing network is capable of handling double its current volume without really increasing its costs, incremental additions to revenue will translate into "dramatic increases" in earnings, Basenese says.
- A Less-Taxing Tax Rate: Before the stock offering, Visa didn't really have to fret about its tax rate, since it wasn't a public company that had to engage in the quarterly cow-towing to Wall Street. As a result, it's one of the few companies with a horrid tax rate of 41%. Even archrival MasterCard boasts a tax rate of only 35%. But now that it's a public company, Visa will pull out all the stops in its efforts to pare its tax rate. If it gets down to MasterCard's level, a 6% reduction in the tax rate on hundreds of millions of dollars in income will have a big impact on the bottom line, Basenese says.
Going Global For Growth
The global payments sector is undergoing a true paradigm shift – away from cash and checks in favor of one that's card-based and highly focused on electronic transactions. Since 2001, transactions using credit and debt cards went from 13% of payment volume to 27%, a compound annual growth rate of nearly 15%.
As dramatic as that metric is, it's important to note that Visa grew at double that rate during the same period.
Expect the trend to continue – and to expand globally.
According to The Nilson Report, a newsletter that focuses on the payments industry, the purchasing card market will expand at an annual rate of at least 11% on a global basis between now and 2012. And much of the growth will be generated internationally – especially in the emerging markets.
Once again, Basenese says that his analysis has found that Visa is poised to grow faster than the market, which means that it's going to grab market share from rivals.
First, two-thirds of Visa's debit cards are in foreign hands, where consumer-spending levels are on the rise and where the use of electronic-payment technologies is still in its infancy.
And, second, research shows that six out of 10 consumers prefer Visa cards. That kind of brand loyalty means that Visa will be able to introduce new products with very little resistance. Visa already plans to introduce those products in four key areas: Prepaid cards, money-transfer technologies, e-commerce and mobile-transaction-processing.
At a time when U.S. consumer confidence is ebbing quickly and when fears of a major potential recession are escalating, investors need to note that Visa's business is increasingly becoming almost recession proof. Here's why:
- Research underscores that 42% of Visa's revenue is derived from non-discretionary spending, meaning that a lot of that revenue won't disappear even if consumers and businesses make major cutbacks in their outlays for luxuries or other non-essential goods and services.
- During the last two recessions, Visa continued to grow – both in terms of total transactions and total volume. And in each of the last 13 months – as a recession becomes more and more likely – Visa's business has continued to grow at double-digit rates.
The Right Play at the Right Time
According to Basenese, Visa's shares could be worth $80 by the end of this year – and perhaps more, if all goes according to plan. The stock actually will pay a small dividend – about 1%, based on the projected IPO price. That's a rarity among newly public companies. But Money Morning Investment Director Keith Fitz-Gerald puts a premium on stocks that generate income.
Basenese likes the company, its business plan, its market position, and its financial strength.
"The pitch for Visa is simple," he said. "It's a rare opportunity to own a piece of a relative monopoly."
[Editor's Note: Louis Basenese is the editor of The Hot IPO Alert and The Takeover Trader newsletters, and is a contributing writer to Money Morning. Basenese last wrote about how to profit from the takeover market. To learn more about The Oxford Club and its publications, please click here.]
News and Related Story Links:
- Reuters: Market turmoil will not stop Visa IPO: analysts.
- Wikipedia: Form S-1.
- Money Morning: .
- Seeking Alpha: Industrial & Commercial Bank of China Sets New IPO Record at $19.1 Billion.
- CNNMoney.com: .
- Reuters: Report: IPO View: Visa IPO a ray of hope for frozen U.S. IPO market.
- Money Morning Economic Forecast Series: Outlook 2008: Three Ways to Profit From A Takeover Market That's Alive and Well.
- AFX News Ltd: .
- MarketWatch.com: Visa set for strong debut in biggest U.S. IPO.
- MarketWatch.com: Visa raises about $17.86 billion in record IPO.
About the Author
Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning. With his latest project, Private Briefing, Bill takes you "behind the scenes" of his established investment news website for a closer look at the action. Members get all the expert analysis and exclusive scoops he can't publish... and some of the most valuable picks that turn up in Bill's closed-door sessions with editors and experts.