MasterCard is confident that the proposed $7.25 billion settlement of allegations that it and Visa engaged in merchant fee price fixing will receive final approval, according to Nomura analysts who recent met with key executives of the card network.
"Although the merchant litigation hasn't yet received final approval in the court system, it has received preliminary approval, and the settlement amount has been earmarked," the Dec. 10 report reads. "[MasterCard's] lawyers remain confident that the settlement will receive final approval."
Since receiving preliminary approval in October, the settlement has been criticized for falling short of the damages that plaintiffs could recover at trial, leading four retailers and six trade groups to challenge the settlement in federal appeals court.
The Nomura analysts wrote that MasterCard has prepared itself to settle the lawsuit, including holding $5.6 billion in cash on its balance sheet, and its impact on the business has been reduced because an outcome is more certain than it was in 2009.
That cash reserves may also be put to other uses, including stock repurchases. Citing CFO Martina Hund-Mejean, the Nomura analysts say MasterCard may "execute on opportunistic share repurchases," particularly if macro-economic factors drive the company's stock price down.
"Many companies tend to have pro-cyclical approaches to buybacks. They repurchase shares when earnings are strong and share prices near peaks, while pulling back when earnings are soft and share prices near lows," the report explains. "In contrast, [MasterCard's] approach is focused on stepping up buybacks as share prices fall further below their intrinsic value."
The stock strategy is part of MasterCard's overall positioning for a strong earnings year in 2013, which also emphasizes flexibility to respond to a variety of macro-economic trends and driving down its global tax obligations.
The analysts wrote that they believe MasterCard is prepared for a variety of economic scenarios, with contingency budget plans that adjust cost-cutting measures depending on the severity of a potential economic downturn, adding they view MasterCard as one of the few financial services companies "with the flexibility to meet aggressive financial targets…under almost any plausible economic scenario."
For example, should the economy slow moderately, but not to the point of a true "crisis," MasterCard plans to cut advertising and market expenses and potentially freeze new hiring. In the case of a severe recession, the first-stage cuts could potentially be deeper, while investments in long-term projects would be delayed.
"In our view, MA's business model is as close to bulletproof as we'll ever get, particularly given all of the expense levers that management has at its disposal," the analysts wrote. "We walked away from the discussion believing that management has a very deliberate and thoughtful process in place for managing the business in the event that revenue growth slows."
The report also cites MasterCard's president of U.S. markets, Chris McWilton, who's expecting "muted" growth of 2% to 3% in gross domestic product in 2013. According to the analysts, McWilton is optimistic that the federal government will avoid the "fiscal cliff" of automatic tax hikes and spending cuts set to take effect if Congress and the White House don't finalize a budget deal by year's end. While Hurricane Sandy negatively impacted MasterCard's results, particularly revenue derived from gasoline sales, the report says results from holiday shopping activity were solid.
Like the impact of the Durbin Amendment in the U.S., the card network faces continued pressure from Australian legislation enacted in 2002 that's resulted in reduced interchange fees. Still, performance in the region continues to grow in Australia as well as in Europe, where despite its cross-border interchange fees being deemed in violation of European Union competition laws, MasterCard has won new business, leading purchase volumes increasing 12% since 2008. And in the U.S., the Nomura report says MasterCard has accelerated its share gains since the Durbin interchange cuts took effect in October 2011.
"These notable examples give management confidence that MA's business model is resilient enough to enable it to manage through any potential pressure associated with lower interchange rates," the report reads.
Furthering its earnings potential, MasterCard is poised to employ tax planning efforts to continue to drive down its tax rate below the company's current guidance of a tax rate of approximately 32% from 2013 to 2015. It's doing this by moving intellectual property and other assets to jurisdictions with lower tax rates, like Singapore, while managing its obligations in other countries where it operates.
"Current U.S. tax law requires MA to pay royalties to the U.S. government as it revises its structure for tax-reporting purposes," the report said. "While these royalty payments mask the degree to which MA is likely to benefit from tax-avoidance strategies in the future, we do expect the benefit of a lower tax rate to continue to trickle in over time."