The Lex Newsletter: a penny for the ferryman, a farthing for Mastercard

Dear reader,

Payment has its own mythology. Greeks and Romans were sometimes buried with a coin in their mouths to pay Charon. He was the ferryman who transported them to the land of the dead. He is shown collecting his fee in the picture above.

I imagine Charon still asks for cash these days. If his customer only has plastic, he may produce a card reader and request a surcharge.

An increasing number of small US businesses do this. They are responding to a 60 per cent increase in the value of credit card purchases in 2015-21. Credit card fees averaged 2 to 4 per cent of the transaction amount.

Visa and Mastercard, the two US titans that dominate card payments, have oligopolistic characteristics in our view. The breadth of their networks create a formidable moat against competition. That is reflected in enviable ebitda margins that peg along at 60 to 70 per cent annually, according to S&P CIQ.

Mastercard and Visa tend to get a bit huffy if you say any of this. They talk up convenience and service. But there are plenty of businesses in other sectors that provide both benefits at lower levels of profitability.

For investors, Visa and Mastercard have been — and remain — a better bet than would-be disrupters of the payments industry such as Adyen of the Netherlands and Block of the US. Many of these stocks have wilted amid the tech sell-off and weakening consumer demand.

Italy’s Nexi is among the casualties, though rumours of a private equity bid lifted the shares this week.

The European Central Bank is, meanwhile, emerging as an unlikely disrupter itself. On Wednesday, the bank announced two-year preparations for the introduction of the digital euro.

Lagardecoin, as I think of it, would have scope to overlay a patchwork of national payment systems, reducing transaction costs.

But there are dangers when state bodies aspire to crowd out private businesses. Particularly in this case. Many central bankers have a high level of belief in the brilliance of their own decisions. Hence the flaming emails I receive when I write critically about them (all comments are welcome at Lexfeedback@ft.com).

Mediobanca analysis suggests European bank profits could decline by 20 per cent as a result of the digital euro. The ECB would presumably expect private investors to go on financing commercial banks to undertake all the other fiddly jobs lenders do to keep economies ticking over.

In contrast to the ECB, the Federal Reserve’s official line on the digital dollar goes something like this: “Well, maybe. Or then again, maybe not. Because we’re not just going to put ourselves out there with something no one wants. But we should definitely talk about it. Whenever.”

A falafelly big adventure

I will forever associate my visits to New York’s financial district with falafel trucks. I started grabbing lunch from these outlets after a US colleague shamed me for unadventurously snacking on the same Pret A Manger sandwiches I ate in London. “Sad!” was her verdict.

US banking is also a spicier proposition than its sluggish UK equivalent. It is bank earnings fortnight right now. JPMorgan Chase, Citigroup and Wells Fargo collectively earned $49.6bn in net interest income during the third quarter, about 30 per cent up on the same period last year.

Consumers are becoming more cautious. The funding costs of banks will rise. But JPMorgan remains an unassailable investment proposition, despite its steep valuation.

Morgan Stanley’s earnings were a little disappointing — down 9 per cent — thanks to its unpredictable investment bank, bolted like a slightly wobbly sidecar to its sleek wealth management business.

Analysts challenged outgoing boss James Gorman on the realism of a target return of 20 per cent on tangible equity. As Lex wryly wrote: “Gorman parried those barbs with the aplomb of a celebrated CEO who will not be accountable for whether goals are achieved.”

There were edgier exchanges between Wall Street scribblers and David Solomon, chief executive of Goldman Sachs. The investment bank believes it can generate mid-teens returns on equity “through the cycle”.

It is questionable whether it will be able to do so when high pay for senior bankers is tilting the cost/income ratio in the wrong direction.

Blackstone is, meanwhile, embarking on private capital’s version of a rock band’s difficult third album. Having broken through the $1tn assets ceiling, the House of Schwarzman is intent on doubling the figure. It has pivoted hard into private credit, though this form of lending gives regulators the heeby jeebies.

At the retail broking end of the investment spectrum, Charles Schwab steadied nerves with the news that deposit flight had slowed. Chief executive Walt Bettinger waxed poetic, likening banking turmoil this year to “dense fog” cloaking San Francisco landmarks.

Investors will have a clearer view of Schwab’s prospects when it pays off $31.8bn owed to the Federal Home Loan Bank. Clearing the debt will hold back earnings for a while.

Writes and wrongs

Lex invests its imaginary billions judiciously. We still make some bad calls. We try to fess up appropriately.

We published one such mea culpa this week. Nokia’s third-quarter sales fell 20 per cent before currency impacts. The Finnish group announced up to 14,000 job cuts. Swedish rival Ericsson is also up to its knees in organic fertiliser.

We believed these telecom infrastructure equipment businesses would prosper thanks to 5G capex by customers and the expulsion of Huawei from many western markets following espionage allegations.

“Fill yer boots!” we cried. That judgment has gone awry. The 5G rollout has been slow and worth less than anticipated. The pandemic and the Ukraine war are partly to blame. But so are spending estimates that were probably too high to start with.

The London Stock Exchange Group has been a better call. Results this week confirmed our belief that aggregated data is worth more than the sum of its parts.

Rentokil’s prospects should improve in proportion to the number of pests there are to squish. But despite a plague of bed bugs in Europe, the exterminator’s growth is slowing. Fewer US house sales mean a reduction in termite control spending.

Rentokil features in Lex’s list of favoured low-profile, steadily growing UK compounders. We have been questioning that status since Rentokil’s hefty £4.5bn acquisition of US group Terminix last year. We prefer businesses that systematise bolt-on M&A to those keen on “transformational” transactions. Usually, these are nothing of the sort.

It is our job to make governance calls as well as the investment kind. We think investors should vote against the continuation of the Hipgnosis Songs Fund and the sale of a chunk of its portfolio to a Blackstone-owned sister fund next week.

The music rights fund has been riskily run and exposed to questionable valuation practices, in our view. A wind-up is one option investors should contemplate.

Not for nothing is the fund’s logo a stoned elephant lying on its back.

Things I have enjoyed lately

The FT’s Michael Stott wrote an intriguing and alarming Big Read on Argentine presidential hopeful Javier Milei, an eccentric libertarian and sometime tantric sex guru.

Lex colleague Camilla Palladino produced a smart column for FT Companies on the perils of private credit. And I took a day of my own away from Lex duties to gauge the value of build-to-rent investment to Generation Rent.

If you like shaggy dog stories, you may enjoy The Feather Thief by Kirk Wallace Johnson, which I have just finished reading. This lifts the lid on the weird world of decorative fly tying and the theft of hundreds of rare bird skins from the Natural History Museum.

Enjoy your weekend, whatever is on your reading list,

Jonathan Guthrie
Head of Lex