It’s become almost tiresome to say that we’re living in times of great uncertainty. That’s true at the macro level in geopolitics and global economics, but perhaps even more acute in the realm of payments and fintech where many of us operate. We’re all working on the long-term implications of these macro trends, emerging technologies, and shifting regulatory postures in our day jobs and consulting assignments in the industry, but for our colleagues in the investment community, it’s imperative to react quickly when these inflection points are reached.

In this episode, Bryan Derman welcomes two highly respected members of the investment community who represent the two sides of that business: Tim Chiodo, Managing Director and Lead Analyst for Payments, Processors and Fintech at the global investment bank UBS, and Chris Kim, a public and private market investor who leads payments and fintech activities for Capital International, one of Capital Group’s three equity units.

Tune in as we discuss what’s happening in the market with publicly traded companies, digital wallets, the merchant acquiring space, and private equity. We’ll consider what investors look for in a payments company, explore new flows, and debate the impacts of regulation, stablecoins, and M&A deals before closing out the episode with an investment perspective lightning round.

 

 

 

Bryan Derman: Hello again, everyone. I’m Bryan Derman from Glenbrook Partners and your host for this episode of Payments on Fire.

It has become almost tiresome to say that we’re living in times of great uncertainty. That’s true at the macro level in geopolitics and global economics, but perhaps even more acute in the realm of payments and fintech where many of us operate. We feel the impact of these macro trends, but we also seem to find that emerging technologies and shifting regulatory postures continue to rock our world seemingly every few months.

For example, Gen AI has set an early target on commerce. Stablecoins are vying for a place in the payments ecosystem. The CFPB, once a powerful rulemaking body, has been pushed to the sidelines. And bank charters, once very difficult to obtain, are becoming more accessible again for fintech companies.

We’re all working on the long-term implications of these issues in our day jobs and our consulting assignments in the industry. But for our colleagues in the investment community, it’s imperative to react quickly when these inflection points are reached. So, as a former member of that community myself, I’ve been excited by the idea of having on the show some leading practitioners of the art of investing in payments companies and other fintechs.

It took us a while to put this together, but I think we’ve hit the jackpot today. So we’re pleased to welcome to Payments on Fire two highly respected members of the investment community who are excellent representatives of the two sides of that business. From the sell side where equity analysts provide published research products to asset managers, we have Tim Chito, Managing Director and Lead Analyst for Payments, Processors, and Fintech at the Global Investment Bank, UBS.

From the buy side, where analysts and portfolio managers put money to work on behalf of their clients, we’re delighted to have Chris Kim a private and public market investor who leads Payments and Fintech Activities for Capital Group.

Gentlemen, welcome to Payments on Fire.

Tim Chiodo: Thank you, Bryan. Pleasure to be here.

Bryan Derman: Great to have you both with us. As I said in the opening, we’re really excited to bring the investment perspective onto the pod this week for what I think may be the first time.

Now, we always like to start these discussions by asking our guests how they found their way into the payment space. I’ve been in it for a long time and I sort of feel like payments found me more than I found payments. But what are each of your origin stories in payments? Tim, we’ll start with you.

Tim Chiodo: Sure. Well, I have to start by saying that I’m a big fan of Payments on Fire and I think I’ve been listening for probably the better part of the last decade. So I would start by saying it’s an honor that you even invited us to be here, and we’re really glad to be here. So thank you for having me. In terms of the partnership with Glenbrook, also want to say we appreciate that all you’ve done for our team over the years in attending our events and helping our research. We really do appreciate that.

But how did I get started in payments? So I was on the internet research team at UBS and I was working under the legendary analyst, Eric Sheridan, who’s done a lot for my career. I’m really grateful for everything Eric’s done for me. And Eric told me that I was covering the e-commerce segment and the online travel.

And part of our coverage as his associate on eBay was a little company they owned called PayPal. And that’s how I really got started in learning payments. And around that same time period was when Apple Pay was launching and the rest is history and now I’m a payments analyst at UBS.

Bryan Derman: Very cool. Sort of the original fintech, in our thinking, is PayPal. Chris, how about you? What’s your payment story?

Chris Kim: Thanks for having me, Bryan. I actually came into payments much later in my career. I started in investment banking 20 years ago, spent a couple years in private equity, and began investing in the public markets in 2011. I’ve invested in a variety of sectors outside of payments, retail, software, business services, telecom, media, and internet, just like Tim.

I joined Capital about five and a half years ago, and I showed up to our offices on day one on March 9th, 2020 in San Francisco, which Tim will remember was day one of the COVID lockdown. That day, I was informed I’d be covering payments, was handed a laptop, and then sent home.

Honestly, Bryan, six years ago, I couldn’t have told you the difference between interchange and a network fee, but I think I’ve come a long way and I’m still learning about this industry every day. Thanks for having me again.

Bryan Derman: Terrific. So kind of an old hand and a new hand here, but I know you both go in really deep, so I’m looking forward to a great discussion here. When it comes to talking about publicly traded companies in the payment space, the discussion always begins with Visa and Mastercard.

I’m old enough to remember when those were sort of private, not-for-profit companies. And they take a very different form today and tend to be a core holding of so many investment managers today. So let’s dive into those and Tim, I’ll start with you, and let’s start on the positive side of this thing. What do you see them doing right these days and what’s the case for people like Chris to continue to view them as a core holding?

Tim Chiodo: Sure. Bryan. I’m happy to start on that one. So there’s a lot to like about the card networks, but three areas that maybe we could hit today would be one, the volume growth algorithm. Number two, the value added services businesses. And then number three, cross-border.

So let’s start with the volume growth algorithm. So it’s a durable, high single digit to low double digit growth algorithm. Really four components to that. One being PCE or personal consumption expenditure, number two would be inflation, three would be cash to card, and four would be new flows. And those numbers can move around in any given year. But in general, that algorithm spits out something in the high single digits to low double digits.

We often get asked about new flows and how that’s defined. I think a simple way to describe it is really anything that’s not in PCE. So really what that means with the networks is two things. One is the commercial or B2B business. Those make up roughly sort of the mid-teens portion of their payments volume.

The other piece is Visa Direct and Mastercard Send. So these are addressing B2P and G2C and B2C. For context on that Visa Direct component, we estimate that Visa Direct makes up maybe a mid single digit or so portion of Visa’s volumes. The most recent data point was transaction growth, not necessarily volumes, at about 25%, which means it’s adding sort of somewhere in the one and a half points to growth. But that’s just to put a finer point on the new flows contribution.

Another observation I’d make about that growth algorithm, if we went back maybe a decade or so, I think the math would add up to a similar place in that same kind of high single digit to low double digit growth algorithm, but the parts would be a little bit different, right? PCE and inflation, those would be relatively similar. The cash to card component might have been a little bit more of a contributor, and new flows a little bit less of the contributor, meaning the Visa Direct component is something that’s really only about a decade old or so.

Let’s move on to value added services. So, value added services, the punchline is this component of the revenue algorithm, it’s adding about five to 700 basis points to revenue growth in any given quarter. So for context, for Visa, this business now makes up sort of a high twenties percentage of their overall revenue, and in the most recent quarter, grew about 25% organic.

Bryan Derman: I think that’d be surprising to some of our listeners. That’s a big chunk of it for something we’ve sort of viewed as ancillary to the core authorization clearing and settlement, is how we’ve always thought about them. You said 20% coming from those?

Tim Chiodo: For Visa, it’s kind of in the high twenties in terms of the mix and for Mastercard, it’s even more. For Mastercard, it’s kind of in the high thirties portion of their revenue. Now, the growth for Mastercard is more in the high teens, and their three year outlook of their guidance is kind of calling for high teens in the value added services revenue growth. But anyway you cut it, it’s contributing sort of in that, call it 600, maybe 700, basis points to revenue growth for both of the companies, and that moves around a little bit from quarter to quarter.

Then the third piece, cross-border. So the cross-border business, our most recent we’ve had on record, cross-border grows a little bit faster than domestic, right? This is generally true. Clearly that was not true during COVID, but it’s been true in most periods on record, including most recent quarters.

So just for example, in the most recent quarter, Mastercard volumes grew 10, cross-border up 15, and Visa grew 8, cross-border up 12. So a little bit faster growth for a higher yielding business, very supportive of the revenue growth.

Bryan Derman: As we often talk about, it’s one of the unique capabilities of the card systems that you don’t really see present in the other traditional bank transfer systems. So no surprise that that one’s a big revenue contributor. Chris, any additional perspective on what you like about these names?

Chris Kim: I don’t have too much to add. I would just say that Tim lays out a pretty compelling case that cash to card, cross selling, and cross-border will help the networks compound top line growth in the double digits range for many years to come.

Bryan Derman: For sure. Now, so many things have been going so well for these companies for so long, we all think about what could upset the apple cart. And there’s a long list of those, but the most recent one in the news was a ruling from a judge in North Dakota, regarding the way the Durbin Amendment was implemented by the Fed.

Quick reminder to everybody, the Durbin amendment governs debit cards, particularly with respect to what the maximum interchange can be on the regulated portion of the cards, which is the majority of them issued by the larger banks.

Does that sort of thing, a potential challenge, a potential further lowering of debit card interchange give you any pause about these companies?

Tim Chiodo: So it certainly comes up in our investor discussions, right? So investors see the headlines and they want to talk about what does this mean for the card network? It’s not necessarily their revenue stream. We’re talking about the interchange revenue stream, not the network fee, but it certainly is a part of the dialogue.

I would add a little bit of historical context to this in terms of if we went back 15 years or so, there were a few things that maybe would’ve been amongst the investor discussions back then around risk to the yield for the networks, yield being defined as net revenue divided by volumes.

The first probably would’ve been large issuer consolidation, meaning this thought that the big banks get bigger. The second would’ve been a similar concept on merchants, so the Amazons and Walmarts and Targets of the world getting bigger and bigger. And the last one, Bryan, is really this topic that you’re referencing, which is around interchange regulation. And the reality is, all three of those things in some way, shape or form, have kind of played out over the last 15 years.

And on this interchange topic, interchange has been regulated in many of the developed markets across the world, most notably Europe in December of 2015, with debit going down to 20 basis points and credit going down to 30 basis points. So this thesis kind of played out.

But when we look at the numbers to see what actually happened, we look at the yield for Visa back in 2010, this is on their reported number, just taking net revenue divided by payments volume. It’s a little different if you do it on total, but the trends are the same. That yield, about 26 basis points back in 2010. Fast forward to today, that yield is about 28 basis points.

So sure, over time, the incentives have gone higher on that measure, call it five basis points of volume back in 2010, more like 11 basis points of volume today. But there’s been offsets, right, investment, M&A, value added services, we mentioned the cross-border business. And the net of it is, the yield hasn’t really changed a lot. It’s been kind of stable-ish to slightly up over time.

Bryan Derman: And by the way, debit card volumes have now started to grow faster than credit card volumes, I think, in the past couple of quarters. I remember back to when Durbin first came out, like you’re saying, 2009, 2010, and everybody thought the sky was falling, right? Banks are going to stop issuing debit cards, it’s not going to be worth it. We can’t possibly, have it regulated for some banks and not others.

But the industry adjusts and life goes on. Though, I would say, it turned out okay for the networks. Okay for the banks, but probably not as good, right? I think that hit has been felt more by the issuing banks than by the networks themselves.

Chris, what’s your view? Any concerns around the latest wave of regulation here?

Chris Kim: You make a good point. The models for the networks have been quite resilient and, as Tim laid out, there are numerous case studies all over the world dating back to the early 2000’s, even well before Durbin, somewhere in the dozen to mid teens, I’m sure Tim will know the exact number, and through the last two decades, the networks have been able to consistently drive-value based pricing for the benefit of all their stakeholders.

Bryan Derman: Yeah, for sure. Debit cards have not gone away no matter what the regulators did to them.

Okay guys, so if we’re feeling okay about regulation, let’s really talk about the elephant in the room. We’re hearing a lot about the potential impact of stablecoins on the payment space right now. Tell us where you think they fit and whether it’s realistic to view stablecoins as a threat to Visa and Mastercard.

Tim, I think you’ve delved into this in your research, so why don’t you kick us off?

Tim Chiodo: Sure, happy to Bryan. So it’s true, back in sort of the June July timeframe, this certainly was one of the dominant topics within the payments industry. We were having investor discussions on this on a regular basis. I would say with the benefit of time, the investment community has gotten a little bit more comfortable with this topic as it relates to Visa and Mastercard at least.

Investors have gotten more comfortable with many of the topics that that you might often discuss, whether it’s ubiquity of acceptance, the chargebacks and disputes processes, the brand, the trust, the revenue model for various parties, and of course the rewards programs that benefit the consumers. All of that has gotten the investment community much more comfortable with this topic.

At the same time, we talk about it as something that we should have a healthy respect for, and it’s because it’s a little bit different than some of the past threats to the card networks that have come up over time.

So in the past, we might have had discussions around MCX or account to account payments, or there was even a time period when BNPL was considered as potentially disruptive to the card networks. But all of those past threats had one thing in common in that they were almost inherently, or almost by definition, very much contained to domestic payments.

And the difference in the stablecoin discussion is that we at least bring into the prospect of the discussion the topic of cross-border. And as we mentioned earlier, that’s a much more meaningful revenue stream for the card networks.

Bryan Derman: Huge profit sanctuary at risk if stablecoins hit that part of the business. But overall, fairly comfortable now. So, even if it’s not a clear and present threat to Visa and Mastercard, Chris, how do you read the stablecoin space? How do you as an investor see it fitting into the payments ecosystem?

Chris Kim: I’d reiterate that it’s a risk that you have to re-underwrite and respect because you have some of the greatest minds in fintech attacking this problem from the stablecoin perspective. And I maybe even just zoom out a bit, Bryan. I’d say one of the simple mental models I have for the industry is that the instant transmission of a payment, bits of data or zeros in one, is rapidly becoming a commodity .You know, it’s managing the friction in the on ramp and off ramp processes that are much more difficult to achieve. And if something, God forbid, because of a bad actor or even an innocent mistake after the transaction occurs, that’s when things get really complicated and ugly.

My colleague and friend, James Bray, has a simple and much more articulate way of explaining it. A payments network is comprised of a core network that contains a massive routing table of payers and payees, and the scheme that governs the rules and regulations. Most of the value, he thinks, resides in the scheme, and I’d agree. Or said another way, I think one of the most durable components of Visa and Mastercard’s moat sits in its compliance stack are their positions as the governors of transaction integrity in global commerce.

With that said, I see two nuances, one of which Tim already mentioned. Stablecoins do in fact offer a credible alternative in cross-border payments, so it’s very different than the UPI’s and Pix’s of the world. And then two, where I spend a lot of time is you’re seeing real innovation and focus within the compliance stack. The deployment of escrow smart contracts to replicate the two step authorization and capture process. I don’t know, Bryan. I think that’s pretty cool stuff.

However, I have yet to see a compelling framework and solution for everything after the transaction takes place, which I talked before about fraud and liability management, dispute resolution, chargebacks, and then just holistically, a modus operandi that all constituents can agree upon a set of rules, governance, and standards that all consumers and businesses can trust.

You guys know anyone that can do something like this?

Bryan Derman: Visa and Mastercard, but if they can do it, others maybe can too. And, you know, arguably UPI and Pix and others are earlier in their journeys, but are making progress down that path and are certainly impacting card volume or the growth of card volume. Even if they’re not cannibalizing card volume, they are taking their share of the growth in those markets. So it has something to do with where cards stand in a market.

Chris Kim: I just, I just think it’s a little different. Like India and Brazil, I think India was not a carded market, right? So kind of like China, they leapfrogged payments. I think Brazil’s a little bit of a different case. I personally think Brazil was the perfect amalgamation of events that allowed Pix to really take share in the country.

Bryan Derman: And terrific government support,

Chris Kim: Very sophisticated Central Bank for sure.

Bryan Derman: For sure. So, the one observable point we have in the stablecoin space from an investment point of view is the IPO of Circle, which did fantastically well coming out of the IPO. It’s backed off a little bit since then, but is way up from where it went public.

What’s your view of that name, Chris?

Chris Kim: Yeah, I think there are some people that say you have to like Visa and Mastercard and not like Circle or the inverse. I’m actually constructive and a fan of all three, Mastercard, Visa, and Circle.

USDC, it has an opportunity to be one of the dominant stablecoins in regulated markets and the Genius Act has the potential to accelerate the adoption of stablecoins here in the US. And something that I also like about Circle is that it’s partnered with some of the most innovative fintech companies in the world, some of whom are led by very visionary founders and ones that are willing to make the hard investments today for the benefit of many years out.

But I do have two big picture questions in my mind that I’m still trying to calibrate. One specific to USDC or the competitive landscape for the industry. And the other is specific to Circle’s earnings power. What will market share for USDC look like in a decade? That’s a big question I’m always pondering. Will the competitive landscape evolve like the Index ETF business where trading liquidity has led to a winner take most outcome in specific corridors or submarkets, or will share be fragmented given the fungibility of stablecoins?

And then, specific to Circle, there are a lot of moving parts as. It relates to how the economics are shared with their various distribution partners like Coinbase, and I think the range of outcomes on this lever is still quite wide and to be determined over the long run.

Bryan Derman: Interesting. And we also see them thinking through some of the concerns you guys highlighted, how to manage disputes. And maybe they’re potentially a leader in thinking about stablecoins as a scheme and not just a set of rails for moving value. So we’re watching them closely to see where they take it.

Chris, you talked about earnings power, and we’re sort of getting into the guts and mechanics of what drives company valuations here. So let’s pull back the aperture for a moment and talk about what it is that investors look for in a payments company and what makes one stock really successful whereas another one might languish.

How do you think about what you’re shopping for and what drives valuation?

Chris Kim: I would have to caveat my answer with that there are many ways to make successful investments in the public markets. And this is just one way how I think about it. And then I’d slightly rephrase the question. It’s how do I think about making a good investment or evaluating a quality company just holistically, not just a payments company.

And I’d say I have kind of four pillars to my investment framework and how I evaluate companies. The first question or topic I always think about is, are they attacking a very large market? Is there a long runway for growth? Is there a large penetration opportunity within a market? Does the industry have outsized secular growth? And my favorite personally is when a company’s creating a completely new category or opening up a previously unattainable market. What Square did a decade ago with micro merchants and their payments dongle is the classic example.

Number two, does the company have a moat or durable competitive position? How are they satisfying customers? Are they making their customers happy? And what’s their right to win?

And then three, does a company have an attractive business model and lucrative unit economics? Is there pricing power? And when they’re spending money on sales, marketing, and CapEx, are they generating an adequate and healthy ROI on that spend?

And then lastly, one that’s very near and dear to my heart is, is the management team a responsible steward of capital? Do they understand how to increase value per share? because I’ve got to say, Bryan, strong capital allocation can be the gift that keeps on giving in the very long run. And you know, Warren Buffet, he’s the GOAT and the classic example of this.

So that’s kind of the funnel. And if they get through that screening process, I try to figure out what can I pay that will generate an adequate return for our clients and shareholders. Here at Capital, we’re focused on long-term investment results. And PMs and analysts, we’re all compensated on a 1, 3, 5, and 8 year basis.

So my 8 year number has the most impact on my compensation, hence I’m trying to maximize that eight year return for the clients. And so I don’t think a lot about this quarter or next quarter, or even this year or maybe next year, I really think about how big is that prize awaiting us 5 to 10 years from now.

And then lastly, a little bit something that’s more nuanced about my frameworks and processes, I think a lot about the expectations that are embedded into a current stock price. I think one simple quantitative way is to just compare what my earnings estimates are to Tim’s. I think the more qualitative way to think about it is, what do you have to believe or what must go right for a company to make this an attractive investment today?

You’ve talked about Circle quite a bit. Circle’s a great example where what you had to believe changed a lot from the IPO price to its highs over the summer.

Bryan Derman: Yeah, for sure. Okay. I I’m hoping our founders in the audience were taking notes there on your four points. I got runway for growth, a moat with a right to win, unit economics leading to a strong ROI, and strong approach to capital allocation. So write those down everybody out there.

Chris Kim: Bryan, I really like those four pithy bullet points. I think sometimes the greatest investments are simple investments and the ability to distill a thesis so crisply the way you did is a sign that you’re probably a great investor yourself and there’s some great investor in there. So I really liked your summary.

Bryan Derman: I have good days and bad days if I showed you my portfolio, and it’s just a distillation of your list after all. But, I think there’s a lot of wisdom in what sound like four simple things. Not easy to do. They sound simple when you just sort of list them out in bullets, but executing on them every day is a different deal.

Let’s talk about another topic that’s sort of been hot, and Tim, this is one I know you do a lot of work on, is the advent of digital wallets. This has the feeling of a megatrend. It sort of hit the radar at Glenbrook a few months ago when Mastercard made this announcement, I think only with respect to Europe, but they said, There’s not going to be any more numbers on your card. We don’t want those numbers floating around. You don’t need them on your card. We saw the Apple card do something similar, and that, to me, just signals a growing importance of digital wallets.

So, Tim, tell us what your research shows in the space about how important the wallets are and which wallets are most important within that.

Tim Chiodo: So I think a good place to start is sizing what the opportunity is. So we’ll start with the US retail e-commerce market at about 1.3 trillion of volume, and that’s a great big number, but about 40% or so of that is coming via Amazon. So often when we talk about the addressable market for some of these buttons, we’re removing that portion because for many payments companies, Amazon is not overly addressable. But for starters, there’s 1.3 trillion of US retail e-commerce.

But from there, the list goes on and on. There’s many other non-retail categories, so we’re talking about things like online travel, ride share, in game or in video game purchases. There’s crypto on-ramp, there’s streaming encryption services. The list goes on. But when we add up all of the non-retail categories, we get another, call it 2.3 trillion or so.

When we add the two together and throw in a little bit of rounding 1.3 and the 2.3, we get to about three and a half trillion of total e-commerce opportunity in the US market. And in terms of the growth of that, of course, some of those categories are faster growth and some of them are slower. When we mix it all together and kind of blend it, it gets to roughly about a high single digit growth market for the US overall e-commerce market, retail and non-retail.

Bryan Derman: Very large, but kind of feeling mature.

Tim Chiodo: Certain parts more mature than others. Yeah, a good high single digit growth rate when you blend it all together. But that’s right, Bryan.

Bryan Derman: Okay. So what’s the role of the wallets within that?

Tim Chiodo: Sure. So we get to the share estimate. So let’s start out with PayPal, obviously the leader, right? PayPal, roughly, let’s call it 8% share or so, these are on our 2024 estimates, and as I mentioned, we’ll do all these on an X Amazon basis.

Apple Pay actually in a pretty similar range. Apple doesn’t disclose sizing numbers, or any kind of disclosures on how big Apple Pay is, but our estimate is last year Apple Pay was kind of just below, a hair below the size of PayPal when we talk only about US online commerce. Clearly Apple Pay is much more than that, but we’re talking US e-commerce, kind of in the same ballpark as PayPal in the US online.

Then we go to two of the faster growth categories, even faster growth, which is Shop Pay, and Buy Now, Pay Later as a category. When we look at those and we’re kind of backing out the PayPal portion, they’re both sort of in the 2 to 3% share. But I think what’s important to call out, it’s not just their current share, but it’s how much share they’re winning of the incremental volume.

So let’s take those three, Apple Pay, Shop Pay, and Buy Now, Pay Later as a category. If we add up their current share, we get to something that’s kind of in the low double digits. But when we look at our estimates for 2025, they’re gaining something like 3 out of every 10 units of incremental volume. So their win share on the forward growth is a little bit higher than their current. So they’re the share gaining platforms

I want to hit on Shop Pay a little bit more. So we take it back to Q3 of last year. The Shop Pay button was growing kind of in the low forties. Take that into Q4, and it hit into the mid fifties. Q1, it was the high fifties. And this most recent quarter, 65% growth for the Shop Pay button. Now, the main driver of this is not this item, but it’s something that’s certainly school support on the come, which is the enterprise move. We think this is a really important move for Shopify.

When we think about that overall e-commerce market, we were talking about such a small portion of it is SMB. And for many years Shopify has been operating much more in that market, but they’re moving more and more successfully into enterprise. So you think about the TAM unlock for this button, it’s kind of been operating in the 15 or 20% of the market that is SMB and now expanding into enterprise.

On Apple Pay, they also have a TAM expansion going on, which is essentially going from mobile only, to mobile and desktop. And it’s still early there, but our team did a check of the top 50 websites in the US maybe a few months back, maybe things have evolved since then, but Apple Pay was already showing up on the desktop of 7 of the top 50 sites in the US. So a good start for Apple Pay.

To bring that all together though, Bryan, just to put a finer point on it, the key point there is both Shop Pay and Apple Pay are undergoing meaningful TAM expansion, which is driving part of their share growth.

Bryan Derman: Yeah. And the whole category has to grow. If they’re going to scrape the numbers off my card, they’re saying you have to use a wallet of some kind. You can’t type in 16 digits anymore. Not that I ever could, but it’s not going to be allowable. I think, even these days, it’s becoming a little bit of a signal of fraud when you do that compared to using a wallet where there’s an authentication layer involved in the transaction. It makes a cleaner transaction in general.

So, really interesting and, to me, you can really look toward the day when a hundred percent of the e-commerce, or the card not present or however we want to describe it, will be coming through some wallet or another, whether it’s traditional player like a PayPal or an Apple Pay, or emerging players like a Shop Pay. We’ll see what happens with Paze and some of the other plays. But it’s going to be a wallet, not a card number, in not too many years, it seems to me. That feels like an investible trend. Something really fundamental going on there.

Let’s hit another element of the space that’s really interesting to investors, which is the merchant acquiring space. And let’s talk about that in general first and then we’ll break it down a little bit and talk about one or two specific sectors of it.

Tim, I know you cover a lot of companies on the acquiring side of thing. What are you seeing going on there in terms of the higher level view of the merchant market?

Tim Chiodo: Sure. Similarly, I think we can start with the sizing and we’ll go into where the share and where the unit economics are shifting. So I’ve started out with really just three key numbers. So those three numbers are 12, 28 and 35. 12, 28, and 35.

The 12 is roughly 12 trillion or so of volume in the US. The 28 is 28 basis points of a net spread for the merchant acquiring industry. And the product of those two gets us to roughly an industry estimate of about 35 billion of revenue.

To put a finer point on that, that revenue estimate that we’re using, it’s intended as much as possible to remove any hardware sales, or value added services, working capital programs. We fully acknowledge that there’s probably some of that making its way into the number, but where we can, we try to remove those.

In terms of the yield, that 28 basis points, it’s really a tale of many cities, right? It includes the coffee shop down the street that might have a 150 basis points spread, to the large retailer that might be in the single digits, and you blend all that together and you get to sort of 28 basis points of industrywide net spread.

Let’s talk about that 35 billion of revenue that that sort of spits out. So one of the key points, and this is kind of where you were heading, Bryan, is where is that revenue shifting? The way we summarize it is about one third of that revenue already for the industry has sort of left the building, right? It’s being accrued by SaaS platforms. These are the likes of Shopify, Toast, Square, Lightspeed, Clover, and thousands of other vertical SaaS platforms. Our estimate is that about one third of that industry revenue, again, is being accrued to the software platforms. And where do we see that going?

By the end of the decade, our forecast is that will be closer to 50% of the net revenue for the industry being accrued by software platforms.

Bryan Derman: I think we’d echo that. I would’ve guessed even higher numbers just based on the work we do in embedding payments into all sorts of vertical SaaS. These days, through the pandemic, everybody has digitized, right? Used to be big companies, now your landscaper and your pool guy are fully digitized, emailing you digital invoices with pay buttons on them and all of that. So everybody’s embedded. The private equity business has really dined out on embedding payments into all their vertical SaaS companies. So that, to me, is another mega trend and obviously the private equity guys have invested heavily behind that.

The sort of crucible of this feels like it’s in the restaurant and small retail business, right, where you have these sort of hardware integrated. I know you said you tried to take hardware out of your market sizing estimates, but it’s kind of inherent to the likes of Toast and Square and Lightspeed and a big chunk of Shift4 are all embedded in these devices.

What’s your sense of what the dynamics are there? Is there enough business for all of those high quality companies to give Chris his desirable ROI and unit economics?

Chris Kim: Thanks for the question. I think there’s a premise embedded in that question, which is, is the space competitive? And you’re right, it has been and continues to be a very competitive end market, but I tend to look at this end market slightly differently from most specialists in payments. Is the company we’re talking about, just the payment point solution or is it a system of record?

And I think the companies that ultimately win will look more like vertical market software platforms, which is something you and Tim had just touched on.

Bryan Derman: So it’s the central nervous system of its vertical, right? Not just the payments.

Chris Kim: Exactly. So I mean, Toast effectively used the point of sale solution to wedge into restaurants, but has continued to broaden its feature set and has become more ingrained into multiple aspects of a restaurant’s operations.

So, for example, they have a KDS, or a kitchen display system, for chefs. They offer payroll and scheduling services to manage the employees. And they’ve got a pretty rich set of modules that help serve both the front end and the back backend of a restaurant’s operations. I think the companies that can successfully evolve into a system of record operating system, system of truth, whatever catchy phrase you want to use, will have the right to win and capture a lion’s share of the industry’s profit pool.

And one thing I really like about Toast is that it screens quite well on one of my favorite KPIs, what I call flow share, which I define as the share of an industry’s growth in a given year. And in less than 15 years, Toast has been able to capture almost 150,000 restaurant locations. A big driver of this has been expansion into new markets.

And I’d say today, public market investors are myopically focused on their core US SMB restaurant market. But personally, I’m spending a lot of my time studying their cohort curves in their newest markets where they’re seeing very positive signals. Enterprise, international, and retail.

I don’t know. I think it’s a plausible scenario looking out a decade that they have more locations in enterprise, international, and retail combined than they do in the core US SMB restaurant market.

Bryan Derman: Interesting. Yeah. And I have heard a lot of people comment that these kinds of solutions are much less penetrated outside the US. Even in Europe, they’ve had pay at the table solutions, but not in the fully integrated manner that we’re talking about here with the, the likes of Toast and Square and, others where it really is a central nervous system.

Chris Kim: In the international markets, the burden of bundling often falls on the SMB customer, which is very difficult for them given their resource base.

Bryan Derman: You have systems integrators trying to paste it all together for them. Yeah.

Chris Kim: Exactly right.

Bryan Derman: Totally see that. And I guess this goes to your point about runway, right? Even as the US starts to saturate on these solutions, we can still point to other places where they have applicability and can find growth outside the US and outside the SMB market, even within the US.

Chris Kim: I mean, I think Tim has a pretty solid framework to kind of assess whether or not the narrow runway that is US SMB restaurants is mature. He might say otherwise, and I, I’d probably would say otherwise as well.

Bryan Derman: Yeah.

Tim Chiodo: Thank you, Chris. Yeah, that’s right. So we, we did recently publish an analysis along the lines of some of the topics that Chris was mentioning. So what we did was we took the US restaurant market and we tried to back out Enterprise and we tried to back out the food trucks and just get really into that core sweet spot of restaurants for the Toast business, aside from some of their growth markets. So just isolating that core US restaurant market.

We arrive at roughly 450, maybe a little bit more, 450,000 restaurants in that core kind of US restaurant market. What we then do is we try to think about what portion of those are up for grabs or what is the jump ball per year, if you will. We arrive at roughly a hundred thousand or so. So this is a combination of market growth, churn, and new business formation, some switchers, but it all rounds to about, call it about a hundred thousand or so that are up for grabs each year.

Well, the good news for Toast is that our estimates suggest that they’re winning roughly three and half out of 10 of the opportunities. And that number was maybe two, two and a half, just a few years ago. So that win share has certainly moved higher over the last few years.

Bryan Derman: Interesting, interesting. Certainly a dominant sort of solution that’s come in. Life changing for a restaurant compared to what they may have been doing before.

To keep going a little bit on the merchant acquiring theme, in a pretty uncertain set of circumstances we haven’t seen a ton of big deals done across the economy this year, but payments almost stands out as an exception where we had some big deals. And, particularly interesting sort of interlocking set of mega deals in involving Global Payments, Worldpay, and FIS, right. And in terms of merchant acquiring, the important aspect of that was it brought together the big portfolio at Worldpay US, UK, elsewhere in the world with a similar sort of portfolio at Global Payments to create sort of the third, from a volume perspective, the third mega player alongside Chase and Fiserv in the US merchant business.

I think those three are controlling something like 75% of the dollar volume at this case. The market had some different reactions to this. I think it took FIS out of the acquiring market, brought them a little deeper into the bank based issuing market because they came away with the issuer services business that had been inside of Global, that came to Global with the acquisition of TSYS.

How are you guys feeling about this rearrangement of the payments assets among those three companies? Chris, we’ll start with you.

Chris Kim: Yeah. Obviously you have great context here for the history of kind of the combinations and the de-combinations and the re-mergers, but look, it’s great to see Stephanie and Cameron refocusing their companies on their heritage industries. So FIS, with the more software orientation, Global Payments with merchant acquiring. And actually, what’s happening in the space reminds me a lot of what transpired in media over the past decade where you began to see horizontal mega mergers as a means to drive earnings growth, especially when industry positions became more established and mature.

Bryan Derman: Yeah. Our take at the time, I think, was similar to yours. Everyone sort of, in a way, going back to what they’re really good at and maybe kind of doubling down on their traditional areas of strength, getting bigger at the things they do really well, which has a good feel to it.

Tim, what’s your take on what this does to the industry market shares and all of that? I just added the volumes up and got about 75%, but I’m sure you have a more nuanced view of what’s happening.

Tim Chiodo: Sure. Well, first I want to give you a ton of credit because almost immediately after the transaction was announced, you had a podcast episode out on this exact topic that many of us, including me, were listening to, and I thought it was great. You talked a lot about this focus and scale, and Bryan, we completely agree.

In terms of the numbers, you’re right. It’s a little bit of, sometimes we see a different story on volumes versus revenue share, just given that some of the volumes are sometimes processing only, they come at a slightly lower yield. And for this one, when we look at our estimates on that sort of true net revenue yield, we’re doing our best to adjust for gross versus net and pay ways and everything we can do to try and get things apple to apples.

We are arriving at sort of a high teens percentage for the combination of Global Payments and Worldpay of the US revenue pool. So let’s call it high teens for the new combined company in the US from a revenue perspective, a little bit higher from a volume perspective.

Couple other things we just call out, the Worldpay business in its most recent form is about 50% of that business is coming from enterprise and e-commerce, and that part is very complementary to the Global Payments business that might have had a little bit more of a skew, well, certainly had more of a skew to SMB and a little bit more of a skew to in-store.

And the other thing we were just highlighting is adding more countries. So there’s only a, you can count maybe on two hands how many companies in the payments industry can process locally in 50 plus markets. And clearly the combination of Global Payments is one of those. And quite frankly, individually, they already were.

But still, to the Global Payments business, you’re adding Japan, France, the Nordics, Middle East and Africa, and really rounds out that country presence for Global Payments.

Bryan Derman: Goes almost all the way back to the original promise. There’s so many deals inside all these companies, but when Worldpay originally merged with Vantiv, I think a lot of that got put in place, but got a little hard to realize as the deals layered on top of themselves and some of that got lost. And it’d be interesting to see it coming back and thinking of the new Global as a real a scale player with economies of scope to it also in terms of the global footprint. Strikes me as maybe underappreciated by people in the industry, but a real factor here.

Just before we leave the deal space, Chris, you mentioned your background in private equity and we have seen a little bit of churn. A couple of years ago, there were a number of fintech companies that went public. Some have been more successful than others. And we’ve been watching the space for a while to see what would happen to some of those companies.

And we started to get the first couple of deals of a go private nature where private equity, sometimes with a strategic partner, is taking some of those companies private. Avid Exchange, who’s an issuer of corporate cards and virtual cards was taken private by TPG and Corpay. And MeridianLink, who is a lending technology provider also went private. What’s sort of your outlook on this?

Chris Kim: This is a topic near and dear to my heart. As you know, my formative years of investing began at the private equity firm, Helman and Freeman. What I learned there is the foundation of my investment process today.

One aspect of my valuation process for evaluating small and mid-cap companies is assessing what a private equity firm would be willing to pay. One general rule of thumb I use is if my LBO analysis spits out a share price below the current trading price and it checks all the boxes in my investing framework, then I think it’s a good place to be hunting for a potentially good investment. Now just to be clear, the takeout premium from a PE bid is not the thesis in itself, but it’s just a signal in my evaluation process that the stock is undervalued, offers a wide margin of safety, which is investor jargon for limited downside risk.

And in preparation for this interview, I actually looked at our LBO analysis for Avid and I pulled up Cole Highland’s model. Cole is a research associate that I work with very closely, he used to work for Tim several years ago. And his first cut at the model said nine bucks per share. I tweaked it a little bit and I kind of came up with 11 and TPG and Core Pay ended up paying $10. So I’d say we were directionally close.

And just to directly answer your question, I’d say yes, there are quite a few companies in the fintech and payments adjacent sectors that are trading near or below my LBO takeout values.

Bryan Derman: All right, so let me see. If I buy Cole and sell Chris, I can make two bucks, right? 20% return.

Chris Kim: Just to be clear, he thought someone would pay $9 and I thought someone would pay $11, but the real answer was in between. It was $10, or TPG and Corpay could have paid a little more and they were able to get a pretty good deal.

Tim Chiodo: Yeah. It’s funny, Chris and I talked about this ahead of time, there was no way we were going to go on this podcast without giving some props to Cole Highland. Cole did a great job, 3 years exceptional associate on our team, and we’re really excited he’s now working with Chris and has been there many years, as Chris mentioned.

Bryan Derman: Very nice. We could go on all day, but we’re running a little short of time, but I thought we could wrap up with a little bit of a lightning round with apologies to Jim Kramer. I don’t think we want to do buy, sell, hold on some companies, but give me a sentence or two from an investment perspective as we think about a set of companies.

So I’ll call some out and we can ping pong them back and forth. So Chris what’s kind of your bottom line on Visa and Mastercard?

Chris Kim: Yeah. Happy to start with Visa and Mastercard. I think they’re the largest IAS businesses in the world, and I’m not talking about the public clout, but I’m talking about integrity as a service, the ultimate trust networks.

Bryan Derman: Interesting. Trust networks. Cool. Tim, we haven’t mentioned these guys much. Talk to me about Block.

Tim Chiodo: I’ll probably hit these more from a business model and fundamental perspective than the actual investment side. But for Block, really things are really working on both ecosystems for them, whether it’s the Square side or the Cash App side. Square’s leaning into product investment, they’re leaning into feed on the street, sales teams starting to work with ISOs, just a lot of things going in the right direction.

Bryan Derman: Yeah. Okay. Chris, what’s your take on Stripe?

Chris Kim: I’m an avid road biker, and so I’m going to use a cycling analogy. I am happy to draft behind the brothers Collison in a rapidly evolving and dynamic industry like payments.

Bryan Derman: Okay. Will they ever take it public?

Chris Kim: Ever is a really long time. So I guess the simple answer would be yes, but I hear you. I’m definitely not holding my breath for anytime soon.

Bryan Derman: I don’t have that much time left, so I better stop waiting. Tim, we’ve talked about these guys, but summarize for us on Shopify. They’re a beast.

Tim Chiodo: They are. Put them up there with Visa and Mastercard as one of the best business models across our coverage. A lot of things going right. Enterprise just starting now. There’s an in-store point of sale business. There’s the Shop Pay button that we mentioned, and really the list goes on for Shopify.

Bryan Derman: Okay. Chris, let’s talk Toast.

Chris Kim: Yeah, I think it’s looking a lot more like a system of record or operating platform, less than a payments point solution. I think if you add up all the locations that they have in enterprise, international, and retail, and 10 plus years in aggregate, those could be greater than the number of locations that they have in US SMB restaurants.

Bryan Derman: Wow. That is runway. Okay, Tim, you get the controversial one. PayPal.

Tim Chiodo: Yeah, PayPal’s got a two-sided network with 440 million users and that would be really challenging for someone to replicate.

Bryan Derman: For sure. Chris, how about Affirm?

Chris Kim: Amex 3.0 with a gold plated infrastructure led by one of the most technically gifted leaders in fintech.

Bryan Derman: Wow. Okay. Drop the mic. Okay, Tim, give one more a couple of words on Marqeta.

Tim Chiodo: Sure. Marqeta, we’re real big fans of the team over there with Mike Milotich. We think he’s doing a great job as the leader. Executing well, expanding into Europe. A lot of things going right at Marqeta.

Bryan Derman: Very good. Okay. Let, let’s just wrap up. each of you, give me a name that’s flying under the radar here. Not getting the attention it deserves from investors and maybe the industry. Chris, who do you think of in that regard?

Chris Kim: I really like the company Wise. They’re building a global infrastructure that is set up to ultimately replace the correspondent banking system. And I think Kristo is one of the most long-term oriented CEOs in the business.

Bryan Derman: He will embrace stablecoins or be eaten by them. I guess your thought is embrace, right?

Chris Kim: It goes back to the bits and zeros and ones, right? And so my original thinking would be that Kristo could actually use stablecoins to accelerate payments in markets where they can’t get direct integrations into central banks and payment systems. But remember, like I said, going back to my simple analogy, it’s the on-ramp and the off ramp.

That is the difficult part that creates the friction and potentially the delay. So it doesn’t necessarily resolve the issue of what they’re trying to achieve. So I think that’s why the stablecoin risk as it relates to their model and their strategy is a bit misunderstood by the public markets.

Bryan Derman: Very good. Okay, Tim, what’s your sleeper hit of the summer?

Tim Chiodo: I am going to go with Shift4. So they’re share gaining, they’re fast growing. They’ve got a great track record of M&A. They’re effectively bringing on customers that they can effectively use as a Rolodex cross sell, bring them onto their end-to-end platform. Shift4, we think is doing a great job. Super early international as well.

Bryan Derman: Yeah, interesting choice. I’ll just lob one in that I know sort of doesn’t fit here, but tip of the cap to Capital One as a well run bank, but a hell of a payments company. And I think we’re just seeing the beginning of what could happen as they begin to integrate Discover there.

But hey, guys, great discussion. Super lively hour here. You left me with a lot to think about in terms of the companies we interact with every day. So thanks for giving us a new perspective, different perspective on how we think about these companies. I don’t envy the amount of information that you guys need integrate and act on as investors.

And hope we get another chance to talk soon and update on some of these issues and see how some of these situations develop. So thanks so much for being with us today. In the meantime, to all of you listening out there in Payments universe, thanks so much for joining us and until next time, keep up the good work, learn new things, keep the world safe for payments. Bye for now.