Apart from Google, Visa is the best business model we have ever seen. It is essentially a royalty on global spending. Visa is the ultimate network effects business, with retailers dependent upon the vendor with the most users (billions of Visa cards issued) and users wedded to the vendor with the most points of purchase (over 44 million merchants). This has resulted in deep integration within the payments ecosystem. Visa accounts for nearly half of all credit card transactions.

Despite its dominance, we expect Visa to experience sustained double digit earnings growth. The secular shift away from cash and checks is in early innings with 85% of global transactions still conducted by cash and check. The migration to plastic/electronics payments should accelerate in coming years with consumers eager to adopt the convenience and security that electronic payments provide, as well as the perks. Enhanced competition among credit card issuers has resulted in a dramatic rise in credit card rewards with the six largest issuers offering over $100 billion worth of rewards over the past six years.

The proliferation of digital payment options, such as Apple Pay and Google Wallet, as well as an increasing share of wallet for e-commerce, should drive increased volumes for years to come. Paradoxically, the growth of mobile payments has weighed on Visa’s valuation as many market participants view payment by mobile phone as a threat to Visa’s business model. Most mobile payment networks, however, utilize Visa’s and MasterCard’s networks. It is easier for Apple to partner with Visa, and its relationship with 17,000+ financial institutions and 44 million merchants, than it is to traverse the regulatory quagmire of establishing a financial network on its own.

There is also the issue of trust, the largest barrier to widespread adoption of a new payment network. Apart from being the global standard of electronic payment – “It’s everywhere you want to be,” Visa has spent billions over decades building its brand. According to Interbrand, Visa is considered the 61st most valuable brand in the world, just ahead of Starbucks. Customers know their finances are secure when using Visa and that the card will be accepted almost anywhere.

As a software based business, Visa can grow with only minimal increased capital investment. As a result, incremental margins inflect higher due to tremendous operating leverage. Increased volumes should bring other benefits as well with Visa poised to reap new ancillary revenue streams through the packaging of data analytics for financial and merchant clients.

Apart from attractive long-term trends there are two medium-term trends, which we think will bolster Visa shares: Visa Europe and increased uptake in India. Visa acquired Visa Europe last year and is early in its integration efforts. Analyst models only expect modest accretion from the deal, but we believe results will surprise on the upside and offer a multi-year earnings catalyst. Credit card penetration in Europe is low at 40% relative to 55% in the U.S. In addition, Europe offers low-hanging fruit for margin optimization. Visa’s fee structure in Europe is well below the Visa network average at $0.055 per transaction compared to $0.21 in the rest of the world.

As for India, Prime Minister Narendra Modi’s decision to remove high value currency notes from circulation should accelerate development of electronic payments in the country. Mr. Modi’s decision was made to curb tax evasion and root out corruption. Nonetheless, the long-term implications of demonetization are profound. India’s war on cash has effectively taken out 86% of the total cash in circulation in an economy that is 90% cash reliant. We don’t expect credit card usage to surge overnight with existing electronic payment infrastructure nascent. However, with limited ability to transact in cash, migration to electronic payment is inevitable. A massive catalyst to jumpstart credit card usage in one of the most populous, fastest growing economies in the world, positions Visa well for sustained double digit growth.

Visa is currently priced at 22x earnings, in line with its historical average. We think analysts are not properly modeling the opportunity for pricing power in Europe, but that aside, Visa is emblematic of what we want from all our holdings, a company that does the compounding for you. This is far preferable than recycling our holdings every couple of years.

Visa is also an example of studying our mistakes. The company is one of our all-time great errors of omission. We did a fair amount of research on the company prior to its IPO but decided to pass due to concerns over valuation. We watched the shares rise by nearly 5x over ensuing years.

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The above post has been excerpted from a letter to partners of Coho Capital Management.

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