Dec 10, 2006

Does Wall Street understand the risk of severe interchange cuts?

MasterCard Europe just announced that they will lower debit-card interchange fees by 60% in response to pressure from European Union regulators (see the Wall Street Journal and Forbes).

The news had no impact on MasterCard’s share price. Wall Street loves the stock.

Analysts keep warning investors that interchange fees could drop substantially, but the stock keeps rising. Check out this article from last July. A Credit Suisse analyst said that concerns about the merchant lawsuits could lead to a reduction in interchange fees for big card issuers. The article should have also made it clear that if banks get less interchange on MasterCard branded products, many would switch their cards over to higher interchange brands like American Express, a trend that is already happening in lots of places. A Goldman Sachs analyst said that merchant dissatisfaction has prompted MasterCard to give more rebates to merchants, as a way to reduce interchange fees without impacting banks' revenues. MasterCard's merchant rebates have increased by 64 percent in 2005, according to the analyst.

Still, the stock keeps rising. From around $40 a share last June to almost $100 today. Investors are valuing MasterCard at a P/E multiple of around 30, much higher than American Express's P/E valuation of 19.

Do investors understand the risk of dramatic interchange fee cuts and are they factoring it into the share price already?

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