Wednesday, September 7, 2016

Business Insider: 'The 800 pound gorilla': A hedge fund manager explains why a $200 billion company is set to take off

Dan Chen, CEO of hedge fund Talguard Investments, knows a thing or two about investing.

He has been a professional investor for almost 20 years and has worked on the sell side in investment banking as well as on the buy side in private equity and fund management before founding Talguard eights years ago.

SumZero sat down with Chen to learn about his search for permanent value in great companies and why Visa is his top pick for a great investment opportunity.

Chen argues that the "800 pound gorilla" nature of the company combined with a huge opportunity for international growth in China create a "perfect storm" of a great investment.Read below for his top reasons on why Visa represents a long term growth opportunity:

Photo of Visa credit cards.
(Photo credit: Justin Sullivan/Getty Images)

SumZero: What about Visa initially caught your attention as a value investor?

Dan H. Chen, Talguard Investments:  I have been following Visa and the card payment industry for years. Visa reorganizing and becoming public in 2008 caught my eye. I do not invest in IPOs because they are usually a transfer of wealth to private shareholders. I waited patiently for the right moment to strike, and that moment came in 2010. Visa has many qualities that I like. It has long term operating history having started by Bank of America in 1958, it has growing and consistent cash flow, and it is the 800 pound gorilla in an oligopoly industry. Visa was able to grow successfully without any leverage prior to reconsolidating Visa Europe, and has many durable competitive advantages that I seek in a quality stock. This investment has produced an average return of over 20% a year for the past 6 years, and it will be a strong investment for years to come.

Logos of China UnionPay are seen on bank cards in this photo.
Logos of China UnionPay are seen on bank cards in this photo. 
(Photo credit: illustration taken in Beijing Thomson Reuters)

SumZero: What is the market missing and why? Visa is a huge company closely followed by millions of investors; how could it possibly be undervalued?

Dan H. Chen, Talguard Investments:  In 2010, America was in the midst of the deepest recession in history due to the financial crisis. The market crushed Visa's stock because it is a financial services company; it was the proverbial "baby that got thrown out with the bath water". Visa has continued to grow cash flow and grow its card network around in the world even during the recession. By contrast, most companies took a big hit on cash flow and lost some business during that period. Most investors do not do the diligence I do for my investments. The average mutual fund manager holds close to three hundred stocks with the average stock position held for less than a month. That is a turnover rate of over 1,000% a year. In other words, they buy and sell so much with so many stocks, they could not possibly know the level of detail required to make a concentrated investment even in a famous company like Visa.

The market has missed the China catalyst as follows: over a decade ago Chinese citizens could only get a Visa debit card. Then the Chinese government allowed Visa to issue joint credit cards with China UnionPay. In 2014, the World Trade Organization ruled China must allow foreign payment card companies to process card transactions of joint cards in China. At the beginning of June 2016, Visa received the initial application to open its own payment center and network in China. It will take Visa one to three years to get this new network started. Eventually, I can see Visa issuing their own stand alone cards which would be the end game. These decades long catalysts are precisely I seek and what the short term minded market does not care as much about.

Photo of a woman making a purchase with a credit card.
According to Chen, Visa has new catalysts that did not exist in 2010.
(Photo credit: Facebook/Visa)
SumZero: Is Visa still attractive to buy at today’s prices?

Dan H. Chen, Talguard Investments:  The Market is still missing new catalysts and it underestimates the known catalysts that will drive Visa's growth. The stock is more expensive than 2010, however, Visa has new catalysts that did not exist in 2010.

Photo of a Costco store.
Visa is the only credit card allowed at Costco stores. 
(Photo credit: Tim Boyle / Staff / Getty Images)

SumZero: What makes Visa any better than Mastercard or other cards? It seems like there is almost no discernible difference to consumers. How does Visa maintain margins? Where does the real competitive advantage lie?

Dan H. Chen, Talguard Investments:  Most people cannot tell you any difference between Visa and MasterCard, but Visa has large and subtle differences that the market misses. Visa has much bigger scale of volume and transactions than MasterCard. Visa has a 70% market share of the U.S. Debit Card market. Visa Checkout is much larger than MasterCard's MasterPass on a customer basis. On a more subtle scale, Visa has a 12 month exclusivity agreement with PayPal to place Visa side-by-side for their customers' checkout pages. Visa's much larger size gives it more weight in negotiations. Visa is the only credit card allowed at Costco stores; that is over $70 billion in sales that is exclusively for Visa.

Visa has a greater percentage of sales in the U.S. than MasterCard and that means Visa has a tremendous opportunity in the future for international growth. Visa processes more volume than MasterCard, AmEx, and Discover combined. Lastly, MasterCard has been trying to increase its domestic business with a concerted effort, and they have not been able to dent Visa's market share.

Photo of a woman standing next to a Visa Chase sign.
Apple Pay uses Visa’s card network.
(Photo credit: Bryan Thomas/Getty Images)

SumZero: Does Visa have to worry much about competition in the wave of new payment systems such as Venmo, Android/Apple Pay, Bitcoin, etc.?

Dan H. Chen, Talguard Investments:  Visa has such a large scale that no one else can match for payment systems. Android and Apple Pay both use Visa's card network so Visa has the upper hand. Venmo is owned by Paypal and makes no money. The recent agreement by Paypal and Visa shows that Paypal capitulated to Visa. Bitcoin is unregulated and highly risky for the mainstream. Look what happened to the largest Bitcoin exchange, Mt. Gox in Japan. In one hack, cyber thieves stole over 90% of the bitcoins on that exchange. The Bitcoin owners have no recourse. Visa has no such problems. Bitcoins themselves are not going to be mainstream for payments. Also, with respect to technological innovation, Visa is not sitting still. Visa Checkout is now accepted by millions of merchants, and Visa invested in Square.

Photo of two toy soldiers and credit cards.
Chen sees regulations as both a risk and a competitive advantage for Visa.

SumZero: What were the biggest risks associated with the trade in your view?

Dan H. Chen, Talguard Investments:  The three largest risks are disintermediation, litigation, and regulations. I addressed disintermediation above. Litigation and regulation often go hand-in-hand. American retailers have sued Visa and its brethren over interchange fees. Visa has won significant cases in the past and it has already settled debit card fees. There is one outstanding lawsuit which has been ongoing for a decade. At some point it will be settled. I see regulations as both a risk and a competitive advantage for Visa. It has successfully worked with hundreds of government regulatory entities across the world. A startup will have to invest tremendous capital just to work with regulators worldwide if they want to set up a global payment network like Visa.

Photo of Warren Buffett.
Chen is a disciple of Warren Buffett.
(Photo credit: Paul Morigi/Getty Images for Fortune/Time Inc)

SumZero: Is this thesis representative of the Dan Chen investing style?

Dan H. Chen, Talguard Investments:  Yes. Visa is a perfect example of investment philosophy. My Visa investment reflects my patience and ability to identify long term catalysts purchased at a reasonable price. I skipped investing in Visa's IPO because I avoid IPOs. I waited patiently for two years and stuck in 2010 when Visa's valuation was depressed since it is a financial services stock. Visa continued to grow cash flow even during the Great Recession and it has many other qualities I like. This investment has produced a multi-year compounding return since 2010.

Read the full article on Business Insider.

Original article on SumZero:
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