Feeling Little Better for Potential Merchant Litigation Outcome: Analyst

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Adekunle Adetiloye is alleged to have masterminded one of the biggest credit card frauds in US history.
Adekunle Adetiloye is alleged to have masterminded one of the biggest credit card frauds in US history

Jefferies feels incrementally better about its base case for potential merchant litigation outcomes as it relates to "buy" rated Visa Inc. (NYSE: V) and MasterCard Inc. (NYSE: MA).

"We believe that while some type of credit interchange reduction is plausible as part of a settlement, this is much more likely to be temporary than permanent. So while litigation chatter may cause periodic volatility in the stocks, we believe the ultimate outcome will be manageable," said Jason Kupferberg, an analyst at Jefferies.

The merchant litigation is being presided over by Judge John Gleeson, who also oversaw the Wal-Mart/Honor All Cards case which settled back in 2003. Kupferberg said his research suggests that based on the judge's approach to driving a settlement in that case, it is probably fair to assume he will work towards that outcome as well on the current litigation.

And in the spirit of working towards a settlement that both sides can tolerate (rather than one that either side is thrilled about), Kupferberg believes it is realistic that a settlement of the current case could include a temporary cut in U.S. credit interchange rates. This cut could be roughly 33 percent and may last about one year (he noted the settlement of the Wal-Mart case included a five-month cut to debit interchange).

Opinions vary, but in general the analyst continues to hear from his contacts that the monetary component of a potential settlement could be in the range of $5 billion to $15 billion. He believes this would be a very tolerable outcome, with MasterCard writing a check for 12 percent of the total (i.e., $600 million to $1.8 billion) and Visa unscathed from a financial perspective.

"In our opinion, if a one-year credit interchange cut is accompanied by repeal of the networks' no-surcharge rule (likely, though probably not too impactful) and monetary settlement in the $5 billion to $15 billion range, we believe that would be a neutralish to slightly negative outcome for shares of Visa and MasterCard," said Kupferberg.

While investors obviously wouldn't be pleased to see credit interchange rates lowered, Kupferberg believes this would be largely offset by the temporary nature of the cut and putting an overhang behind.

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