Ingenico, Gemalto Morgan Stanley Leaders in Mobile Payments; Apple in the Wings
Morgan Stanley analyst Andrew Humphrey and colleagues today issued a so-called Blue Paper research note to clients on the future of mobile payments technology, as an update to a paper issued a month ago, after soliciting feedback from investors, and pondering the implications of recent data breaches at Target (TGT), Neiman Marcus and others.
The original report posited that mobile payments as a market could be worth $75 billion in technology sales annually at some point, based on about 2 billion smartphones being in use versus 1.3 billion active credit and debit cards globally. But the industry, wrote Humphrey in that note, is caught between different payment models, including well-developed kinds in Japan and Korea, and emerging models such as Google‘s (GOOG) Google Wallet, and whatever Apple (AAPL) decides to ultimately offer. Visa (V) and MasterCard (MA) are expected to maintain their dominant position in mobile payments, which will “remain unchallenged under all scenarios,” Humphrey writes.
Investors Humphrey spoke with are interested in so-called EMV, a technology that uses an embedded chip in swipe cards:
Most of the investors we’ve talked to are focusing on the potential roll-out of smartcard payment technology in the US, particularly chip-and-PIN and EMV (Europay MasterCard Visa). Questions have centered on whether the data breaches seen at Target, Neiman Marcus, and other as-yet unnamed retailers in late 2013 could accelerate the timeline for deployment of EMV. We believe the payment security questions raised by the data breaches are likely to lead to renewed focus on the US roll-out of new payment technology, including EMV, which could create a short-term earnings boost for both Gemalto (GTO) and Ingenico (ING.PA)
EMV might have prevented the Target data breach on December 19th that compromised 110 million shoppers’ accounts, writes Humphrey:
There has been much discussion around this. Consensus is that EMV would have partly prevented the Target breach – or at least have made the theft of payment card details significantly less likely (and less valuable). When a traditional magnetic card is swiped, the cardholder details contained in the magnetic stripe (similar to a VHS or cassette tape) are transmitted into the terminal, where they are encrypted using Payment Card Industry (PCI) standards. If the terminal has been compromised, card data can be stolen or ‘skimmed’. With an EMV card, the chip embedded in the card employs cryptography and other security features to protect cardholder information. The ability to combine the chip with a secure PIN (which can be verified offline), as well as the back end infrastructure, mean that EMV has reduced fraud substantially in markets where it has been introduced. Discover Financial Services stated in 2013 that the EU has seen an 80% reduction in credit card fraud since EMV was introduced, while the US has witnessed a 47% increase over the same period. The US is one of the last markets globally (other than China) to introduce chip card technology.
Humphrey predicts some speed-up in the use of EMV in the U.S. given that both Visa and MasterCard have noted that retailers who don’t use the technology come October 15th could be liable for charges of fraud in the event of a breach.
He thinks Ingenico of Paris is one of the big potential beneficiaries, with replacement of point-of-sale terminals, while Gemalto may benefit from issuance of new cards with chips in them:
Among our coverage, we believe Ingenico is best positioned for growth in the US EMV market. POS terminal shipments are 65% of revenue for Ingenico, where Gemalto’s banking business is ~25% of the Group total. In addition, we believe Ingenico could benefit from growth in market share in the US following recent deals. Gemalto market share is likely to be lower in the US than in the rest of the world, at least initially [...] In a bull case for Ingenico the company could win a market share of 40%, on an addressable market of 2 million POS terminals per year. In this scenario Ingenico could ship 800,000 terminals into the US, compared to current US shipments of ~200,000, and global shipments of around 6 million terminals. In practice, the addressable market could be larger, as growth of wireless terminals in the hospitality sector grow the addressable market and installed base. In any scenario the opportunity for additional terminal shipments is material [...] Gemalto is a leading supplier of chip cards globally, we estimate with around 50% market share globally in smartcards used in the banking sector (chip-and-PIN cards). We estimate a total installed base of credit and debit cards in the US of 1.5 billion. The typical replacement cycle for bank cards is 3-4 years, which is consistent with annual card issuance of 400-500m (likely higher once store cards are taken into account). Gemalto’s market share is likely to be lower overall in the US market, and management has stated is will likely partner with local card issuers. We believe a market share of 30% would not be out of the question. Applying our estimate for Gemalto ASPs of €0.85 in 2013, this could be a €100-130m revenue opportunity on total FY13e revenue of of €2.4 billion (so 4-5% revenue opportunity).
Of course, Humphrey and his team also speculate about an imminent arrival of Apple in the payments market:
Recent comments by the company indicate increased likelihood that Apple will launch a mobile payments platform. CEO Tim Cook commented on the December quarter earnings call and since then in the Wall Street Journal that the company plans to launch new product and services categories in CY14. When asked directly about mobile payments on the earnings call, Cook said that customers want to purchase content using Touch ID (the fingerprint sensor) because it is simple, easy and elegant. Currently, Apple allows users to purchase content from the iTunes and App Stores using their fingerprint but the technology is not available to third-party applications. Cook also said he saw more opportunity in this area, especially when given the demographics of Apple’s customers and the amount of commerce that goes through iOS devices versus competing platforms. Apple and others are creating an ecosystem of beacons. In recent months, we have seen trials and adoption of beacons and Bluetooth Low Energy (the 4.0 standard). This network of beacons will be essential to a simple and easy-to-use mobile payment network, in our view. In fact, there could be many applications, such as to deliver advertisements or public information, and to locate something or someone indoors. We believe Apple will unlikely launch a mobile payment system unless the supporting infrastructure is ready, based on its historical behavior, since it does not want users to have a frustrating experience with an incomplete network [...] Management has been clear that it plans to monetize future services, and we believe that likely includes mobile payments. Recode.net recently reported that ebay (covered by Scott Devitt) approached Apple to discuss using PayPal as the foundation for Apple’s payment service. According to sources cited in that article, Apple is unlikely to partner with ebay. If this is true, we believe it further suggests Apple is looking to build its own infrastructure where it can control the whole system, collect more user data, and importantly retain all the economics from the service.