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The News

MasterCard

American Express

The agreement removes a major legal overhang for the world's second largest credit-card network, which was accused along with industry leader Visa of anticompetitive practices. An AmEx lawsuit alleged that MasterCard and Visa prevented banks from issuing American Express credit cards.

Purchase, N.Y.-based MasterCard plans to take a $1 billion after-tax charge in the second quarter. The maximum settlement amount is $1.8 billion, the company said. MasterCard will pay up to $150 million in each of 12 quarterly payments, depending on the performance of American Express's U.S. Global Network Services business. Wall Street's consensus earnings estimate for the quarter now stands at $2.04 a share, a 42% jump from the $1.42 profit the previous year.

"We are pleased to have reached a settlement with terms that will enable us to keep our strong balance sheet intact, so we can continue to build on our exceptional business results and vigorously pursue our strategy," said Chief Executive Robert Selander. "Eliminating the uncertainty, time commitment, and expense of a prolonged court case is in the best interest of our shareholders, our customers and our management team."

The card processor's stock has soared 82% in the last year, despite broad-based economic woes, as Americans tap into personal credit and the company continues its vigorous expansion.

Shares of American Express remained flat after the settlement was announced. Chief Executive Kenneth Chenault said the money coming from MasterCard would be helpful since AmEx is being hit by a rash of late payments.

"The antitrust settlement we've reached with MasterCard provides us with a multiyear source of funds that should, among other things, help to lessen the impact of this weakening economic cycle," Chenault said.

MasterCard and Visa also face a similar set of accusations from Discover Financial Services, which has a $6 billion lawsuit set for a September federal court trial in New York.

The Analysis

Taking a nearly $2 billion hit wouldn't sound like good news for any company, but it's a welcome relief to MasterCard's many fans on Wall Street.

Fox-Pitt Kelton Cochran Caronia Waller analyst Howard Shapiro wrote that it clears the way for the company to keep up its robust growth, eliminating one major legal tussle and implying limits on the damage MasterCard might suffer in its continuing battle with Discover.

"We regard the settlement with American Express positively, because it removes to a large extent the uncertainty regarding the size of legal settlements with American Express," he wrote Wednesday. "We believe it also puts a soft cap on the legal liability with Discover, which we expect will be far less that what MasterCard will pay American Express."

Anurag Rana, at KeyBanc Capital Markets, echoed many Wall Street analysts with his view that while the financial hit to MasterCard is significant, it's about what observers expected, and the company has the resources to deal with the 12 quarterly installments it agreed to pay AmEx.

"We expected MA would end up spending at least $1.5 billion on this case, based on Visa's previous settlement with American Express of a maximum payment of $2.25 billion," he wrote Wednesday. "While this amount of money is significant, we believe MA has ample cash ($1.87 billion in cash and equivalents, $790 million in short-term investments, and a net cash position of roughly $2.5 billion as of 1Q08) to fund this settlement."

With projected annual revenue growth of 21% this year and 14% in 2009, when MasterCard is expected to notch $5.6 billion on the top line and earn $10.99 a share, the end of the legal muddle is very welcome, says Macquarie Research analyst Ben Stretch.

"The pop today just reflects the unwind of one of the few overhangs for MasterCard," he says.

The Bottom Line

Both card networks are Wall Street darlings because they don't carry the same damaging baggage as other financial stocks, and are seeing huge overseas growth. Wednesday's settlement deal helps put MasterCard on a more equal footing with Visa, though both face the same hazard of a protracted U.S. economic slump, which could do some real damage to growth.

"Investors have loved them because they've been safe havens when they can't buy any other financials out there," Stretch says. "They don't have any credit risk and they don't have any subprime mortgage risk." MasterCard and Visa don't issue credit cards directly, but rather license their brands to banks and process charge payments.

Now that MasterCard has settled the same issue as Visa, he says that eliminates the rationale for the No. 2 card network to trade at a discount to the No. 1 network.

"It existed because of the relative litigation risk of MasterCard to Visa," although the larger company has other advantages, including a bigger share of the Asia-Pacific market. "Now people are saying the disparity shouldn't be as large as it is."

But big-picture factors could crimp the effects of foreign growth on both companies, and might even offset those global gains.

"People are going to be at their credit limits, and issuers aren't going to be extending customers more credit," Stretch cautions. "That will limit the size and number of transactions, and that could, at least in the short term, limit what's happening overseas."

But until the bill for the slowdown arrives, MasterCard investors can still cash in.

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