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Chip-and-PIN ... Don’t Leave Home Without It

I spent most of last weekend planning an upcoming trip to Europe (Prague, Munich and Amsterdam). I reserved a rental car, found a couple places to stay... and looked into getting a new credit card. I already have credit and debit cards that don’t charge foreign transaction fees, which is important...

I spent most of last weekend planning an upcoming trip to Europe (Prague, Munich and Amsterdam). I reserved a rental car, found a couple places to stay... and looked into getting a new credit card.

I already have credit and debit cards that don’t charge foreign transaction fees, which is important to me as a frequent traveler, but last time I traveled in Europe, I ran into problems using them. In grocery stores, cashiers asked me to enter a mysterious PIN number for my credit card, and in train stations ticket machines spit my card back out.

That’s because the machines were looking for something that wasn’t there. In addition to the familiar magnetic stripe on the back, most European credit and debit cards now have an embedded microchip called an EMV (for Europay, MasterCard and Visa) or smart chip. The embedded chips are more durable and, more importantly, more secure than the magnetic stripes. As a New York Times reporter wrote in an article last June:

“Over the last decade, such cards (commonly referred to as chip-and-PIN cards because users punch in a personal identification number instead of signing for the purchase) have been widely adopted in Europe as a means to reduce credit card fraud; the information stored in the magnetic strips used in traditional cards can be stolen fairly easily. E.M.V.-enabled chip cards, requiring a PIN for authentication, are harder to counterfeit and are becoming the standard in other regions, including Canada, Latin America and the Asia-Pacific region. More than a third of the world’s payments cards (approximately 1.2 billion) are E.M.V. capable, along with roughly two-thirds of cashier terminals (18.7 million), according to EMVCo, the standards body owned by American Express, JCB, MasterCard and Visa.”

Unfortunately for me and other American travelers, almost none of those 1.2 billion chip-and-PIN cards have been issued by U.S. banks. A few pilot programs sprung up over the past year or so—Wells Fargo offered chip-and-PIN cards to 15,000 frequent international travelers, and JPMorgan Chase introduced a chip-and-PIN card for its high-net-worth clients—but most of us are still out of luck.

And with most of Europe already converted, our old-school magnetic-stripe cards are increasingly getting rejected by machines that only read microchips (like those used to buy train tickets, borrow public bikes or pay at unattended parking garages) and cashiers who only know how to process a chip-and-PIN card.

I gave up on getting a new credit card for this trip; I’ll just have to carry cash. However, there’s a chance I might be able to get one by the next time I go on vacation.

As I learned while putting together the most recent Investment Digest, MasterCard and Visa are both working to transition America to chip-and-PIN cards beginning in 2013. Since the main stumbling block is merchants who don’t want to upgrade their payment processing equipment, both card issuers plan to employ a combination of carrot-and-stick incentives. According to a Dow Jones Newswires story from late last month:

“MasterCard plans to shift liability starting in October 2015 to merchants who have not upgraded their checkout equipment to process transactions made with chip-based cards if a customer pays with such a card and fraud occurs, [a MasterCard rep] said. Banks currently pay for most card-fraud costs.

“The company will also allow merchants to reduce some security-audit activities if they upgrade to certain EMV terminals. That relief would phase in beginning October 2013. However, they must still be in compliance with the security requirements.

“MasterCard is urging banks that issue its cards to adopt the standard, and will hold them liable for some forms of card fraud if they have not issued chip-based cards to their customers, depending on whether a merchant has EMV terminals.”

Visa is taking similar action, according to the story, but its “security incentive is set to kick in this October and its liability shift is scheduled for October 2015.”

As I mentioned, I first learned about these incentives last week, while putting together the Investment Digest. The issue’s Spotlight Stock is a company that will be one of the prime beneficiaries of a U.S. transition to chip-and-PIN cards. That’s because this company makes the equipment—card readers and the software they run—that merchants use to process credit cards. It’s already growing fast thanks to global credit card adoption—the stock was previously recommended in the September 15, 2010, Investment Digest, and climbed 73% between the first recommendation and last week’s. (At the time, it was recommended by The Periscope Report edited by Tom Byrne and the now-closed Double-Digit Trading.) Chip-and-PIN card adoption in the U.S. should just be a turbo boost to its growth. Here’s Ian Wyatt’s recommendation of the company, from Top Stock Insights, as it appeared in the Investment Digest:

VeriFone Systems, Inc. (PAY) provides retail electronic payment devices that process debit and credit cards. Next time you’re at a gas station or department store, take a look at the machine that reads your card. With 20 million locations globally, chances are that machine was provided by VeriFone. But VeriFone does more than put their name on the machine. VeriFone produces the systems, software and services that enable the acceptance and processing of electronic payments for goods and services. In other words, your credit card would be as worthless as a used envelope without them. As the world transfers its payment method away from cash and check and toward debit and credit cards, VeriFone will be there to provide the infrastructure for the payment systems. Though growth in the U.S. is saturated, electronic payment systems are just beginning to gain ground around the world, as processing costs decline and card availability increases.

“Another key driver for VeriFone over the next few years is payment by mobile systems. These mobile systems are designed to increase security and decrease the time it takes to complete transactions. In November 2010, the three largest U.S. mobile network operators—AT&T, Verizon and T-Mobile— announced a joint venture branded ‘Isis.’ When the three biggest mobile carriers see an opportunity, you should too. The stated goal of Isis is ‘to build a nationwide mobile commerce network utilizing smart phone and near-field communication technology.’ ... In addition to the opportunity presented by Isis, VeriFone’s strategic relationship with Google will also bring success from the growth in mobile business and with near-field communication (NFC). Google Wallet was introduced last year and has been adapted by 40,000 retail sites across the country. Instead of using a traditional card that ‘swipes,’ consumers use smart phones to pay. NFC is the payment method likely to take hold in the future.

"[Near-term,] the biggest driver for growth this year is EMV smart card adoption. ... In America, most cards still use magnetic strips that are scanned at the cash register. But those stripes are not durable and pose a security threat. Most new cards outside of the United States make use of smart cards, which assist operability and enhance global consumer security. Customer data is stored in a chip with encryptions that make it harder for hackers to gain personal data. It also isn’t subject to the wear and tear of the stripe, so the card is more durable.

“MasterCard is urging banks that issue its cards to adopt the new standard and will hold them liable for some forms of card fraud if they have not issued smart cards to their customers by 2013. Visa has made a similar overture to banks, although it isn’t holding their feet to the fire until 2015. MasterCard also went another additional step further than Visa to expand smart card use. MasterCard will provide financial incentives to clients who adapt chip card technology and ditch the old-school magnetic stripe.

“A move to chip card technology by merchants could also advance mobile-payment equipment. The terminals that handle smart cards also are compatible with systems that allow customers to tap and pay with a smart phone embedded with payment technology. After consumers realize the usefulness and better security behind these new payment technologies, the emergence of chip cards and smart phone payment systems will spread quickly. And VeriFone will be there to upgrade or install new electronic payment systems for merchants.

Recent Performance

“In stark contrast to the sluggish global economy, business at VeriFone was excellent. VeriFone reported a 30% increase in sales in 2011 as net revenues rose to $1.3 billion from $1 billion a year ago. Management also reported impressive earnings growth last year, as EPS expanded 70% to $1.92, from $1.13 in 2010. VeriFone claims nearly $600 million in cash equivalents too.

“Analysts are no less optimistic about the growth prospect for VeriFone in 2012. Consensus sales estimates call for a 48% increase in 2012 to $1.92 billion while EPS is expected to expand to $2.58. In 2013, sales are expected to increase another 15% to $2.2 billion, while EPS should increase to $3.22.

“Shares of VeriFone made a nice 21% gain in January 2012, but I think more is on the way. VeriFone operates in a high-growth industry that will remain in high demand for years to come. In the more immediate term, the news from MasterCard should act as a boon to sales and profits alike. Shares should have no problem hitting my $53 target price this year, riding the tailwinds of a strong trend away from cash and to cards. Whether you pay by cash or credit, make sure you purchase VeriFone stock before it’s too late.”

VeriFone will announce earnings again on March 5. Technically, the stock has recovered from its last post-earnings drop in December, and if it reacts positively to the coming earnings announcement, the last few months’ action could serve as a nice base for a strong upmove. The risk-averse will want to wait to see a positive reaction to earnings before buying in, but the stock may be more expensive then.

Wishing you success in your investing and beyond,

Chloe Lutts

Editor of Investment of the Week

Chloe Lutts Jensen is the third generation of the Lutts family to join the family business. Prior to joining Cabot, Chloe worked as a financial reporter covering fixed income markets at Debtwire, a division of the Financial Times, and at Institutional Investor. At Cabot, she is a contributor to Cabot Wealth Daily.