MasterCard legal woes persist
MasterCard is facing some legal challenges, including one looking to unwind its IPO. Should investors be worried?
NEW YORK (CNNMoney.com) - MasterCard shares have been on a tear since its highly anticipated initial public offering late last month but legal concerns continue to hang over the company, an issue that could give investors a reason to proceed with caution.
Earlier this month, a group of merchants challenged the legitimacy of the company's IPO and are now looking for a federal judge to unwind MasterCard (down $0.35 to $44.67, Charts)'s public offering. For the credit card company, it's the latest in a string of litigation concerns facing MasterCard. But for investors, who have helped lift MasterCard 16 percent since its debut, it highlights the inherent risk of buying into the credit card giant.
At the heart of the matter are interchange fees -- those fees received by issuer banks within MasterCard's network. MasterCard and its privately-held competitor Visa receive separate fees in order to process credit card transactions but do not receive any portion of the interchange fees. But merchants from around the country, who are suing MasterCard and Visa, claim that the companies colluded with the member banks that issue the cards to set inflated fees, leaving merchants with little choice but to accept the high charges. (See correction.)
In the latest legal move, attorneys for the merchants plan to file a supplemental complaint at the end of June with a federal court in New York asking the court to unwind MasterCard's IPO, saying that the $2.9 billion offering was an attempt by the company to insulate itself against antitrust liability.
MasterCard, for its part, contends that the original lawsuit regarding interchange fees is "without merit," according to a statement on the company's website. And Sharon Gamsin, a spokeswoman for MasterCard dismissed the latest complaint over the IPO saying "class action attorneys often make ludicrous statements."
A clever move
But by selling shares to the public, critics contend the liability burden falls on investors while MasterCard protects itself.
"Firms often do things that try to minimize legal exposure," said K. Craig Wildfang, lead attorney representing the merchants and partner at Robins, Kaplan, Miller & Ciresi LLC . "I give them credit for being very clever about it."
In essence, collusion requires more than one party to be involved. Prior to the IPO, MasterCard and the member banks that issued cards on its network set an interchange fee together, giving critics grounds to say that there was a conspiracy to fix higher prices. But by becoming a single entity through the IPO - as opposed to an association of member banks - it makes it difficult for plaintiffs to point to multiple parties that were involved in a conspiracy. Wildfang said MasterCard is hoping to argue that it can't be subject to antitrust law as a stand-alone company.
But Wildfang said attorneys for the merchants will argue that the act of member banks selling off a significant amount of assets in the credit card business to a single company will harm competition - making it a violation of antitrust laws.
While he conceded that he's not aware of any other case of a company's IPO being unwound on this basis, "it's up to the court and jury to determine whether or not these [actions] are anti-competitive."
He added if the court finds in favor of the merchants in their overall lawsuit, they will seek damages in the "tens of billions of dollars."
While that figure could strike fear in the hearts of investors, analysts aren't so quick to run from the stock.
Complaints are overhyped
Dan Schatt, senior analyst at independent research and consulting firm Celent LLC, said it was unrealistic to believe that a judge would find a reason to unwind the IPO. While he said the company could face damages of about $5 billion, Schatt said that much of the merchant lawsuit regarding interchange fees "is overhyped."
He added that MasterCard, as a public company, could actually over time stand to benefit merchants by allowing them the opportunity to hold stakes in the company.
"As a public company it can potentially be more merchant friendly," Schatt said. "A more merchant friendly stance will take out the hyped law suits out there."
And for investors, MasterCard presents a solid financial opportunity, said Craig Maurer, managing director at Fulcrum Research.
"Fundamentally, aside from any legal risk, MasterCard has fantastic growth in front of it," he said.
Maurer said the company expects consistent revenue growth of 8 percent to 10 percent and earnings per share growth of 15 percent to 20 percent going forward. He added that MasterCard has enormous opportunity to gain market share internationally in markets that don't use credit cards yet - potential that should appeal to investors.
Some bumps in the road
But he warned that it could be a bumpy road for the company next year.
"The IPO insulates them from future accusations of pricing collusion but that they remain open to litigation regarding past practices," he said.
While that includes the merchant lawsuit, he said there are larger concerns regarding other lawsuits from American Express (down $0.31 to $52.61, Charts) and Discover Card, the credit-card division of Morgan Stanley (Charts).
In 2004, MasterCard and Visa lost a landmark case before the Supreme Court that voided rules banning members from issuing cards from rivals like American Express and Discover, calling it an anti-competitive practice.
Subsequently American Express and Discover Card filed lawsuits against both MasterCard and Visa to recover billions of dollars in revenue they contend was lost due to the prior practice of blocking member banks from issuing cards on rival networks.
"Investors see the American Express lawsuit as a larger issue," Maurer said. "I think MasterCard is a good investment but I do think that you might need to have a strong stomach next year when, for instance, American Express completes discovery of their lawsuit."
Still, analysts said the litigation risk is embedded within the stock, which had an IPO price of $39 - below the $40 to $43 range that was originally forecast. And while the stock is up about 16 percent since its debut, it's down 10 percent from its high of about $50.
"The company is going to be able to grow regardless of market share at healthy rates and show good returns," Maurer said. "With the stock pullback, it's at a healthy buying opportunity right now."
Related: MasterCard IPO: Not so priceless