24 April 2019 | 10:53PM JST The following is a redacted version of the original report. See inside for details. Japan Financial Services Japan Cashless: Credit cards remain front and center Japan has made slow strides toward a cashless society, lagging behind other Taiki Okada +81(3)6437-9917 | [email protected] developed economies. However, with new modes of electronic payments such as Goldman Sachs Japan Co., Ltd. contactless payments/QR codes and the government’s support, including subsidies Katsunori Tanaka +81(3)6437-9973 | to cashless operators, we see a structural shift towards cashless payments [email protected] Goldman Sachs Japan Co., Ltd. among consumers. Within this report, we look at the various factors affecting Masaru Sugiyama consumers, retailers and cashless operators and try to answer four key questions: +81(3)6437-4691 | [email protected] Goldman Sachs Japan Co., Ltd. 1) What is the scope of increase in cashless transactions? We forecast cashless Sho Kawano +81(3)6437-9905 | [email protected] payments to double to ¥120 tn by 2025E from ¥60 tn in 2017, driven by growth in Goldman Sachs Japan Co., Ltd. e-commerce and a rising weight of offline cashless transactions, especially following Masatomo Okawa +81(3)64379931 | the recent uptick in contactless/QR payments in retail. [email protected] Goldman Sachs Japan Co., Ltd. 2) Which payment method/s are best positioned? We expect credit cards to Tomoko Imoto +81(3)6437-9908 | remain the key payment method from a speed/points reward perspective. [email protected] Goldman Sachs Japan Co., Ltd. 3) Within the credit card ecosystem, which categories stand to benefit the Yusuke Noguchi +81(3)6437-9894 | most? We expect the cashless profit pool to increase to ¥4.3 tn (2025E) from ¥2.6 [email protected] Goldman Sachs Japan Co., Ltd. tn (2017), with credit card pool to grow to ¥3.7 tn from ¥2.5 tn. The key players are (i) Serene Yang financial service providers, (ii) retail-based businesses, (iii) IT companies, (iv) online +81(3)6437-8531 | [email protected] Goldman Sachs Japan Co., Ltd. payment processors, and (v) card issuers. Shoto Sakuma +65-6654-6925 | [email protected] 4) Credit card business models poised for growth? i) IT players with a solid online Goldman Sachs (Singapore) Pte ecosystem and attractive reward points program, and ii) Financial service companies with retail networks and a stable customer acquisition base without exposure to excessive reward points competition. Goldman Sachs does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification and other important disclosures, see the Disclosure Appendix, or go to www.gs.com/research/hedge.html. Analysts employed by nonUS affiliates are not registered/qualified as research analysts with FINRA in the U.S. Goldman Sachs Japan Financial Services Table of Contents Executive Summary: Credit cards remain front and center 3 1.What is the scope of increase in cashless transactions? 7 2. Which payment method/s are best positioned? 16 3. Within the credit card ecosystem, which categories stand to benefit the most? 22 4. Credit card business models poised for growth? 25 Disclosure Appendix 26 Note: The following is a redacted version of “Japan Financial Services: Japan Cashless: Credit cards remain front and center" originally published April 24, 2019 [88pgs]. All company references in this note are for illustrative purposes only and should not be interpreted as investment recommendations. 2 Goldman Sachs Japan Financial Services 3 Goldman Sachs Japan Financial Services Executive Summary: Credit cards remain front and center Japan has made slow strides toward a cashless society, lagging behind other developed economies. However, with new modes of electronic payments such as contactless payments/QR codes and the government’s support, including subsidies to cashless operators, we see a structural shift towards cashless payments among consumers. Despite inroads made by new forms of cashless payments, we expect credit cards to remain the preferred method of choice for cashless payments due to factors such as speed, convenience and attractive reward points. Our forecasts for cashless transaction value and the market profit pool are as follows: n We estimate that cashless payments will double to ¥120 tn in 2025E, from ¥60 tn in 2017. n We expect the profit pool to grow to ¥4.3 tn in 2025E from ¥2.6 tn in 2017. n For the credit card profit pool, we estimate fee income to increase to ¥2.4 tn in 2025E from ¥1.5 tn in 2017. Including fees on revolving credit and cash advances, we forecast credit card profit pool growth to ¥3.7 tn from ¥2.5 tn over the same period. Four key questions 1. What is the scope of increase in cashless transactions? We expect cashless payments to double to ¥120 tn from ¥60 tn on e-commerce market growth and higher weighting of offline cashless transactions: n We estimate that e-commerce market growth will account for c. ¥19 tn of the ¥60 tn growth in cashless payments and a higher weighting of offline cashless transactions in retail for c.¥23 tn. n We forecast that the e-commerce market will grow from ¥17.0 tn in 2017 to ¥24.8 tn in 2021E and ¥36.1 tn in 2025E, supporting an increase in cashless transactions. n We estimate that the weighting of retail cashless transactions will rise to 37% in 2025E from 22% in 2017. n We believe the rise in weighting of offline cashless payments will be driven by changes in consumer behavior and more locations offering cashless payment facilities. Specifically, we expect smartphone/contactless payments will drive the growth in retail. We see recent government measures such as subsidies to cashless service providers, especially credit card providers, helping in the momentum too. 2. Which payment method/s are best positioned? Credit cards to remain the cashless payment method of choice: n We expect credit cards to remain the key payment method in the Japanese market even as we expect a variety of payment methods to coexist. n New payment methods include contactless payment mainly via smartphones and QR code-based systems, however, we expect credit cards to remain the top consumer preference thanks to their speed, convenience, and additional 4 Goldman Sachs Japan Financial Services benefits offered to consumers (reward points, discounts, etc.). n When it comes to concerns about the impact of lower merchant fee rates on profit margins for credit card companies, we focus more on the impact of competition than the fee cap of 3.25% proposed by the government starting Oct 2019. This is because we estimate average market rates have already declined to 2.9% and assume a further decline to 2.5% by 2025E. 3. Within the credit card ecosystem, which categories stand to benefit the most? We expect the profit pool to increase to ¥4.3 tn in 2025E from ¥2.6 tn in 2017: The cashless payment profit pool can be broadly divided into card issuers, acquirers (such as UFJ Nisoc/SMBC Card, who encourage merchants to join a cashless payment network), and card networks. n We estimate that the profit pool totaled ¥2.6 tn in 2017, with the share of these three categories at 78% (¥2.0 tn), 20% (¥530 bn), and 2% (¥5 bn), respectively (based on reported general fee share of various players). n We expect acquirers to gradually gain a greater share of the market, with share in 2025E as follows: issuers 71% (¥3.1 tn), acquirers 27% (¥1.2 tn), and card networks 2% (¥8.0 bn). n Looking at all industry players, we expect payment processors to enjoy the fastest growth, followed by IT companies, and then retailers. 4. Credit card business models poised for growth? We believe that credit card payments will eventually be the main form of payment as highlighted in the earlier point, and highlight two business models that have been successful within this space. n The model used by IT players that have a solid online economic ecosystem and an attractive reward points program. n The model used by companies that have a stable customer acquisition base, thanks to their retail networks, and are capable of stable profit growth without exposure to excessive reward points competition. 5 Goldman Sachs Japan Financial Services Japan lagging the rest of the world in the transition to cashless payments As shown in the exhibit below, where we compare each country’s cashless payment ratio as of 2015, the weighting of non-cash payments remains low in Japan, at 18%, versus 89% in Korea, 60% in China, 55% in the UK, and 45% in the US. However, Japan is distinguished by a relatively higher percentage of credit card payments and usage of prepaid cards (e-money) . In our view, the factors contributing to Japan’s low cashless ratio include (1) the social climate: Japanese people prefer to use cash, and the volume of cash in circulation-to-GDP is much higher relative to other industrialized nations, with ATM usage (convenience) also high; (2) retailers’ perspective: retailers often avoid cashless transactions owing to the cost of installing payment terminals and the need to pay merchant fees; and (3) consumers’ perspective: a number of factors preclude greater uptake by consumers, including the presence of shops unable to process cashless transactions, concerns about overspending and security, and “general unease amongst older shoppers” (excerpt from METI’s Cashless Vision, released in April 2018).