Saturday, November 22, 2008

Long Case for American Express

American Express is a leading global payments, network and travel company that offers its products and services throughout the world.

Key Highlights

• Trading at 7X earnings
• Is the largest issuer of cards, with a broad array of charge, credit and prepaid products
• Best credit quality of anyone in the business, with premium customers
• Have successfully shed unrelated business to focus credit card ops
• High ROE (36% in 2007)
• Superior management
• Competitive advantage and long-term growth prospects
• Best service, and reward programs
• #1 in customer satisfaction
• Wide acceptance in US, and internationally
• Should be relatively unscathed by credit crisis
• Should trade at 18-21 times earnings

Investment Thesis

American Express issues charge and credit cards and even operates the transaction and processing side of the business. The business model which the company calls “ spend-centric” is to attract premium customers and drive spending on their cards and this results in significant competitive advantages. The average spending on an AXP card which is 4-5 times those of its competitors represents a greater value to merchants in the form of loyal customers and higher sales. This enables AXP to earn a premium discount rate and invest in greater value-added services for merchants and card members . As a result of higher revenue generated from higher spending, it has the flexibility to offer more rewards to its card members which acts as an incentive for them to spend more on their cards. This results in a positive feedback loop. The higher the rewards the higher the spending per card. This business model alongwith closed loop in which they are both the issuer and the merchant acquirer gives them significant informational advantage which they seek to leverage and provide greater value to it card-members, merchants and issuing partners. It has economies of scale in marketing, advertising and rewards and that is one of the competitive advantages. Credit card network is very difficult to replicate, it has a first mover’s advantage posing a massive barrier of entry for new entrants.

The key risk for AXP is default rate on lending and unable to get liquidity for funding its loans and receivable. However the company believes that it has enough liquidity to operate a year without access to financial markets.
The peak write-offs for AXP`s lending card were 9.6% in 1990-91 recession and 6.0% in 2001. Assuming a worst case scenario of 12% write-off rate, it will still break even.
I believe a very high quality business is available at an extremely cheap price