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U.S. consumers spent more using their credit cards than with either cash or checks for the first time in 2006. The American Express Company (NYSE: AXP), a global financial services institution whose main offerings are charge and credit cards, is a beneficiary of this shift. The company earned $28.4 billion in net revenue in 2008 from its $683 billion in total customer transactions.^[1] On November 10, 2008, American Express was approved by the US Federal Reserve to become a bank holding company making it eligible for a part of Troubled Assets Relief Program (TARP)'s $700 billion in recovery funds,^[2] and on November 12, 2008, it requested a $3.5 billion capital infusion from the US Government.^[3]

In the fourth quarter of 2008, American Express converted into a bank holding company, and in doing so became under the regulation of the Federal Reserve.^[4] The main reason American Express converted to a bank holding company was to become a Federal Reserve member, enabling it to receive benefits of government programs. This is especially advantageous in times of uncertainty because it allows the company greater flexibility. American Express has declared that conversion to a bank holding company will not in any way impact their core business or business model.

For the fourth quarter of 2009, American Express managed to post a net income of $716 million despite revenues remaining relatively flat at $6.5 billion, compared to a net income of only $240 million a year ago.^[5] American Express cited much lower credit losses, which accounted for most of the gain in net income. Because total revenues did not increase much, with the growth in net income mainly attributed to reductions in credit losses, American Express CFO Dan Henry has cautioned that growth in the coming quarters may be slow.

Company Overview

Headquartered in New York City, American Express is a global payment and travel service company. American Express earns about half of its revenue from merchants, charging them a discount rate for each transaction processed. The other major source of revenue is cardholders themselves, who pay annual fees and interest charges on balances. Because American Express is one of the leading issuers of corporate credit cards, its customers on average spend up to 2-4 times as much as customers using competing cards; in 2008, the average AmEx cardholder spent $12,025 per year, excluding cards issued by affiliates.^[1] This allows American Express to charge a discount rate over twice as high as either of its main competitors (an average of 2.55% in 2008). This combination of higher discount rates and big-spending cardholders means that American Express earns much more per swipe than either Visa (V) or Mastercard (MA).

As a credit card issuer, American Express's performance is highly dependent on the overall state of the economy. During economic downturns, consumer spending drops, while booms can stimulate spending and borrowing. With the falling U.S. home prices, tightening credit markets, and the general economic uncertainty caused by the subprime lending fiasco, credit card issuers like American Express are facing declining consumer spending as well as the increased likelihood that some customers will be unable to repay their balances. Additionally, interest rate cuts could pressure lenders like American Express to lower the rates they charge on balances, further hurting earnings.

Business and Financial Metrics

For the second quarter of 2009, American Express posted total revenues of $342 million for an earning per share (EPS) of $0.27, slightly above analyst estimates of $0.26 per share.^[6] Despite a 10% decrease in revenues, in large part due to a 17% decline in discount revenue, transaction volume only fell 3%, meaning its consumers continue to use their cards, but are spending less.^[6]

For the third quarter of 2009, American Express beat analyst estimates and posted a net income of $640 million, despite a 16% decrease in revenues and an 11% decrease in total card spending.^[7] American Express was able to post a profit in part by cutting expenses by 17%.

Business Segments

In 2008, American Express generated $28.4 billion in net revenue from four sources: i) Discount Revenue, ii) Cardmember Lending Financing, iii) Card Fees, and iv) Other Revenue.

Discount Revenue (52.8% of total revenue)

Discount Revenue accounted for $15 billion, or 52.8% of all revenue for American Express in 2008.^[10] The company receives a portion of every transaction charged to its credit and charge cards, and this fee is assessed to merchants' respective businesses. American Express's average discount rate declined to 2.55% in 2008 from its 2007 level of 2.56%.^[11]

Cardmember Lending Financing

This segment represents the second largest revenue center for American Express. While the company is traditionally known for its charge cards, the balance of which needs to be paid in full every month, American Express has introduced an increasing number of traditional credit cards with revolving balances.

Card Fees

Card Fees come from annual memberships, foreign exchange conversion fees, and service fees.

Other revenues

This segment include various fees--including commissions from partners--as well as fees from its travel business. The company also makes money off of net interest income, which is derived from the difference of the company's interest expense compared to financing revenue.

Products/Services

American Express offers a number of products and services to its customers. It breaks its segments down into four segments: i) U.S. Card Services, ii) International Card & Global Commercial Services, iii) Global Network & Merchant Services, and iv) Corporate and other segments.

U.S. Card Services

U.S. Card Services earned $14.0 billion in net revenue for 2008.^[12] This division's products include their branded cards as well as several niche charge and credit cards (e.g., student, travel rewards).

• Charge Cards include Green, Gold, Platinum, and Centurion cards. Charge cards operate like credit cards, with the exception that cardholders must pay outstanding balances in full every month.
• Credit Cards are different from charge cards in that customers are allowed to carry a balance. American Express makes money from financing charges for accrued balances by charging interest on the balances.
• Travelers Check and Card are used by travelers because of its loss protection. American Express offers pre-paid card version of this product as well.
• Travel Services provide Card members and non-members with travel options including flight schedules, car rentals, and hotel bookings.
• Small Business OPEN allows small businesses to manage expenses, budget for travel and gain rewards through targeted credit and charge cards as well as tools. American Express is the leader in this niche.

The company spun off its investment brokerage arm (American Express Financial Advisors) into Ameriprise Financial Inc. in 2005. The spin off gives the investment brokerage the capability to react quickly to market changes. Ameriprise Financial, Inc. (AMP), with $400 billion in assets under management, has seen its stock price rise almost 50% since 2005.

International Card & Global Commercial Services [GCS]

The GCS branch of American Express provides expense management services to firms worldwide. Products offerings include corporate cards provided to a company's employees and corporate purchasing solutions for items such as office supplies. American Express also focuses on business travel planning and expense management.

Global Network & Merchant Services [GNS]

The GNS business operates a business that signs merchants to accept American Express cards and processes card transactions for those merchants. In 2004, American Express successfully sued Visa and MasterCard on anti-trust grounds to allow U.S. banks to issue American Express cards. This business segments oversees the charge and credit card network that includes both proprietary cards and those licensed under partnership agreements.

In order to secure partnerships with merchants, GNS also provides partner financial institutions and merchants with services such as back-office products and marketing programs.

Corporate and Other Segments

This segment of American Express has limited impact on revenues and acts more as a complementary segment that aids and increases the image of the rest of the corporation. Products includes magazines, guides and travel-related websites.

Trends and Forces

Impact of credit card reform bill

On May 22, 2009, President Obama signed into law the Credit Card Accountability, Responsibility and Disclosure (CARD) Act, a wide ranging credit card reform bill set to fully take effect beginning in February 2010.^[13] However, the first stages of the reform take effect as early as August 20, 2009.^[14] Included in this bill are restrictions on interest rate increases, a 45 day notice before changing interest rates, restrictions on fees that can be charged, requirements for more disclosure, and limits on ability of those under the age of 21 to obtain cards, among others.^[15] Banks have warned that the new legislation will increase rates, decrease credit extended, and increase the use of annual fees for cards.^[16] Less credit likely means less transactions, transaction amounts, and thus a negative impact on earnings.

Consumer Payment Means

In 2006, for the first time, U.S. consumers used credit cards to pay for more purchases than cash or checks, a trend that continued into 2007. In addition to credit cards, debit cards and electronic payments (like PayPal) have taken market share away from more traditional means of payment. It should be noted that debit cards have doubled in usage over the past six years, but American Express does not provide debit card products.

One particular technology driving increased usage of credit cards is contact-less payments which do not require a swiping through a machine. American Express entered the contact-less market through its ExpressPay service. The company estimates that ExpressPay not only shortens the length of time for a transaction but also increases average transaction size by 20-30% compared to cash spending--both attractive for merchants using this system. One of the primary participants within the contact-less payment sector is MasterCard's PayPass, which is currently accepted in major businesses such as McDonald's (MCD) and CVS (CVS).

Partnerships with Banks

Mastercard (MA) and Visa have grown to their current scale in large part by having banks issue their credit cards as members of their respective associations. In 2004, American Express also joined this fray when courts ruled that competitors Visa and MasterCard had unlawfully prevented its member banks from issuing American Express cards.

The GNS segment has grown at a rapid rate from the standpoint of cards in force (CIF) and dollar transaction volumes. CIF is the number of American Express cards issued (including supplements), which has grown over 30% annually since 2004. Total transaction volumes increased at an even faster rate (46% per year). On the other hand, the other two company segments' combined CIF growth was under 6% and transactions growth was about 14%.

Partnerships with banks may continue to be a strong growth area for American Express, but it may dilute the company's prized brand name though the dissemination of co-branded cards. Based on calculations from their annual report, these cardholders spend about 4-5 times less on their cards compared to proprietary American Express cards.

Closed Loop Merchant Network

A charge and credit card company is only as good as the merchant network that accepts its cards--after all, a customer cannot make a charge unless the card is accepted. One of American Express' primary competitive advantages is its closed loop network, meaning that it acquires both cardholders as well as merchants into its network. This allows the company to have a deep understanding of how its cardholders charge purchases. Merchants are attracted to the American Express network because of the company's wealthier demographic.

The net effect of this closed loop network is an average cardmember spending 2-4 times higher than competitors, as well as a merchant discount rate twice as high as its competitors. All in, American Express makes 4-8 times as much discount revenue from a typical cardholder compared to either Visa or MasterCard.

The company estimates that its network accommodates approximately 80-90% of the general transactions its customers make in a given year. As such, American Express has shifted away from its legacy of travel and entertainment--which used to drive two-thirds of all transactions in 1990--to general retail and other sections, which currently generates the majority of all charges from its cardholders.

Competition

American Express competes against companies in the general purpose payment card industry, as well as against all other forms of payment. Its top competitors within the general purpose payment card industry include Visa (V), Mastercard (MA), and Discover Financial Services (DFS). American Express's advantages include its low exposure to subprime cardholders (based on credit score), thus reducing risks of write-offs when cardholders do not pay their bills. American Express also owns nearly half of all transaction volume in the U.S. Small Business niche, which is estimated to charge nearly $200 billion on cards a year.

• Mastercard (MA): Mastercard has a strong brand loyalty and name recognition through its "Priceless®” marketing campaign. It has also experienced rapid growth as it has pushed to switch from paper to a fully electronic system.^[17] American Express has an advantage over Mastercard because it has direct relationships with both cardholders and card issuers, and is not affected by regulation of interchange fees.

• Visa (V) is the world's largest retail payment processor by far. Within the United States, Visa accounts for 60% of the debit-card transactions in the U.S. market - a four-to-one advantage over second place Mastercard. Visa is also the largest in terms of total transactions and total volume. As with Mastercard, American Express holds an advantage because of its direct relationships as well as avoiding interchange fee regulation.

• Discover Financial Services (DFS): Discover is smaller than American Express, and competes with it almost exclusively in the US. American Express also competes against Discover's PULSE, a network that increases the compatibility of debit cards and ATMs in the network.^[18]

References

1. ↑ ^{1.0 1.1} AXP Annual Report 2008 Pg. 22
2. ↑ CNN Money: "UPDATE: American Express Co To Become Bank Holding Company" 10 Nov 2008
3. ↑ CNN Money: "American Express seeks $3.5B from feds" 12 Nov 2008
4. ↑ AXP Annual Report 2008 Pg. 13
5. ↑ American Express, Capital One earnings beat forecasts. Christian Plumb. Reuters.
6. ↑ ^{6.0 6.1} Highlights From AXP's Q2 Conference Call. StreetInsider.com. American Express Q2 Conference Call.
7. ↑ Strong Profit at American Express . The New York Times.
8. ↑ AXP 2008 Financial Results
9. ↑ AXP 8-K 1Q 2009 "Statements of Income" p.6
10. ↑ AXP Annual Report 2008 Pg. 25
11. ↑ American Express Annual Financial Supplements. American Express. Pg. 6
12. ↑ American Express Annual Financial Supplements. American Express. Pg. 8
13. ↑ Obama signs sweeping credit card reform bill. John Poirier. Reuters.
14. ↑ Credit card rules change Thursday. MSN Money.
15. ↑ Key provisions of credit card reform bill. MSNBC.
16. ↑ Credit-Card Fees Curbed. Sudeep Reddy. The Wall Street Journal.
17. ↑ 2006 MA 10-k, Item 1, pg. 4
18. ↑ Google Finance "Discover Financial Services" - Summary