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WIKI ANALYSIS
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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 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.[5] 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.[5]
Company OverviewHeadquartered 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 MetricsIn 2008, American Express generated $28.4 billion in net revenue from the following sources:
| Annual income data, in millions | 2003 | 2004 | 2005 | 2006 | 2007 | 2008[8] | 1Q2009[9] | |
|---|---|---|---|---|---|---|---|---|
| Net Revenue | $19,549 | $21,897 | $24,068 | $27,894 | $27,559 | $28,365 | $4,123 | |
| Operating Expenses | - | - | - | - | $17,762 | $18,986 | $3,579 | |
| Operating Income | $3,415 | $3,831 | $4,248 | $5,139 | $4,126 | $2,871 | $443 | |
| Net Income | $2,987 | $3,445 | $3,734 | $3,515 | $4,012 | $2,699 | $437 | |
Products/ServicesAmerican 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.[10] This division's products include their branded cards as well as several niche charge and credit cards (e.g., student, travel rewards).
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 SegmentsThis 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 billOn 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.[11] However, the first stages of the reform take effect as early as August 20, 2009.[12] 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.[13] Banks have warned that the new legislation will increase rates, decrease credit extended, and increase the use of annual fees for cards.[14] Less credit likely means less transactions, transaction amounts, and thus a negative impact on earnings.
Consumer Payment MeansIn 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 BanksMastercard (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 NetworkA 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.
Building Customer Loyalty Through RewardsAmerican Express can fundamentally grow its charge and credit card businesses by issuing more cards or accruing higher spending per card (or both). As mentioned earlier, the company has expanded the number of cards issued through partnerships with banks.
A key lever for the company to gain higher spending on its cards, or increasing the "share of wallet", is with its rewards program. Recently, the American Express has focused on driving "everyday purchases" such as grocery, gas, and drug store transactions to their card by offering 2 points for every $1 in spend (1:1 ratio is typical). Membership Rewards is a 16 year old program that has yielded some of the highest returns in the business (see below). Cardholders have used points to redeem for items such as everyday shopping as well as high end luxury automobiles and private jet timeshares, demonstrating the loyalty American Express has built.
CompetitionAmerican 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.
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