AXP: Structurally Improving Business Model
The economics of AXP’s business model are improving meaningfully as it overcomes the anti-competitive constraints imposed by V and MA through the exclusionary rules (preventing Amex from distributing its network services through the bank channel) which were struck down by the Courts in 2004. Amex is achieving this in both credit and debit:
- Credit: Amex’s GNS business (where a bank, rather than AXP itself as in the “proprietary” business, issues an Amex-branded card) has grown at a 20%+ CAGR since 2004 and now accounts for $140bn of annual purchase volume representing 15% of Amex’s total. AXP recently announced that WFC and USB will be issuing Amex-branded cards and, unlike partnerships with C and BAC which have tended to focus on the T&E segment, we expect these new programs to include everyday spend cards.
- Debit: Through the Serve brand (with annualized transaction volume of ~$5bn at the end of its second full year), Amex offers consumers a checking-account alternative through retail partners, such as WMT, and online/mobile channels at substantially lower cost (all-in $1/month which is waived with direct payroll deposit) to typical low-balance checking accounts. Serve (which offers card, ATM, and check-access, online bill-pay, and FDIC insurance, check-access) has a structural cost advantage because Amex does not support a branch infrastructure and is not subject to the Durbin cap on merchant debit fees. In the US, the addressable market for Serve (at $5tn including debit, cash, and checks) is twice that for Amex’ credit products (see Exhibit below)
By 2020, we expect over one-third of Amex’s volumes to be from its GNS and Serve businesses. These are balance-sheet efficient businesses (because, unlike in the “proprietary” credit/charge card business, Amex does not have to support cardholder balances) and generate an estimated ROE in excess of 60% versus 15-20% for the proprietary credit business.
As a result of this mix-shift, we expect the firm-wide ROE to increase from the current 25% to over 30% creating a positive re-rating of the stock of at least 20%. We are not concerned at the prospect of “brand dilution” as Amex expands its customer and merchant footprint nor the possible acceleration in the decline of the discount rate (which AXP will mitigate, if not overwhelm, by adding value to merchants through end-to-end management of loyalty programs including coalition programs):
- Brand dilution: The days of aspirational card branding to the affluent are waning as consumers look for service and rewards; among the unbanked, Amex remains an aspirational brand and this is part of the appeal of Serve.
- Discount rate: Amex’s discount rate (representing the ratio of revenue, before payments to third parties, to billings on merchants where Amex is the acquirer) has declined by about 1 basis point per year over the last decade and presently stands at 2.51%. This is largely as Amex has diversified from the T&E segment accounting for ~30% of billings versus 34% in 2007. The offset is improving network economics as AXP builds “everyday” spend billings particularly on products where it is not supporting cardholder balances.