Amex, Antifragile & Able to Spend
Underpinning the value of The American Express Company (Amex) is its global payments network. It is able to command premium discount revenue from this network due to the high-income cardholders that its rewards program, and to a lesser extent its brand, attract. The business is insulated by both the way the company earns revenue and the business's inherent network effect during both booms and busts.
The discount revenue earned from the company’s merchant and cardholder network is the focus of this analysis, it is proposed that the company has been negatively affected by a heated consumer credit market in recent years. It is also proposed that over the long-term the company gains more than it loses from downturns in the consumer credit cycle.
Part 1: Why & How Amex Exists
Why Does Amex Exist?
Amex exists because merchants are willing to pay a premium merchant service fee on Amex transactions, as transactions made by Amex cardholders are on average significantly larger than non-Amex transactions.
Why are transactions larger?
There are two main reasons why Amex card members spend more on average:
Firstly, and most importantly, Amex cardholders spend more because they are typically wealthier and earn a higher income than the average.
Secondly, and not so importantly, Amex cardholders are incentivised to spend more by the company’s membership rewards program, and to a lesser degree the extension of credit.
To emphasise, the rewards program attracts high income earners who naturally spend more, which causes Amex transactions to be larger on average than cards issued by competitors. It is not the earning of rewards on each transaction that is driving the majority of spending, just the type of customer the rewards attract. It is this characteristic of the business, and its durability, that this report will be focused upon.
Why do high income earners use Amex?
Amex attracts high income earners because of its membership rewards program. The membership rewards program is structured to reward those who spend at a minimum tens of thousands of dollars per annum, with a proportion of cardmembers spending into the hundreds of thousands to millions of dollars, on their Amex.
The structure of the rewards programs attracts high income earners due to the following three features:
It is a points system where card members earn points per dollar spent, with no cap on points earned. The more spent the more earned, with the ways in which points can be redeemed increasing with the more points held.
Rewards points are redeemable primarily on items consumed alongside other items high income earners can afford to enjoy, such as flights, hotels, upgrades and events.
Ancillary membership services of the membership rewards program compliment large purchases typical of a high-income lifestyle. For example, they include fast-tracked access to the highest tiers of airline and luxury hotel loyalty programs, access to a global network of airport lounges, entry into global dining programs, as well as many others.
This structure eliminates the attractiveness of the membership rewards program for what has been determined to be the lower 90% of income earners within developed economies.
How Amex Earns a Return for its Services
Amex makes money from merchants who pay premium fees to accept Amex cards. To begin understanding why merchants are paying Amex premium fees, and how much they are paying, it is best to first break Amex’s revenue into the two broadest categories possible. By doing this we find that revenue is earned from merchant service fees, which Amex refers to as discount revenue, as well as interest income.
Management have organised revenue into these categories for us already in Amex’s financial communications. The numbers for the prior 3 years are below to help aid in understanding the scale of each revenue source.
With discount revenue being the primary source of revenue, understanding how it is earned from both the customer and accounting perspective is critical. Both perspectives can be understood from the companies stated significant accounting policies. These are found within the notes to Amex’s financial statements. Here it states that “the merchant discount is generally deducted from the payment to the merchant and recorded as discount revenue at the time the Card Member transaction occurs.”
First is understanding how revenue is earned from the accrual accounting perspective, and whether the accounting perspective is an accurate enough portrayal of the cash nature of the business, i.e. does the accrual accounting of revenue largely match the underlying reality of business activities. The accuracy of accrual accounting to the cash reality for a business of Amex’s nature could be undermined by any significant timing lags between discount revenue booked and cash received from cardholders.
Based on the company’s receivables turnover, and how they structure their charge card products, we are able to roughly estimate their receivables turnover at around 47 days. We find this by dividing transaction volumes, spending where Amex is both the issuer and not the issuer, by the sum of Amex charge card receivables and credit card loans.
Receivables/Loan Book Turnover
Given the timing difference between the accrual recognition and cash collection of revenues, in conjunction with the growth rate of the company, the impact is evidently immaterial.
Understanding how discount revenue is earned from the perspective of a merchant is the next step, and to do this it helps to look at how competitors charge for their services. However, this is not as straightforward as it would appear.
Amex is rare in respect to the fact that it is what’s referred to as a closed-loop network. This means that Amex controls the entire relationship between proprietary card holders and merchants, and for transactions occurring on GNS cards, it acts as the acquirer whilst simultaneously still maintaining control over the authorisation of transactions, as well as card issuing rules.
The main effect of the closed-loop network on pricing is that it makes Amex’s pricing much simpler to understand from the merchant’s perspective. It also affords considerably more price setting power to Amex, as the reliance on suppliers is almost non-existent.
Rewards cards not issued by Amex, but issued by banks, using the Visa and Mastercard network, are issued within what is known as four-party card schemes. These four parties are the cardholder, merchant, issuing bank, and the merchant's acquiring bank.
Both four-party and three-party card schemes are illustrated in the below graphic:
Within four-party card schemes, the card networks, acquirers and issuers all must be compensated in some way for the functions they provide within the system. This compensation comes in the form of the following fees:
Interchange fees, which flow from the acquiring bank to the issuing bank
Scheme processing fees, which are paid by the issuing bank to the card schemes
General card fees and interest, paid by the card holder to the issuing bank
These are the main fees charged, however, for smaller merchants who do not have a direct relationship with an acquiring bank but deal with a payments facilitator (PayFac), such as Stripe or Square, a margin is also paid to the PayFac for their services. This margin is charged on the total sum of the three fees mentioned above.
PayFac margins are only applicable for Amex where merchants have a turnover under $1 million. These are the only merchants who have the option to accept Amex cards through third party PayFacs. Amex have established agreements with third party PayFacs under Amex’s OptBlue program. OptBlue will be covered in further detail in a subsequent report.
The main point of comparing the four-party card schemes to Amex’s three-party model is to highlight the following key point. On their statement at the end of the billing period a merchant sees a single merchant service fee deducted from payments made by debit or credit cardholders. For four-party card schemes this fee flows to the issuer, acquirer and in some cases the PayFac, however, for Amex this fee is captured entirely by Amex itself.
Key Business Segments
The next layer of revenue analysis breaks down the company into three key distinct segments in which Amex operates. Amex labels these three business segments as Global Consumer Services Group (GCSG), Global Commercial Services (GCS) and Global Merchant and Network Services (GMNS). The company’s results have been split into these three segments within its financial reports since 2016.
The focus of the report has so far been, and will continue to be, on the GCSG segment. This is not only because it is the most material segment for Amex, but by focusing upon it we are also able to gain a more holistic understanding of the company’s underlying purpose. GMNS will be analysed to a limited extent within this report, whilst GCS will be the centre focus of my next instalment of Amex analysis.
The importance of each segment is illustrated below in the business segment revenue breakdown for the prior four years:
Within the GMNS segment there are two forms of relationships that Amex has with its customers, or better referred to as partners. The GNMS partner either takes the form of an Independent Operator (IO) or a Network Card Licensee (NCL).
Under the independent operator model the IO is responsible for more or less the entire arrangement and network. Amex is simply licencing its brand and leveraging its existing global rewards suite. With an IO Amex earns its revenue through:
Card licencing fees (fee for the brand)
Royalties on cardmember billings
Foreign exchange conversion revenue
Royalties on merchant acquisition volume
In some partnerships, royalties on interest income
This arrangement is quite shallow from Amex’s perspective. It is pursued by Amex in countries where they do not have a proprietary card presence, in essence a first step towards establishing the company within the country.
The more common GMNS relationship involves NCLs, and a much more involved role from Amex. Within this relationship the NCL is responsible for:
Issuing bank branded Amex cards
Design of product features, such as the rewards program
Credit risk, all credit card loans are originated and held by the NCL
Authorisation of transactions
Amex are responsible for the following duties:
The merchant network
Processing of transaction from the point of sale to the settlement with card issuers
The relationship between merchants and the network
Acting as the acquirer
Whilst earning revenue via:
Retaining a share of the discount revenue earned on cardmember billings
Revenues from forex
Licensing fees paid by the GNMS partner (fees for brand)
In some partnerships, royalties on interest income
It is quite evident when comparing the above functions of Amex within IO and NCL partnerships, that Amex is primarily leveraging its brand with IOs, and leveraging its merchant network, and to a lesser degree its brand, with NCLs.
IO partnerships also allow Amex to slowly build relevance in countries where their relevance is weak. In regard to IO partnerships they state that “the partner’s local presence and relationships help us enhance the impact of our brand in the country, reach merchant coverage goals more quickly, and operate at economic scale and cost levels that would be difficult for us to achieve on our own”.
For further context, countries where Amex has IO partnerships include Brazil, Colombia, Croatia, Indonesia, Malaysia, Peru, Portugal, Russia, South Africa, South Korea, Turkey and Vietnam.
Countries where Amex has entered partnerships with NCLs include Australia, Japan, the United Kingdom, European Union and the United States. NCL agreements allow the company to increase cardholder numbers with the assistance of established banks, increasing the attractiveness of the Amex network for merchants.
The banks both sell card products on Amex’s behalf and assume all risk on credit extended. The result is that Amex requires little capital to grow within countries where it has an NCL partnership, while it still retains the control and economic benefits of any expansion of its merchant network that the NCL relationship drives.
The net benefit here is due to what is in effect a one-way relationship. Banks onboard their existing high-income customers onto the Amex network and brand, whilst Amex makes no comparable contribution of customers or network assets.
Regulations put in place by governments in Australia and the EU have recently forced Amex to withdraw from the GNS business in these regions. The new regulations resulted in the fees collected by Amex on behalf of GNS partners being included under new caps on interchange fees. The ultimate result is that rewards cards issued by banks using the Amex network have been cancelled, with customers encouraged by the issuing banks to move to rewards cards that use the Visa or Mastercard network.
What we have seen since Amex's withrawal is a large spike in the growth of Amex proprietary billings in both Australia and the EU. Amex do not publish the number of proprietary cardholders for these regions, so proprietary billings are our next best metric to follow, and it indicates that a large number of prior NCL Amex cardholders have moved over to proprietary Amex cards. The increases in billings were material, with a 25% and 12% increase in proprietary billing in Australia and the EU respectively during FY2018.
The increase in proprietary billings can also be put down to the fact that some banks have moved from a GNS partnership to a cobrand partnership with Amex. A great example of this is with the Australian bank Westpac. Previously Westpac issued its own Amex rewards cards, but now the bank offers an Amex rewards card under a cobrand agreement, where the card is issued and managed by Amex.
Take this excerpt from the Westpac Altitude rewards card terms and conditions as an explainer, “American Express will pay a monthly commission to Westpac in relation to your account. As the commission is dependent on all American Express Westpac Altitude customers’ use of their Cards, the amount is not ascertainable. Fees or charges in relation to this Card are only payable to American Express, not Westpac. Note: The Card issued by American Express will be a separate credit card contract to the Westpac Altitude Card, with its own credit limit, statement and annual Card fee.”
Part 2: Protecting Pricing & Controlling Costs
The Competition Question
"In today's highly fluid and competitive business world, obtaining well-above-average profit margins at a high return on assets is so desirable that, whenever a company accomplishes this goal for any significant period of time, it is bound to be faced with a host of potential competitors." – Phil Fischer
When thinking about Amex’s competition we need to ask one critical question, can cards issued by competitors on the Visa and Mastercard networks render Amex’s network focussed at large spenders redundant?
By redundant we mean Amex providing immaterial value for merchants and GNS partners as the gap between four-party card scheme spend and Amex spend per transaction narrows. As well as redundancy for Amex, as the rising cost of maintaining a competitive rewards program erodes the business's profitability.
Answering this isn’t an easy task, but it can be done. It requires going back over the company’s history as far as one can, and understanding how Amex has managed to maintain its market position and profit margins over time. It also requires looking at whether past strategies that increased profitability and ensured cashflow durability will be viable in the future.
Amex faces competition primarily in the form of bank issued rewards cards. Like Amex, these banks offer rewards programs that are attractive for those who spend large sums each year, something only possible for high income earners. These card issuers derive their revenue from interest, late-fees, membership fees and interchange fees. Though of the greatest importance is the fact that the majority of revenue is derived from their lending activities.
The profitability, and competitiveness, of bank issued rewards cards is largely determined by the underlying shifts in the credit cycle. Importantly, they are detrimentally affected by downturns in the credit cycle in the short-term and long-term, as bad debt expenses increase and lending revenues decline. The point I'm making is that the profitability of bank issued rewards cards is remarkably fragile to unexpected adverse movements in the credit cycle.
On the contrary, Amex derives 80% of the company’s total revenues from discount revenue, a product of its merchant network and card member spending. Importantly, when looking at the company’s consumer segment in isolation, most of the revenue is still earned from card membership fees and discount revenue. This is after deducting membership rewards, effectively a contra revenue, from the total discount revenue amount. Discount revenue is still to some extent effected by the availability of credit, but when compared to the effect of the credit cycle on bank issued card revenue its effect appears immaterial.
To put this in perspective, during 2018 Amex processed $1.18 trillion in transactions, with $83.3 billion of credit card loans outstanding on the balance sheet at reporting date. In comparison, J.P. Morgan Chase, Amex's largest competitor in the US, processed $692.4 billion in transactions, with $157 billion of credit card loans outstanding on the balance sheet at reporting date.
The extension of credit is a secondary and much less important value proposition. One example of the evidence supporting this view is in the 19Q4 call, where current CEO Steve Squeri states that Amex “have less than half their share of wallet and we have, as we said for a long time, we only have about 23% of their share of lending”.
The above was an outline of where the primary competition is coming from, and how they are both similar in offering, but different in their business model. The following section will try and explain how even though the offerings are similar, that due to the differences in business models and revenue compositions Amex is able to both defend its market position, and expand it, over the long run.
The Antifragility of the Amex Business
To start, three quotes from Nicholas Taleb, taken from his book Antifragile:
“For the antifragile harm from the errors should be less than the benefits”
"Antifragility implies more to gain than to lose, equals more upside than downside, equals favourable asymmetry”
“When you want deviations, and you don’t care about the possible dispersion of outcomes that the future can bring, since most will be helpful, you are antifragile”
It is the rewards program that attracts high spenders and incentivises them to spend more, so why can’t competitors do this to a better degree than Amex? The short answer is that they can for periods of time, but not over the long-run, we will now look into why that is the case.
Since Amex derives its profits primarily from discount revenue, they are able to invest material sums, relative to competition, into their products during credit cycle downturns, whilst their primary competitors are at their weakest point. These investments come in the form of investments in membership rewards as well as in the form of acquisitions. This has been their strategy in the early 90s, early 00s, during the GFC and even with the cards first introduction, which occurred during the 1958 recession. I expect now during the Covid-19 pandemic that their strategy will remain the same.
This advantage is down to the fact that the costs of maintaining a payments network are largely fixed. So, whilst discount revenue does decline during a downturn, expenses related to the network do not increase materially.
Consumer credit businesses also see revenues decline, with a reduced amount of interest earned on a loan book that is shrinking. The shrinking loan book is due to a reduction in the amount of credit being extended whilst existing credit matures. Though unlike Amex, consumer credit providers also see a simultaneous and material increase in expenses, due to a spike in write-offs.
As we can see, Amex still takes a profit hit from a decrease in discount revenue, but not to the same extent as credit providers who face decreased revenues simultaneously as costs increase materially. This above-average profitability of Amex during downturns allows them to compete vigorously for wealthy high-income earners, whilst competitors are trying to plug the holes in their sinking loan books whilst limiting the extension of new credit.
The remarks by Kenneth Chenault in the 2007 letter to shareholders particularly highlight this, "Lending is a planned and profitable outcome of our spend-centric strategy as we offer cardmembers the flexibility to revolve payments, but it is not our primary focus" and " Our practice has been not just to manage through periods of economic weakness but to exploit them for competitive gain, to build and invest so that we come out of a cycle stronger than we went in".
This importance of when a company makes its money is critical in defending, and winning, market share, though it is often overlooked. Quite simply, how can you compete in the long run if during, and immediatley post, every downturn you are unable to defend your current market position from a material intrusion by your competitors? Now the inverse to this question is that a competitor can grow their market share by significantly more amounts in credit cycle upswings than what they lose in downswings. However this isn’t really the case, as the tail wind provided during credit cycle upswings applies to all companies fighting for the same market share, resulting in a heated consumer credit market with few winners.
This is what gives Amex an inherent antifragility to unforeseen economic downturns and credit cycle tightening. Whilst Amex is impacted materially in the short-run, it is not as badly effected as its competitors, allowing it to invest and position itself to gain considerably more in the resulting upswing in business conditions than it lost in the downturn.
Whilst heated consumer credit markets are a headwind Amex still has other ways to grow. In particularly by focusing their attention inwards on their existing cardholders who have a large capacity to spend, and where Amex currently has only around 43% of spending. This can be seen below, where billed business has continued to grow due to growth in average card member spending, whilst amidst limited growth in cards-in-force.
Additionally, investments during downturns and the gaining of market share allows Amex to gain premium spenders prior to, and during the early stages, of economic upswings. During economic upswings is where the real acceleration of spending amongst an economy’s wealthiest occurs. This is evident in the expansion of profit margins to above their prior peaks post GFC and dot-com bust in the below section.
How This Manifests in Amex’s Reported Profitability
Below we see an expansion of the Operating Income Margin from the recession in 2001 to a peak of 23% in 2006, the margin begins to deteriorate in 2007 and eventually bottoms out in 2009, reflecting the tough trading conditions during the depth of the GFC.
We see a similar expansion of profit margins post GFC as we saw post the recession of the early 2000s. With investments made during the depth of the GFC allowing the company to capture the increased spending and borrowing activities of high-income earners. We also see the operating margins peak in 2014 and 2015, and the effects of increased competition from bank issued cards taking a toll.
Controlling the Costs of the Memberships Rewards Program
If we look at the Card Member Reward (CMR) expense growth in the below table, we can see that there has been a 20bps increase in the CMR relative to proprietary card billings. This is directly attributable to an increased level of competition from bank issued rewards cards. The amount of rewards offered on recently refreshed cards, such as the Platinum card for example, have increased CMR expenses materially.
Though these rewards have been met with an increase in annual fees one should still focus on the below relationship. This is due to the CMR expense acting in effect as a contra revenue. Note, Amex’s main competitors report rewards expenses as a contra revenue, whilst Amex reports them as an expense.
The company is also investing heavily in membership services, which have been ancillary components of the rewards program to date. The aim of this investment has been to maintain Amex’s attractive value proposition for high-income earners, whilst decoupling increases in rewards offerings from billings growth. Membership services are only truly valuable to the highest income earners. Examples of their typical offering are below:
The GFC, A Brief Case Study on Amex Under Adverse Conditions
If you want to understand how something will react to adverse conditions, it helps to look at how it was affected by similar adverse conditions in the past. To do this with Amex I’ve looked back at how the company reacted to the events during the five years surrounding the GFC, 2007-2011 inclusive.
Beginning in 2007, when economic conditions started becoming turbulent, with defaults and arrears on credit repayments increasing, most financial companies were focused on putting in place measures to sure up liquidity and survive. In comparison, Amex were identifying opportunities where they could capitalise on the turmoil.
This is best captured in the following statement by CEO Kenneth Chenault in the 2008 shareholder letter “We made many adjustments to navigate through the worsening environment. At the same time, we maintained a long-term view and took steps to prepare the company to take advantage of substantial growth opportunities when the economy rebounds”.
This manifested in 2008 with the purchase of Corporate Payments Systems from G.E. Money in March 2008. The New York Times reported at the time that “G.E. is selling the business as a step to prepare for the company’s planned exit from the private-label credit card business”. Looking at the growth in GCS discount revenue and profit below, during what was a depressed economic environment, it is both impressive and an example of the business’ inherent antifragility to unforeseen cyclical downturns.
In 2010, whilst the global economy was entering the early stages of the post-GFC hangover, Amex grew billings faster than any other issuer. Amex saw billings growth of 15% on the prior years whilst Citi, JPM, BofA, Capital One and Discover saw their billings change by -5%, 6%, 3%, 5% and 6% respectively. Amex repeated this again in 2011, growing billed business again at a rate of 15%, which was greater than all competition, except Capital One.
These above average results are a direct result of Amex’s corresponding above average investments in its business, customers and rewards during the depths of the GFC. A product of the average being lowered and Amex taking advantage of the increased amount of opportunity presented.
These achievements continued for the next 5 years, until an increasingly heated consumer credit market saw competition catch up and start to erode Amex’s growth and profitability in the past 4 years.
I believe, however, that we will see Amex take advantage of an economic shock once again in the wake of the Covid-19 pandemic. I hope this brief case study helps the reader visualise mentally what Amex’s antifragility to economic downturns looks like in practice. If successful, it will help to drive the point home and enable the reader to look out for similar practices that may be implemented by the company in the short to medium term.
Also, it is important to note that “this time it’s different” is true with the Covid-19 pandemic. The economic impact is hitting Amex particularly hard, but so did the GFC. The GFC was very much a new ball game in terms of economic downturns, and for Amex as well. This is summed up quite well by Kenneth Chenault in the 2007 letter to shareholders, “in past recessions, spending by affluent consumers held up relatively well compared to the broader population, which insulated American Express to some extent because of the concentration of high-income cardmembers in our portfolio. This downturn is different in that it is hitting the affluent particularly hard. Many of these consumers have significantly cut back on their discretionary spending as they have seen their home values, personal wealth and job security erode.”
This time Amex’s exposure to travel and dining will see the company over exposed to the downturn. With the chances of a 15% decline in discount revenues and a doubling in bad debts expenses being far from remote, and also being enough to push Amex into a loss-making position for 2020. Whilst one wouldn’t be surprised if this were to occur, the nature of the company’s revenues will still see Amex be in a significantly stronger position than its competitors whom are materially more exposed to the credit cycle.
The Competition Answer, How This Supports AmEx’s Premium Merchant Service Fee
“What can the particular company do that others would not be able to do about as well?” – Phil Fischer
Over the long-term Amex is in the position to grow its share of spending by high-income earners and wealthy individuals, whilst these individuals continue to increase their use of electronic payments as a share of overall spending. This is not the equivalent of Amex increasing their share of the electronic payments market at a faster rate than the growth rate of the electronic payments market itself. This is a common misconception and the primary reason I believe the company has continued to be overlooked as an attractive investment.
For Amex’s competitors to be able to attract and retain high-income earners and wealthy individuals over the long-run, they would be required to derive an equivalent amount of revenue from merchant service fees. This would require each issuing competitor to invest in and create their own payments network. Not only would this require incredible amounts of capital to create, it is also not in the business interest of banks who focus their expertise on lending.
Also, whilst Visa and Mastercard already have payments networks in place they do not issue any cards, let alone cards focused at high-income earners. Both Visa and Mastercard rely on issuing banks to issue cards on their networks, and to pay a fee for the privilege to do so. If either company were to enter the issuing business, it would put them in direct competition with those whom their incredibly profitable businesses rely upon. Quite simply, there exists very little incentive for the two companies to compete against their own customers. If Visa and Mastercard where to enter the rewards card market, the facts would change materially, and the investment thesis would not apply.
To summarise the answer to Phil Fischer’s quote at the beginning of this section: whilst Amex can still connect merchants with high spending customers, it can continue to charge a premium merchant service fee. Also, whilst its competition is dependent on the performance of their consumer loan books to fund rewards, Amex will be able to maintain its Membership Rewards Costs at levels that support profitability. The combination of these two factors will allow Amex to continue to provide what is the leading rewards card for high spenders, and to be the network of choice for merchants seeking to attract these high spending individuals.
Part 3: Growth, Management and Valuation
Expansion of Business Activities
Whilst lending has been highlighted by management as a key growth area it is not exposed to the level of tail winds that the billings business is. This is down to the fact that further electronic payments adoption in the economy is unlikely to be outpaced by the growth in prime lending activities.
The company also has more experience in attracting high income spending than it does in attracting high income borrowers. What they have been good at in the U.S. in the past will be more easily transferrable internationally. Transplanted strategies to international markets from the U.S. won’t work as effectively as they did in the U.S., but they will still drive growth in billings to some extent.
An example of one strategy that has been exported to Australia from the U.S. is the approach to cobrand cards. Take the American Express® Qantas Business Rewards Card, launched in 2017. It is a replica of what was on offer in the U.S. market, in the form of the Delta SkyMiles® Platinum Business American Express Card. Whilst this is an example of a non-consumer product, it highlights how it is quite simply to introduce certain products that leverage what worked in the U.S.. A brief look at the consumer cards offered on the U.S. Amex website will show the catalogue of options available to be replicated in international markets.
The current CEO & Chairman of Amex is Stephen Squeri. Mr Squeri replaced long-time CEO and Chairman Kenneth Chenault in 2018. He is a company veteran, joining Amex in 1985. Since his arrival at the company he has worked his way through multiple divisions, from travellers’ cheques to acting as the company’s chief information officer in 2009 until his appointment as CEO.
Whilst in the position of CIO, Mr Squeri also acted as the head of Amex Corporate Development. This division is responsible for investments and acquisitions made by Amex.
When calculating cash flow left over for equity investors, we are usually trying to workout what income is remaining after repayment of debt and required reinvestment needs are met. This is the case with every company, though with financial services firms the reinvestment needs do not come in the form of typical capital expenditures.
Reinvestment needs vary widely between financial services companies, but in the case of Amex they primarily come in terms of reinvestment in the infrastructure underpinning its payments network and reinvestments made in cardholder receivables.
Investments in the technology underpinning the payments network are straight forward to determine and have been deducted in the calculation. The most accurate measure for determining the cost of reinvesting in further cardholder receivables growth has been identified as the provision for bad and doubtful debts. This is management’s estimate of receivables that will not be repaid, with the interest costs of capital invested in funding further receivables being caught in net income already.
What these adjustments result in is a calculation that is best depicted by the below equation:
FCFE = Cash from Operations – Capex - Provision for Credit Losses
Using this formula, we get an average for the pat 3 years of around $8 billion p.a.
The below assumes that FCFE for FY2020 is equal to $0, due to the impact of the Covid-19 pandemic. To account for this the terminal value has been discounted by an additional period at 9.26%.
For the prior 20-years, Amex have grown net income by an average of 14%, global GDP has grown at 2.95% and payments industry revenue has grown at an average of 6%, or roughly twice GDP, for the past 10 years.
Determining a conservative growth rate is hard, so to reduce the consequences of being wrong it always helps to revise downwards. Hence, a growth rate of 4% has been used in the below calculation as it is just under the mid-point of growth in payments revenue and the global GDP growth rate, which appears to be a conservative base.
The inputs and result of this valuation approach are below:
The aim of this report was to get to the core of why Amex exists for its multiple customers. By doing this, with a focus on the consumer side of the business, we were able to get a thorough understanding of how the company attracts high-income cardmembers and uses their spending power to command a premium fee from merchants.
By understanding how Amex earns the bulk of its revenue we are able to understand to what degree their now understood core value proposition is protected from others trying to imitate the company’s offering. The resulting understanding of the structure of competitor business models has provided what I believe is a quite accurate impression of what are durable cash flows and a sound strategy for growth.
There is still significantly more to the company than was covered in this report, in particular the commercial billings business, retail savings as a funding source, OptBlue, regulation, membership reward liabilities, and the company’s corporate structure.
All of these mentioned aspects will be covered in subsequent reports. Whilst they represent material components of the Amex business, they are better suited to later instalments of the company’s coverage, after an understanding of the company’s core purpose has been established.
 Cardmember household self-reported income at roughly $200,000 in 2016 Investor Day deck. Split between two income earners this would put AmEx Cardholders in the 90th percentile of income earners based on the 2017 U.S. census data.  American Express 10-K 2019  Data ta sourced from AmEx annual reports and 10Ks, no adjustments made  For a breakdown of the four-party card scheme I recommend https://www.rba.gov.au/payments-and-infrastructure/review-of-card-payments-regulation/conclusions-paper-may2016/interchange-fees-and-transparency-of-card-payments.html  A guide to the Card Payments System Reforms, Michele Bullock, RBA (2019)  Data sourced from S&P Capital IQ, no adjustments made  Refer to Financial Community Meeting August 1, 2017, for a more detailed breakdown of AmEx’s GNS business provided by the company itself  Presentation slide 120, American Express Company Investor Day, March 13th 2019  Altitude Platinum Bundle, Westpac, 2019, https://www.westpac.com.au/personal-banking/credit-cards/reward/americanexpress-platinum/  Common Stocks and Uncommon Profits, Page 200, Philip A. Fisher  American Express Company Investor Day, Slide 43, March 10th, 2016  2007 Annual Report, Letter to Shareholders, Kenneth Chenault  Data sourced from AmEx annual reports and 10Ks, no adjustments made  Data sourced from S&P Capital IQ, no adjustments made  Data sourced from S&P Capital IQ, no adjustments made  Data sourced from AmEx annual reports and 10Ks, no adjustments made  Presentation slide 133, American Express Company Investor Day, March 13th 2019  Data sourced from AmEx annual reports and 10Ks, no adjustments made
 American Express Company Annual Shareholders’ Meeting, presentation slide 4, May 2nd, 2011  American Express Company Annual Shareholders’ Meeting, presentation slide 5, April 30th, 2012  Qantas business rewards and American Express launch new card to make spending more rewarding for businesses, https://www.qantasnewsroom.com.au/media-releases/qantas-business-rewards-and-american-express-launch-new-card-to-make-spending-more-rewarding-for-businesses/
 Data sourced from S&P Capital IQ, no adjustments made
World Bank national accounts data, and OECD National Accounts data files, The World Bank
Global Payments Report 2019: Amid sustained growth, accelerating challenges demand bold actions, McKinsey & Company, September 2019