The Color Of American Express (AXP)

Last night American Express (AXP) released earnings information and provided "color" on its earnings call. The targets of the analysts' questions points to a lack of focus on the business model.

AXP began as a company in 1850 to transport money and other valuables safely. In a sense, AXP's focus has not changed. Today, AXP is a payments company, safely moving money on behalf of consumers and businesses.

AXP is compensated for its work in the form of "discount revenue." Discount revenue is the fee which facilitates a transaction between the merchant and the consumer. In a reversal of the old days when AXP got paid for moving money by the customers who had the money, now AXP gets paid for moving money by the merchants who receive the money.

For example, when I go to a restaurant, I pay with my American Express card (I carry no others). If my bill is $100, the restaurant receives $97.44, typically within one business day. (AXP reports a fee of 2.56%).

If all goes well, that little $2.56 is wonderfully profitable for AXP. AXP simply put a piece of IOU plastic in my pocket to run through a machine and took $2.56 from the merchant. No meals to serve; no dishes to wash. The merchant would prefer to have $100 in cash, but settles for $97.44 in "plastic" that might not otherwise have come.

To get this $2.56 from the merchant, AXP has two costs: financing and bonding. AXP sends $97.44 to the merchant and does not receive my $100 for about 30 days. This is "reverse float," that is, money that is not held that costs interest. If AXP is paying 5% annually, then the month's cost is $97.44*(.05/12) = $0.41. This is the financing cost associated with the generation of discount revenue.

The other cost is that the consumer won't be good for the money. One way to think of AXP is as a bonding company. When I am to "pay my dues" for my meal, AXP posts bond. If I pay AXP, then all is well and AXP received a fee for the work. If I don't pay AXP, then AXP is on the hook and will be looking for me. This is the major potential expense for AXP.

The "failure to show" bonding cost dwarfs the financing cost, but all of the questions of Wall Street's finest were slow pitches focused on financing costs. What's the color of American Express? Yellow, at least on that call.