American Express (AXP) Gettin' No Credit

American Express (AXP) has been a fixture of payment systems since the rough and tumble days of horse back riding. There has always been a need for secure payment systems; the question has been who is going to pay for it. Back in the day, if a person purchased an item, that person was often responsible for getting it shipped.

In today's world, the merchant pays the "freight." Because AXP delivers the funds on behalf of the purchaser, AXP receives a payment in the form of discount revenue.

There are two lines of business which deliver discount revenue. The first is charge cards. Charge cards do not have a lending balance, but do have a receivable. Once a purchaser charges an item, AXP pays the bill and then waits to collect from the purchaser at the end of the month. AXP has a "reverse float," that is money not held, but owned. This "reverse float" has costs to it, but these costs are borne by the annual card fees.

The second line of business to deliver discount revenue is the credit card business. Credit cards do have a lending balance which charges high interest rates. These lending balances are funded by low-cost borrowing through the capital markets. With the capital markets frozen, AXP has been scrambling for ways to replace the low-cost borrowing at exactly the time default rates on loans are rising. Not a good combination.

To ascertain the value of AXP, one needs to weigh these two lines of business. Each does have a value. The charge card business is more consistently profitable, but has slower growth. The credit card business has greater growth, but is more cyclically profitable. Historically a credit business trades at a low of .5X book value up to a high of 1.5X book value with an "intrinsic value" of 1X book value. The book is what is required to manage the net spread business. AXP has $75 billion of receivables, with a new bank requirement of at least 6%: meaning roughly $5 billion of net worth.

The charge card business should generate about $4 billion of pretax profits with a multiple of roughly 6X giving $24 billion of value. The combination of the two businesses should be roughly $30 billion. In addition, there is a processing business globally which should make $1 billion pretax profits with a multiple of 10X, given the valuations of MasterCard and Visa. The total of $40 billion puts an "intrinsic value" of $35 - a far cry from today's stock price.