American Express (NYSE:AXP) has successfully implemented its spend-centric model and closed-loop network to achieve growth over the last few years and was one of the few financial companies to come out of the economic crisis of 2008 virtually unscathed. Its performance in the U.S. was helped by consumer trends as customers started paying off credit in time in order to avoid staying in debt during the financial crunch. The delinquency rate on credit card loans for all commercial banks in the U.S. dropped from 6.76% in the second quarter of 2009 to 2.73% in the fourth quarter of 2012.  In the same period, the charge-off rate on credit card loans for the top 100 banks ranked by assets in the country dropped from 9.59% to 4.08%. 
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Outside the U.S., Amex has taken a step away from its closed loop model where it issues its own credit cards and also acts as the acquirer for merchants accepting the card. In 2012, almost 80% of American Express branded cards issued outside the U.S. were issued through third party financial institutions, in agreement with the company’s global network services (GNS) division. Transaction fees earned through third party issuers have increased by a CAGR of 15% – higher than 9% for propriety cards in the U.S. Revenues earned through third party issuers accounted for 15% of the company’s gross revenues in 2012, indicating the importance of this business.
Our $62 price estimate for the company’s stock is in-line with the current market price.
How Does This Business Work?
American Express invites financial institutions to issue cards carrying the signature American Express logo and also to act as merchant acquirers on the Amex network by leveraging its infrastructure and brand image. This allows the company to enhance its presence in countries where the institutions are already established and expand its cardmember and merchant base at cost levels that would not have been feasible on its own. The agreements with the financial institutions can be one of three categories:
Independent Operator Agreement
In this type of agreement, the partner institution owns the credit risk for the cards issued, handles customer relationships and is responsible for transaction authorization, billing and pricing. The independent operator can issue local currency cards and serves as the merchant acquirer.
American Express earns revenues from card licensing fees, royalties on billings, charge volume, net spread revenue and cards in force, foreign exchange conversion revenue and also a share of the discount revenue earned by the operator. This type of agreement is common in countries where Amex does not offer its own propriety cards. At the end of 2012, there were 67 such agreements across the world, including Brazil, Russia, Indonesia, Turkey and Ecuador.
Network Card License Arrangement
In this type of agreement, the third party institution can issue branded cards and is responsible for design of product features, customer service, billing and credit and authorization of transactions. American Express is responsible for the merchant network, processing transactions from point of sale to settlement with card issuers. The company charges fees based on transaction volume and also earns royalties and currency conversion fees. This type of agreement is implemented in countries where American Express has a propriety card business. There were 77 such agreements in place at the end of 2012, including those with Lloyds TSB Bank in the United Kingdom and Westpac Banking Corporation in Australia.
Joint Venture Agreement
This is exactly what the name suggests wherein the company has an ownership stake in a business in collaboration with a third party. The business typically issues local currency and U.S. dollar denominated cards with both parties sharing risk and profit and loss responsibilities. The income primarily depends on the level of ownership interest. This agreement is in place in Switzerland and Belgium.
Third Party Cards Could Reach 20% Of Sales
Third party issued cards in use have grown at a CAGR of 13% over the last four years, from 26.3 million in 2009 to 37.6 million in 2012. In contrast, propriety cards in the U.S. have grown at just 2% from 29.5 million in 2009 to 31.3 million in 2012. Outside of the U.S., the growth in propriety cards has been stagnant. There were 10.5 million cards in use in 2009 and 10.6 million in 2012. This is primarily due to the company’s strategy to use GNS partnerships to enter high growth economies, particularly in Asia and Latin America. We expect double digit growth for third party cards in the coming years.
Transaction volume on third party cards has increased at a compound rate of 22% over the last four years from $71.8 billion in 2009 to $128.8 billion in 2012. This growth has been driven primarily by the growth in cards in use. Average annual spending per card has grown at a slower rate (8%) from $2,730 in 2009 to $3,426 in 2012, and we expect this growth to continue over our forecast period.
Transaction volume on propriety cards has grown at a CAGR of 11%, both in and outside the U.S., over the last four years. However, the average annual spend per propriety card in the U.S. is much higher than the spend on third party issued cards at $14,986 in 2012.
On average, American Express earns around 3.66% as a percentage of transaction volume on third party issued cards. This percentage fell from 4.29% in 2009 primarily due to expansion in growing economies and varying agreements with partner institutions. We expect this percentage to decline to 3.36% by the end of our forecast period.
We believe that third party issued cards will drive business for American Express in the coming years. Revenues from third party cards currently account for 15% of the company’s total revenues, and we expect this percentage to increase to 20% by the end of our forecast period. You can modify the interactive charts above to gauge the effect a change in forecasts will have on our price estimate.Notes:
- Delinquency Rate On Credit Card Loans, All Commercial Banks, Board of Governors of the Federal Reserve System [↩]
- Charge-Off Rate On Credit Card Loans, Top 100 Banks Ranked By Assets, Board of Governors of the Federal Reserve System [↩]