AmEx Plays Its Winning Card
By Mara Der Hovanesian
When it spins off its brokerage and money-management unit to shareholders later this year, American Express (AXP ) will become far more streamlined, living and breathing the business of plastic -- from credit cards to prepaid gift cards and renewable travelers checks. It's also likely to become much more profitable.
AmEx bought the financial-planning outfit in 1984 as part of its goal to offer one-stop shopping in financial services. Although American Express Financial Advisors -- which will get a new name after the spin-off -- has grown steadily, in recent years it hasn't come close to matching the growth or profitability of the card business. Today the unit features a network of 12,000 advisers serving more than 2.5 million clients with assets totaling $410 billion and life insurance policies worth $145 billion. Analysts estimate the stand-alone AEFA could have a market value of $10 billion.
The move frees AmEx to focus ever more incisively on its core card business. "More companies like ours are recognizing that if you don't have focus, you're at a competitive disadvantage," Chief Executive Kenneth Chenault told BusinessWeek Online on Feb. 1, the day the deal was announced. Encouraged by the sale, investors initially pushed up the stock 6.4%, to close that day at $56.75, after briefly hitting a four-year high. By the end of trading on Feb. 2, it had lost a little ground, closing at $55.77.
AmEx's card business overcame a serious hurdle on Oct. 4, when the Supreme Court gave it the go-ahead to issue plastic through banks. Visa USA and MasterCard International had blocked AmEx from doing so for years (see BW Online, 11/16/04, "AmEx Charges Rivals for Damages"). AmEx is still leagues behind its competitors in transaction volume, but soon after the ruling, Chenault quickly signed up MBNA (KRB ) and Citigroup (C ), the nation's largest credit-card issuers, which represent more than 100 million cardholders. These bank partners are expected to start issuing new American Express cards to customers this year.
Such deals should accelerate the already considerable momentum in AmEx's card business. Transaction volume jumped 18% last year, to more than $400 billion worldwide. Cards in circulation edged up to more than 65 million, with cardholders increasing their spending by 13.1%, to a record $9,460 each per year on average -- the highest in the business. Overall, AmEx's net profits came in at a record $3.4 billion, up 15% over 2003 -- an increase driven in large part by growth in spending and borrowing on American Express cards and higher travel sales.
Losing the capital-hungry financial-planning unit should spur AmEx's profitability. The advisory business gobbled up 40% of capital but generated just 21% of earnings. Michael Hughes, a Merrill Lynch analyst, says the unit "has been a drag on AmEx's growth rate and returns for some time." Indeed, while the advisory business earned a modest 12% return on capital last year, the travel and card unit produced a 33% return.
Now Chenault says he'll be able to put that capital to better use by beefing up membership rewards to get cardholders to spend more. Along with generating more transaction fees for AmEx, that move should bring the added benefit of attracting more U.S. bank partners, since they get a cut of the transaction volume. Chenault also will have the funds to develop new fee-generating services -- such as cost control and inventory management -- for corporate customers.
After the spin-off, Chenault figures he can boost AmEx's overall return on capital to a range of 28% to 30%, from 18% to 20% now. "We believe that the returns and the growth are in the payments business," he says.
There's another potential benefit to the spin-off that Chenault isn't emphasizing: The firm's bank partners may be less worried that AmEx will spirit away their customers. Some industry skeptics speculated before the Supreme Court decision that even if banks were permitted to issue American Express cards, they would never do so for fear of seeing their customers poached and sold AmEx-branded financial services. By Mara Der Hovanesian
Selling the financial-planning unit also rids Chenault of a business rife with potential conflicts. Until 1999, AmEx advisers were encouraged to sell in-house products such as mutual funds and insurance policies, mediocre performers at best. Since then, the unit has been hit by Securities & Exchange Commission enforcement actions and clients' class actions for allegedly failing to adequately explain investment offerings, not awarding certain bulk-rate discounts, and selling inappropriate financial plans.
Chenault says worries about conflicts and legal quagmires didn't drive the sale: "This was not a situation where we said we need to get out of this business because the compliance and regulatory issues are too challenging," he said, adding: "Quite the contrary. This is a growth business, and we are constraining that growth."
Flying solo may not be easy, however, and AmEx's James Cracchiolo, who'll remain chairman and CEO of the renamed AEFA after the spin-off, has his work cut out for him. He'll be competing directly with the likes of Merrill Lynch (MER ) and Morgan Stanley (MWD ), which are under attack from discount brokers. So he'll be counting on marketing deals with AmEx, including offerings from Financial Advisors' Gold & Platinum Financial Services and co-branded programs with partners such as Delta Air Lines (DAL ) and Costco Wholesale (COST ).
FILLING IN THE BLANKS.
Chenault's goals for increasing profitability in the card business also will face challenges. Visa and MasterCard have an edge over American Express in that they charge merchants less. That's the main reason many more merchants today accept those two cards: Visa and MasterCard each boast some 5.4 million merchants in their networks, vs. 3.2 million for American Express.
Chenault believes merchants should pay for quality, since his customers tend to spend more per transaction than those using rival cards. New bank partners are also being lured into the fold with promises that Chenault will give them a cut of those lucrative fees.
But there's a catch-22: AmEx can't add card members without increasing merchant acceptance at the same time -- and merchants won't pay the outfit's higher fees until it can prove it will deliver enough high-spending card members to justify the higher cost.
Chenault was clearly elated the day the spin-off was announced, eager to be one step closer to achieving his grand plan of building a card-focused American Express. But even as investors cheered the decision to spin-off the financial planning arm, it was clear that achieving all the results he hopes will require several more pieces falling into place.
Der Hovanesian is Finance & Banking editor for BusinessWeek in New York