Why AmEx Suddenly Looks Vulnerable

Its merchant fees are under siege, and rivals are wooing high-end customers

If there's a sweet spot in the credit-card industry, American Express Co. (AXP ) appears to be in it. Its rich cardholders are spending more than ever, and the reward has been 13 straight quarters of earnings growing by at least 10%. But suddenly, Chief Executive Kenneth I. Chenault is facing some tough problems.

The lucrative fees AmEx charges merchants are under attack, and it has been slow to sign up U.S. banks to issue its cards. What's more, rivals Visa International and MasterCard International are fast encroaching on its high-end turf. In a July 12 report, UBS (UBS ) card analyst Eric E. Wasserstrom said he expects the aggressive marketing of Visa's Signature card, aimed at upmarket customers, to slow AmEx's earnings growth. Adds Duncan MacDonald, former general counsel for Citibank cards: "AmEx has to be scared for a bunch of reasons."

Chenault was not available for comment, but the company says it's not worried about the future. "Over the past few years we've posted the strongest growth and steadiest momentum in the industry," says spokesman Michael J. O'Neill.

Since last October, when the Supreme Court cleared the way for AmEx to issue cards through banks, only one -- MBNA -- has started to do so. And that deal suffered a big setback on June 30, when Charlotte (N.C.)'s Bank of America (BAC ) Corp., a pioneer of the rival Visa system, announced it was buying MBNA. Says Sanford C. Bernstein & Co. senior analyst Howard K. Mason: "MBNA is likely to invest less in the AmEx brand under BofA's umbrella than it would have as an independent company." Meantime, AmEx so far has signed up three other partners: Citigroup (C ), UBS, and USAA Federal Savings Bank. Morgan Stanley (MWD ) finance analyst Kenneth Posner figures that bank-issued cards will contribute far less to AmEx's earnings than the market is betting: only 6 cents to 9 cents per share even by 2008, vs. the consensus forecast of 20 cents to 30 cents.

AmEx hasn't exactly been winning the hearts of the banks lately. Armed with the Supreme Court decision, the company hired star litigator David Boies last fall and sued eight of the nation's biggest banks, alleging "conspiratorial conduct" to prevent AmEx from issuing cards through banks.

More important than the bank deals is a looming threat to a cornerstone of AmEx's business. Class-action lawyers, regulators, and critics are mobilizing against the billions in fees that all credit-card companies charge merchants and then share with banks as an incentive for them to issue the cards. On June 22, a group of merchants sued Visa and MasterCard in U.S. District Court in Connecticut, arguing that they illegally fix the fees. Noah J. Hanft`, general counsel for MasterCard, says the fees are appropriate, and consumers get a system that provides "extraordinary efficiencies and benefits."


AmEx isn't named in the suit, but it would feel pressure to cut fees if the merchants win. AmEx collects an average of 2.6% of customers' bills, vs. about 2% levied by rivals. Morgan Stanley's Posner estimates that a cut of one percentage point off its fees would slash profits roughly in half. (Last year's net income was $3.5 billion.) AmEx says merchants pay higher fees to gain access to its high-end customers.

Some Wall Streeters are wondering whether AmEx can go it alone much longer. The BofA-MBNA deal and Washington Mutual Inc.'s purchase of Providian just weeks earlier point to the need for scale in a business that has seen annual growth plummet from 20% in the mid-1990s to about 4% now. "American Express is in play," says David A. Hendler of New York research shop CreditSights Ltd. One of the few buyers that could afford AmEx, with its market cap of $67 billion, is Citigroup. "If AmEx was willing to sell, it would be Citi's deal," says Hendler. "They're now No. 3 in cards. It's programmed in their DNA that they should be No. 1 -- not the boys from Charlotte."

Neither AmEx nor Citi would comment on the speculation. But if AmEx can't overcome its looming obstacles, Citi or some other suitor may come knocking.

By Mara Der Hovanesian in New York

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