American Express's Antitrust Downside Scenario

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The US Department of Justice (DoJ) recently sued the three largest credit card companies in the US - Visa Inc, MasterCard Inc and American Express Co., for anticompetitive practices, which prohibited merchants from offering customers discounts or rebates for using a particular kind of card, thereby impeding the merchants from promoting the use of other competing credit and charge cards.

While Visa and MasterCard have reached settlements with the US DoJ, American Express has vowed to fight back. Our price estimate of $47 for American Express is about 5% ahead of the current market price.

How American Express Differs From other Credit Cards

Every time a consumer makes a transaction using cards a transaction fee is charged to the merchant, a significant portion of which (the interchange fee component) is passed on to the card-issuing bank to compensate for the risk associated with lending and to fund membership reward programs. American Express cards command a much higher average fee of about 2.2% compared to the competitors at around 1.5% since it brings higher spending customers with an average spending per card member 2-4x that of the competitors'.

In order to maintain and attract high-income consumers, American Express offers higher promotions and membership rewards, which again are afforded only by the higher fee. This is American Express' s much-publicized 'spend-centric model' wherein American Express stands to earn more per transaction (4-8x per transaction compared to competition).

How Does the Antitrust Lawsuit Impact American Express and Others?

Visa and MasterCard do not stand to lose much on account of this since the law primarily targets the interchange fee, the component of the transaction fee that accrues to the issuing bank. Visa and MasterCard do not extend credit but only facilitate payment processing over their network, the fee for which stays unaffected.

Since the lawsuit proposes giving the merchants freedom to offer discounts and incentives to customers for alternative forms of payment, it has the potential of steering away customers to other low cost cards thereby affecting American Express's revenues from transactions.

Our estimates reveal that Card Transactions and Execution Fee currently constitutes over 74% of American Express's stock. So the proposed lawsuit puts American Express at the greatest risk. If American Express were to lose the lawsuit, one or more of the following are expected to happen.

Decline in transaction fee to industry average levels : To avoid losing transactions to competitors, American Express might reduce the fee to the industry average levels of close to 1.5%. This could have a -14% impact on our Trefis price estimate for American Express stock by our estimates.


Decline in expenses incurred in Membership Reward Programs : The most likely response to a decline in transaction fee is a reduction in membership rewards. Instead of a gradual rise currently forecasted, the expenses incurred on membership rewards could decline sharply in the short-term in such an event. We expect the decline in Marketing, Promotions and Membership Rewards as a % of Total Revenues to be about 24% by 2012. A decline in this would help the bottom line in the near term but undermine one of the most appealing points of being an American Express card holder.

Rise in Annual Card Membership Fee : The decline in transaction fee can be compensated by a rise in annual card membership fees. However, given that card providers compete for new consumers by offering competitive annual card membership fees, increasing these is likely a last resort. A rise in card membership fees to an average of $50 by the end of our forecast period, can have a +4% impact of our Trefis price estimate of American Express's stock.

Losing the antitrust lawsuit could be a blow to American Express's unique business model which lets it attract and maintain higher-income and higher spending consumers, but as this point it is too early to tell how this judgement will turn out as American Express appears confident in its defense.

You can see our detailed $47 Trefis Price estimate of American Express stock here .



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Stocks , US Markets

Referenced Stocks: AXP , MA , V

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