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Third Wheel

“You can’t create another American Express”

– Warren Buffett

arvy’s teaser: American Express, Warren Buffett’s favorite, is thriving with a unique model geared towards affluent customers. This contrasts with the pure network approach of Visa and Mastercard. Despite the premium edge, economic downturns pose a risk.


Payment cards.

It is impossible to imagine today’s world without them.

The two names that immediately spring to mind with this connection are the card network companies Visa and Mastercard. They serve as the backbone of the global financial ecosystem by enabling seamless transactions between cardholders, merchants and issuing banks. Due to their immense power, they form a duopoly with a global market share of 63% (MA 24%/V 39%). In the US it is even 87% (MA 26%/V 61%, chart 1). But there is a competitor that has chosen a more aggressive business model to compete with the two giants.

It is the third wheel in a duopoly that is claiming its right to exist.

And it is Warren Buffett’s favorite stock.

American Express.

In short, AmEx.

Chart 1: Market share of Visa, Mastercard, AmEx, Discover, based on value of transactions

Source: Statista

Different Business Model

The main source of income for all three companies is the payments you make with your card.

How does it work?

For each transaction, they earn between 0.15% and 0.30% (AmEx charges more) of the total amount you spend. This means that for a $100 transaction you make anywhere, be it online or in a local store, they receive $0.15 to $0.30.

So contrary to popular belief, Visa and Mastercard do not issue credit cards, they just provide the settlement network. They only process the payments mentioned above. This means they have little exposure to the credit risks from cardholders who miss payments. But they win big when consumers spend more. It is called “Open Loop”.

Little downside but significant upside.

However, while payment transactions generate almost all revenues for the duopoly companies, this is not the case with American Express, where it only accounts for ¾ of their revenue, as it follows a slightly different business model called “Closed Loop” (chart 2).

American Express also issues credit cards like a bank, considering the risk of cardholders not paying their bills. AmEx earns interest on late payments – a whopping 21% now. This means that they earn money from card users not only through transaction fees (network), but also through interest income, annual fees, foreign currency fees or value-added services such as fraud prevention or data analysis by issuing credit cards.

More downside, but even more upside.

Chart 2: Difference between Visa, Mastercard and American Express

Source: arvy

Lifestyle Brand

American Express does not just take on any credit risk. The company, which has been around since 1850, only focuses on the affluent segment when issuing cards, i.e. high spending individuals.

AmEx positions itself as a premium credit card provider that will not accept just anyone and places an emphasis on things that go beyond simply paying with the card.

You are no doubt familiar with Miles & More, where you earn 1 mile for every CHF 1 spent with AmEx, compared to just 0.4 miles per CHF 1 spent with other providers. This is AmEx’s clear focus on travel and entertainment spending.

What else is AmEx known for?

Exclusivity and benefits, for example through the American Express Centurion Card (chart 3). It gives you a variety of benefits such as 24/7 concierge service, free upgrades on air travel or in hotels, exclusive transportation or better access to luxury goods or private events and much more.

The card is by invitation only and of course comes at a price. Annual fees of $5,000 and you must spend around $250,000 per year with the card.

The result?

AmEx is on solid footing, with the number of cardholders growing at an attractive rate in the mid-single digits, and efforts to position its products as premium lifestyle cards are bearing fruit.

A strong consumer who stands behind a product is something that every investor likes.

Chart 3: American Express Centurion Card, the most exclusive payment card

Source: American Express

Warren Buffett’s favorite

Buffett owns 21% of American Express. The reasons for his long-term investment in the company?

  1. AmEx has a strong global brand with loyal, affluent customers.
  2. These customers are less affected by recessions and less likely to default on payments, which minimizes bad debt in the credit card business.
  3. Several sources of revenue over its competitors. Customers pay a high annual fee, transaction fees on payments (network) and currencies, net interest income on credit card loans and so on.

Investing in American Express exposes you to both the payment processing business and the credit card/loan business, similar to banks. However, our point of concern is on economic pressures that can impact consumer spending, especially in travel and entertainment, where AmEx is heavily focused.

While a strong consumer may keep default risks low, spending in these areas will decline during economic downturns, making AmEx’s business more cyclical. Unlike Warren Buffett, we tend to favor the two Pure Plays that focus on the long-term cashless trend and like to exclude the banking part of the business.

Therefore, we neglect the third wheel and keep what we like much better in our portfolio.

The clear focus and the duopoly of Visa and Mastercard.

Chart 4: American Express, Mastercard and Visa over ten years

Source: TradingView

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