Why did Warren Buffett invest in American Express (NYSE: AXP)? In the mid-1960s, Buffett bought 5% of American Express with 40% of Buffett Partnership capital (approximately $13 million). The Warren Buffett American Express investment has generated spectacular returns for the Oracle of Omaha.
Founded in 1850 as a joint stock association and incorporated in 1965 as a New York corporation, American Express is a multinational financial services corporation best known for its credit card.
American Express has four major operating segments:
- U.S. Card Services – American Express has two major U.S. banking subsidiaries (Centurion Bank and AEBFSB). Its card business targets a premium customer case and strives to increase average spending per card instead of growth in mere number of cards. Its consumer travel business provides travel services and complements its core card business.
- International Card Services – this operating segment issues and manages the company’s charge and credit cards around the world.
- Global Commercial Services – this operating segment offers a comprehensive range of corporate card programs and business-to-business payment solutions.
- Global Network Merchant Services – this operating segment focuses on broadening the company’s merchant base. It offers point-of-sale, servicing and settlement and fraud prevention services.
American Express’s Competitive Advantage
American Express’s competitive advantage stems from two key areas: its ‘spend-centric’ business model, and its brand.
AMEX’s Spend-centric business model
The company focuses on generating revenues primarily by increasing spending on its cards – finance charges and fees provide only asecondary source of income.
As American Express notes in its annual report, “average spending on our cards… is significantly higher on a per-card basis for us versus our competitors”. This means that American Express is more valuable to merchants, as it has a following of loyal customers that drive higher sales.
This generates a virtuous cycle that perpetuates the company’s competitive advantage: higher average spending per card allows American Express to earn premium discount rates, which combined with higher spending customers increases revenues for the company; the company can then invest in more attractive rewards and incentives for its customers, to generate an even stronger following.
Warren Buffett Liked the AMEX Brand
Few brand names are as globally recognized as the American Express brand name. Many published studies have rated the American Express brand as one of the world’s most valuable brands.
In 2011, Interbrand ranked American Express the 22nd most valuable brand in the world and estimated its brand value to be $14.97 billion. Similarly, Fortune ranked American Express among one of the 20 most admired companies in the world.
Warren Buffett’s Investment in American Express
The Warren Buffett American Express investment has paid off many times over, but when Buffett bought American Express, it was battered by an infamous salad-oil scandal, because of which American Express was held liable for $60 million in damages. Although this scandal had nothing to do with the business economics of American Express, Wall Street bailed for the exits. Buffett correctly recognized that the competitive advantage of American Express’s consumer monopolies was still very much intact and had nothing to do with the scandal. Indeed, the American Express credit card is honored in more than 180 countries around the world. The competitive advantages described above and the franchise value of the company was not impacted by the salad-oil scandal in any tangible way.
Thus, he proceeded to acquire 5% of American Express with 40% of his partnership’s capital at a cost of only $13 million.This investment has produced spectacular returns in hindsight.