Posted on 22 February 2012.
American Express (NYSE: AXP) has made a name for itself as the most successful closed loop credit card providers in the United States, but achieved its success primarily because it was held out of the open loop market until recently. Its recent entry into the open loop credit card market has placed pressure on the credit giants of Visa (NYSE: V) and MasterCard (NYSE: MA) and cost the two giants billions of dollars to American Express, which has come at no better of a time— when the financial markets struggled and creditors were pulled into the undertow. Through its transition into the open loop market, American Express has the opportunity to become more successful than ever anticipated.
American Express got its start as a closed loop card that was very similar to the Diner’s Club card. Its famous green card has been its flagship through its existence and the creditor was originally an exclusive card that could only be used at merchants who were enrolled in the program. American Express cards could only be offered by banks that it had agreements with, and while it historically offered cards to more credit worthy members than its competition, its existence in the closed loop market hindered it against Visa and MasterCard, which operated on the open loop network.
The open loop system varies from the closed loop network in that it requires cooperation between banks and funds transfers while the closed loop network has traditionally been limited to local businesses. American Express initially met heavy resistance when it made its first attempt to enter the open loop market due to agreements that both Visa and MasterCard had with banks that shut those banks out from doing business with their competitors. In 2004, a court ruling in favor of American Express and other previous closed loop creditors allowed American Express to conduct business with the same banks that Visa and MasterCard had been, giving the company an opportunity to expand into a larger market.
Four years after the antitrust ruling in 2008, American Express won a lawsuit against both Visa and MasterCard for damages of $2.1 billion from Visa and $1.8 billion from MasterCard. The settlements were structured into quarterly payments that brought American Express $880 million per year over the last three years. American Express was not the only credit card company to file a suit against Visa and MasterCard and Discover (NYSE: DFS) benefited from the antitrust ruling with a $2.8 billion settlement of its own.
Both American Express and Discover are in an advantageous position heading into 2012 after having received billions of dollars during an economic slump that both companies needed. Visa and MasterCard, on the other hand, have been weighed down by the settlements over the last three years. Now that Visa and MasterCard have made good on their obligations, however, the pressure is off and they are able to challenge American Express and Discover without a handicap.
All four credit companies have positive stock histories over the last three years. American Express has grown from $12 per share to $52 while Visa has moved from $50 per share to $114, MasterCard has risen from $158 to $399 per share and Discover has made gains over the same period from $5 to $30. Visa is the largest contender and has a market cap of $76.8 billion, which is followed closely by American Express, which has a cap of $61.5 billion. MasterCard maintains a market cap of $50.5 billion and Discover is the smallest of the group with a cap of $15.7 billion.
American Express has increased its profit from $2.6 billion in 2008 to $4 billion in its last fiscal year and added $4.4 billion in equity over the same time period. Having had an extra $880 million per year to play with over the last three years has put American Express in a position to strengthen itself against its competitors and it is insulating itself pretty well against both Visa and MasterCard. I believe that 2012 will be a positive year for American Express and that it will begin to move into a position to challenge Visa over the next two or three years for the top position in the credit card market.
Visa and MasterCard haven’t been defeated, but their past practices have come back to haunt them and the settlements with American Express and Discover have allowed each of the closed loop cards to pressure Visa and MasterCard in new ways. American Express stands out as the most solid investment here due to its history of offering cards to more credit worthy members and having less customers default on payments as a result. If you are looking to diversify your portfolio in the financial sector, however, all four of these companies have the opportunity to grow significantly over the coming years.