Morningstar Magazine - December 2017/January 2018 - 68

Investors

company would be the most successful, but it was
a good bet to short horses. That's what we
feel about the hardware industry in general. We're
seeing that across technology, and it holds
in payments as well.
The other key trend is that payments are becoming
integrated into enterprise software systems. This
can dramatically lower the cost of distribution and
increase profitability-but you risk payments
becoming a commodity portion of a larger software
package. These are some of the reasons we
like the companies with scale. If the hardware
goes away, if the brand is now in the background,
you're going to be focused solely on cost
advantage. The companies with the lowest cost
are the ones that have scale: companies like Visa
on the network side and Vantiv on the merchant
processing side.

But it has two big advantages. One of them
is the corporate business. More than half
of Fortune 500 companies use American Express
for corporate spending, and it's hard for an
organization with thousands of cards outstanding
to switch from one issuer to another. There
is a very high switching cost, and it ensures that
a lot of businesses in the travel and entertainment industries accept American Express. The
corporate business is the crown jewel.
The second advantage, which American Express
could monetize over time, is their direct
connection from consumers to merchants. Visa and
Mastercard connect banks to other banks.
American Express, however, connects consumers
directly to merchants. They can use Big Data to
offset some of its competition going. They can offer
unique rewards to cardholders based on their

The companies with the lowest cost are the
ones that have scale: companies like Visa
on the network side and Vantiv on the merchant
processing side.
Jim Sinegal

How does American Express maintain a wide moat
in this world?

Sinegal: On the retail cardholder side of things,
the brand is not as prestigious as it once
was. American Express used to charge higher
fees but give away more in rewards, but
fees have come down because of regulation,
and there is more competition on the
rewards side. The banks can use their card
business as a loss leader, give out a lot
of rewards, in hopes of picking up wealth
management business, mortgages, and deposit
accounts. American Express doesn't have
any of that.

Morningstar December/January 2018

spending patterns and sell that customized data
to merchants and justify their higher prices.
American Express management has been a little
slow to react. They are not going to monetize data
in the next few quarters, but they have time
to adapt. I'd like to see them doing more, and I'd
like to pay a little bit less for that opportunity.
But it's too early to say it's the end of the road for
American Express.
None of the companies we've discussed are great
deals right now. Any events you foresee that might
improve valuations?

Sinegal: These companies tend to get hit when
there's any sort of consumer data breach,
such as with Equifax EFX, and historically they've
been able to come back. Also, because
their competitive positions are so strong, one
of the biggest threats is on the regulatory front.
When you have a near-monopoly, you have
problems with litigation, with antitrust, with
new laws that serve to hurt your business.
American Express, Visa, and Mastercard are
always dealing with those issues, and they create
buying opportunities on occasion.

Then, there's consumer spending. Visa
and Mastercard benefit a lot from cross-border
spending. When travel goes down around
the world, whether it's due to a slower economy
or geopolitical issues, their revenue goes
down, and the stocks tend to follow. Those are
some of the negative events one could look for.
On the other hand, there are very few companies
that have solid long-term growth prospects as
well as wide economic moats and very little in the
way of reinvestment needs. It's important
to remember that Visa, Mastercard, American
Express are still growing fairly quickly while
returning about 100% of the income they generate
to shareholders in the form of repurchases and
dividends. They are extremely attractive
businesses. You can arguably pay a higher price
for them than some others, and there are
not a lot of opportunities in the general market
right now. Some investors may want to dip
their toes into those companies based on their
long-term prospects, even if they're not the
cheapest companies in the world right now. K
Laura Lallos is the managing editor of Morningstar magazine.

Table of Contents for the Digital Edition of Morningstar Magazine - December 2017/January 2018