V - American Express: Big Apple Card Opportunity

2023-12-14 08:25:50 ET

Summary

• American Express has the potential to acquire the Apple Card partnership from Goldman Sachs, which would open up card spend from the key demographic of Gen Z.
• The partnership would align Amex with a younger, tech-oriented consumer base and leverage its appeal among millennials and Gen Z.
• The potential partnership could add billions of dollars to Amex's market cap and could significantly increase its net income.
• Even without the partnership, the stock appears undervalued.

Investment Thesis

The American Express ( AXP ) potential pickup of the Apple ( AAPL ) Card partnership from Goldman Sachs ( GS ) represents a pivotal opportunity for the credit card company, especially as Goldman Sachs' retreats from consumer finance given their missteps with their consumer division, Marcus.

If Amex is able to win the Apple card partnership away from Goldman, this would represent a major opportunity for the card brand opening them up to card spend from a key demographic: Gen Z. American Express partnering with the tech giant helps the firm align with its push towards a younger, more tech-oriented consumer base. The partnership would leverage Amex's appeal among millennials and Generation Z, a demographic increasingly intertwined with the Apple ecosystem (and a group that also sees Amex credit cards as a luxury signal). With American Express trading below the multiple of other credit card companies, the stock appears cheap (even if a deal from Apple does not close). I think it's a buy.

Background: Goldman's Pain is Amex's Gain

Goldman Sachs partnership with Apple is in rough waters . Recent reports are noting that the partnership including the Apple Card and Apple Card Savings Account are both under review by Apple and that the tech giant is looking to end their partnership with Goldman Sachs. Bloomberg has reported that this desire may be mutual due over a billion dollars in losses by Goldman Sachs for participating in the program.

This marks a significant strategic shift for the banking giant. Despite initial expansions and supportive measures during the COVID-19 pandemic, such as introducing 0% financing on Apple products and the "Customer Assistance Program," the partnership has faced operational difficulties and regulatory scrutiny . Marcus, the consumer banking division pushed under CEO David Solomons, as a whole has seen a series of losses and setbacks in the post-Covid era.

Goldman Sachs has struggled with managing the rapid growth and high volume of customer disputes related to the Apple Card. This challenge, coupled with regulatory requirements to set aside substantial funds against potential non-payments, significantly impacted the financial viability of the partnership.

The termination of this partnership aligns with Apple's strategy to internalize its financial services. Under "Project Breakout," Apple aims to develop its own payment processing technology, reducing its reliance on external partners like Goldman Sachs.

Why Amex is a Great Partner for Apple

American Express (Amex) could be a great partner for Apple, especially in targeting younger, tech-savvy consumers. Amex has seen a significant increase in spending by millennials and Generation Z, indicating their strong appeal to these demographics. Furthermore, over 60% of new consumer accounts globally for Amex come from these younger cohorts. This aligns well with Apple's customer base, which is deeply integrated into the Apple ecosystem. The potential partnership could capitalize on Amex's strength in attracting young, financially capable customers and Apple's technological prowess and brand appeal. This synergy could be particularly beneficial in the current financial landscape where many young consumers are managing credit amid inflationary pressures.

In addition, Apple is looking for a financial partner that gives them more flexibility on back end processing as they are a leader in payment processing technology like Apple pay. American Express offers to be a perfect partner for this. Much of this has to do with the setup of American Express: while Goldman Sachs is a bank, they are not a credit card company. Technically, the Apple Card currently operates under the Mastercard payment network. With American Express, Apple can get both sides of the credit card processing. American Express is a bank and a credit card company meaning their ability to get all of the backend under one roof could be game changing.

What is the Recent News on the Partnership?

Recent news regarding the partnership between Goldman Sachs and Apple reveals that Goldman Sachs is in talks with American Express (Amex) to transfer its Apple Card partnership following billions in losses. This development follows Goldman Sachs's decision to scale back its consumer finance operations, a move underscored by its reported losses of over $1 billion on the Apple Card deal since 2020. Despite previous commitments to continue their partnership through 2029, the significant financial losses have led Goldman Sachs to reconsider its strategy.

The Wall Street Journal reported on November 7th that Goldman Sachs has had formal talks with Amex about the partnership:

The bank has held conversations with American Express to gauge the card giant's interest in taking over the Apple program, The Wall Street Journal previously reported -WSJ 11/7

This is on top of discussions Goldman Sachs had in June in Amex, with the WSJ also previously noting that:

The Wall Street firm is in talks with American Express to take over its Apple credit card and other ventures with the tech giant, according to people familiar with the matter...the tech company is aware of the talks, which have been ongoing for months, the people said. -WSJ 6/30

The talks with Amex , however, are not yet conclusive and are ongoing (but they appear serious and more than an informal conversation). Any deal to transfer the partnership would require Apple's agreement and could take some time to finalize. This potential shift comes as Goldman Sachs seeks to offload its consumer businesses, including the credit card partnership with Apple.

It's important to note that while discussions with Amex are underway, a final agreement is not imminent or guaranteed.

This news is indicative of the challenges Goldman Sachs has faced in its venture into consumer credit and the evolving landscape of financial partnerships in the tech industry.

What Could This Partnership be Worth?

The potential partnership between American Express and Apple for the Apple Card could be poised to provide significant financial opportunities. Amex could capitalize on the younger, tech-savvy consumer base that aligns with Apple's demographic.

For example, Amex has reported a 28% increase in spending by millennials and Generation Z in the first quarter, with more than 60% of their new global consumer accounts coming from these groups. This demographic alignment suggests a robust potential for revenue growth and customer acquisition for Amex, especially considering the financial capability and spending power of these younger consumers.

Considering that more than 60% of American Express's new consumer accounts globally come from these demographics, an estimate can be made regarding the number of Gen Z customers Amex could potentially gain with an Apple Card partnership if Goldman transfers it.

Assuming Amex acquires 10,000,000 new consumer accounts (this is the estimated number of Apple Card accounts with Goldman Sachs as of early 2023), their estimated earnings per account per year could be $80 (Amex made ~$2.5 billion in earnings in Q3 on ~122 million customer accounts ). Annualized this is about $80/year/cardholder.

In essence, Amex could increase their net income by $800 million/year with the opportunity.

Valuation

An Apple Card partnership with American Express could add billions of dollars to the company's market cap. For reference, the company's current Forward Non-GAAP P/E Ratio at 15.00 , below the Forward PE of Mastercard ( MA ) of 33.87 , or the Forward PE of Visa ( V ) at 26.27 .

If American Express can win this partnership, I think we could see an additional $800 million/year in net income. With a 15x forward PE multiple, I believe this translates into roughly $12 billion in market cap appreciation or ~10% upside in the stock.

Even without the partnership, however, I can see Amex as undervalued. Their ROE of 30.80% is significantly higher than the sector median ( 11.67% ). In my opinion, given that Amex PE is 50% higher than the sector median but its ROE is almost 3 times higher I think there is more room for the stock to appreciate without the Apple Card Partnership. A 50% higher buy-in price for returns that are 163.82% higher than sector median.

I like it.

Why I don't think this is priced in

American Express's PEG Ratio (GAAP, FWD) is at 1.09, significantly lower than the sector median of 1.34. This lower PEG ratio, which considers the company's growth, indicates that Amex's growth potential is not fully priced into its shares. The Apple Card partnership is arguably one of the biggest partnerships up for grabs, yet its PEG ratio does not even indicate near sector median growth potential?

Compelling.

Risks

The biggest elephant in the room is obviously if Amex will even get the partnership at all. One of the key concerns is Amex's perceived limited acceptance compared to Visa or MasterCard. This could pose challenges in terms of widespread usability and customer convenience and could affect how many people stick with the Apple card if the card processing network switched from Mastercard. I'm not super worried about this risk, however, as Amex is a more luxury card and brand. The places consumers tend to use Amex currently (in the US, at luxury stores, on hotels and airfare) tend to be places that already take Amex. This means an Apple-branded Amex card would still be accepted in all locations where people currently spend on an American Express product.

Additionally, Amex CEO Steve Squeri highlighted that Amex's premium card base might be a significant impediment to forming such co-brand partnerships. This could lead to challenges in integrating and branding the Apple Card under the Amex umbrella, potentially impacting its appeal and effectiveness in the market. I think this concern is also fairly muted, however. Much of Amex's premium base is likely an Apple customer in some way or another. I think they would not view an Amex card with hesitation as it fits in with the Apple brand (and vice versa).

Bottom Line

The potential partnership between American Express and Apple for the Apple Card, despite its risks, presents a unique opportunity for both entities. American Express could stand to gain significantly, tapping into a younger, tech-savvy consumer base that aligns with Apple's brand. This could drive revenue growth and customer acquisition, especially among millennials and Generation Z. Valuation metrics suggest Amex might be undervalued, reflecting strong growth prospects, and the risks including Amex's limited acceptance compared to competitors and potential integration challenges. Overall, this partnership could mark a strategic win for American Express, enhancing its position in the competitive financial services market. I believe this makes American Express a buy even without the partnership. The stock appears undervalued.

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