7 Reasons Why Apple Should Buy American Express

by Kyle David on May 23rd at 9:04 am EST

For those that missed the original internet bubble, you may be in luck.  The market seems to be working on the sequel as m&a activity grows tremendously and company valuations are verging on the absurd.  In just six months we’ve seen Groupon valued at $6B and Microsoft actually paid $8B+ for Skype.  It seems like only yesterday we were doing this the first time.  However, a few things have changed.  1) These companies actually make money; though in a lot of cases, not much.  2) Most of the companies have some idea how they are going to continue to make (some) money.  3) Many, if not all, of the new dot com’s are purveyors of services rather than products.  These changes aside, I still see us headed for a disaster if the contagious gold rush in technology spreads to retail investors as it has within investment banks.

Now, I’m not a complete pessimist, because I think a lot of companies like Facebook were actually undervalued for a long time.  However, that doesn’t mean overvaluation is the solution.  (Did you hear that LinkedIn?)  There is one deal that I have been championing since last Spring, but I fear that if it takes place it’s going to rock the market and officially mark a critical moment in bubble 2.0: Apple needs to acquire American Express.  Now, I will make my case from not only the technological angle, but also a financial angle to support why I feel that this is the next leg for Apple and the internet in general.

Most notably, the reason why a marriage would be so fantastic hinges on the potential to integrate payment into the iPhone as a “mobile wallet” or even just a credit card through the device.  (We’re thinking the creative geniuses at Apple might name it iMoney.)  True, this is not a concept that has never been thought of before.  Starbucks has already integrated a direct payment solution into their app which has been wildly popular.  Unbridling this technology to all purchases is something that has banks and technology companies scrambling, fighting, and dealing behind closed doors.  There isn’t another day that goes by that the WSJ doesn’t have another story about a bank’s attempt at a “mobile wallet” only to never appear again.  That is why I feel strongly, that Apple should negate all of the nonsense, and just buy AMEX.

When I speak I always throw in a bit of chatter about why this deal will ultimately be tremendously successful.  Predictably, I will have my balloon deflated by b-school students that want to read me case studies of Coke acquiring Oil of Olay or some other example of why acquisitions outside of the acquirers core business won’t build value.  They have some merit too.  Running a bank/travel agency/publisher is vastly different than a technology and software company.  However, American Express’s bread and butter is in payment cards and merchant services.  This will be the next wave in what Jim Cramer refers to as the “mobile internet tsunami.”

Reason 1: The Business Ideals Match

Apple’s meteoric rise from the brink of failure to a technology and media powerhouse is no doubt in large part to the brilliance of Steve Jobs.  However, Jobs’s acumen in developing high-quality devices and software would not have worked without a rock solid business model focused on controlling the user experience.  This level of complete control is what has afforded them the opportunity to challenge Microsoft in a big way. 

Once the DVD of Windows 7 ships, Microsoft loses all control of it.  Not to mention the ostensibly non-existent technical support from Microsoft.  With any Apple product, you must purchase it at the Apple store or through an authorized dealer.  You service it through Apple Care and the Genius Bar.  You are holding a piece of their hardware, software, and support together in a ménage a trois that geeks and tech newbies can agree on.  That level of control allows them to quickly mitigate any issues and provide completely standardized support services—a massive advantage in the computing world.

Now, let’s shift to American Express.  (For the purposes of this piece, I’m going to be exclusively speaking to their payment card business when I reference them unless I state otherwise.)  American Express has always excelled in part because of their high-class clientele (a theme I will refer to later), however one of the hallmarks of any AMEX customer is their distinguishing taste for world-class customer service.  Rest assured, they are not the best.  When dealing with people’s money, you are always going to get some pushback.  However, American Express also controls (very tightly) both sides of the transaction.  Not only does Amex issue the card to the user, but they also issue the processing service directly to the merchant with the only “middle man” in the transaction being the party that connected AMEX with the merchant.  Unlike VISA and MasterCard who allow their card acceptance to be sold and resold like mortgages.  As any merchant will tell you, AMEX keeps a tight grip on their merchants.  This standardized support is analogous to Apple’s.

Summary: From a standpoint of experience control and customer service, Apple and AMEX are a perfect fit together.

 

Reason 2:  There is a war going on over mobile banking.

Online banking is no longer something for the tech savvy.  It is ubiquitous.  On the horizon is mobile banking, which hasn’t taken the spotlight yet, but will soon do so.  All major banks and credit card providers allow for some sort of mobile access.

There is a war going on with banks over mobile wallets.  Owning the bank would present a situation where Apple is the first mover (which they love to be) in the market, and be able to deliver a simple and consolidated product.  Given Apple’s track record at creating markets this is not new territory for them.

Summary:  Apple has a long history of setting precedents and standards.  To become the first market mover circumvents the war and will quickly establish dominance.

 

Reason 3:  Brand Status

Apple is a premium brand at a premium price.  There are plenty of knockoffs that are cheaper and may even be better, however the brand perception with Apple is that there is nothing more innovative or of higher quality.  Celebrities carry the iPhone, because there is simply nothing better.  That brand perception is what allows them to charge heavy premiums on their products while still dominating their market.  Their products range nearly all price points so that “status” can be obtained with an iPod touch for $100 or a MacBook Pro for $2500. 

To those who know the story of American Express, there is simply no difference.  The exclusivity and “high brow” perception of American Express is one of the reasons that notoriously savvy investor Warren Buffett took such a large stake in the company in the 1960s and holds it to this day.  To test his thesis that he should buy the company, he sat at nice restaurants to see how many people paid with an AMEX.  Apparently there were a lot because Buffet is the largest single investor in the company.  That brand perception is what brought American Express back from the brink of disaster when it made some poor investment choices (sound familiar?)

Now I’m sure that there are market research companies around the world that have sophisticated metrics of how luxurious a brand is and its general perception, however I like to use a highly academic metric of my own: the rapper metric.  Rappers make things luxurious. (i.e. Cadillac Escalade & Patron.  If someone can show me another segment that can make a grandpa car into a young and fit status symbol and tequila into a high brow drink and I will buy you lunch.)  By my last measure “Android” hasn’t been mentioned once.  However, multi-platinum rapper Lil’ Wayne’s lyric,

“Like a F-350, tank never empty
Damn everybody in the bank act friendly
Used to think my shit didn't stank boy was I wrong
Approving million dollar deals from my iPhone”

And American Express’s mentions in hip hop are innumerably great with particular frequency on the black card.  Jay-Z’s lyric in “It’s Alright”:

“Regardless of the fame
It’s hard, I can’t even walk through Harlem again,
Charge it to the game, I’m platinum like American Express”

Smartphones are personal devices.  People concern themselves greatly with their next purchase and how it is going to transform their lives.  The luxury brand in smartphones is no doubt Apple’s iPhone.  American Express is the luxury brand in credit cards.  It’s the reason Warren Buffett is such a large stakeholder.  Not only is it a world-class brand, but it is a toll bridge business.  The people that use it, use it for status and will keep using it as long as the cachet stays the same.  That has been the message from AMEX since day one.  Remember this ad?  And this one?

Summary:  Both brands cater to the perceptions of a higher class.  No realignment necessary.

 

Reason 4: Apple is missing the fifth “M”

The five reasons people access the Internet are: messaging, (social) media, music, movies, and MONEY.  Currently Apple caters to four out of the five.  As a company, Apple as created experiences and products that have proven their ability to weave the Apple brand into the fabric of our lives.  The brand extension into music, drove sales through its entire suite of products, creating a pathway to turn a low volume buyer into a high volume buyer. 

However, Apple’s connection with a person through music proves that it can hit someone at his or her core.  This is especially significant because they were not only able to capture someone’s musical habits, they were instrumental in curbing rampant piracy that was brought about by services like Napster.  This connection got people that were used to getting freebies to pay for their music, a largely unprecedented shift on the internet.

Music elicits the entire range of emotions that money does.  Music is personal as is money.  Just try to tell someone in Nashville that country sucks or ask someone how much money they make.  The reaction will be about the same.  People need to be able to control their music and their money and there is no better way to control it than through the device that has become a bodily appendage to many.

Summary:  Apple can seize markets and win.

 

Reason 5: It would put Google on the defensive

Google could do it faster as they have more android phones in force.  However, the Google brand doesn’t fit AMEX like Apple does.  The Apple brand is “hand-in-glove” for American Express.  The ability to get a deal on your smart phone, pay for it, and go would allow Apple to make Groupon its bitch.  This would be a huge coup for Apple and could quickly extend into the territory of PayPal and Google Checkout.

I think most importantly in this situation is that it would devalue Android powered devices.  They would be the number two player in this game and if MP3 players and tablets are any indication, the number two is barely visible from the throne of the number one.  When was the last time you heard someone say, “Golly, I can’t wait to get a Zune?”

Keeping the competition at bay is something that Apple is great at doing.  With Chrome OS from Google becoming a reality, it is going to be all the more important to keep the competition on the chase.  There is no better place for your competition.

Summary:  If Apple leads on this, Google will have a hard time catching up.

 

Reason 6: Acquisition that will immediately add $.02 per share.

For some high-level math, let’s take a look at Apple’s 20B in sales in 2010.  According to Quora, 20% of credit card transactions take place using an AMEX card.  Now, yes I understand that I’m making gross generalizations, but it is to prove a point.

20 Billion in 2010 annual sales X 80% by credit card X  20% of them are AMEX, and AMEX takes 1% of the transaction. $320M in savings. 

That is just an appetizer to the entre of savings that would he had through an acquisition. 

Summary: Most acquisitions don’t add value, but this one would right out of the gate.

 

Reason 7: Derivative Benefits

There are a plethora of secondary benefits Apple would receive, presenting an abundance of opportunity for future growth.  The biggest one would be they amalgamation of user purchase habits, preferences, and behaviors.  All of that data is a goldmine for advertisers.  It also has the potential for Apple to open up distribution channels and create strategic retail partnerships.  This is barely a secondary benefit and could be considered a primary.  If you can get a discount by just paying with your iPhone, bye-bye Groupon.  If your iPhone can alert you of deals within walking distance and let you checkout on the phone instantly, the landscape of capitalism in population dense areas will forever be changed.  Most importantly though for Apple, if your phone becomes a device that “pays for itself” you are creating a moat so wide for competition Google would have to start a crew team to even think about crossing it.

Now, there is the argument about privacy that comes with the territory of user data collection, however I don’t buy it.  People like to pretend they care, until their personal data gets them 2 for 1 pedicures.  Just look at the protests, and uproar that has come from Facebook changing their privacy policies daily, and Apple tracking users’ locations within their mobile devices.  What has come of it all?  Nothing, but a few 90 second filler segments on CNN.

Finally, in the derivative benefit column, this marriage would put VISA/MC on a strong defensive in addition to Google; a position that they really don’t know.  Having dominated the market for so many years, I would wage to guess that the lack of time spent in the trenches is a perfect reason why they will make knee-jerk reactions to this type of a deal and do something stupid like do a deal with Microsoft so that the next Kin can integrate payment.  Just imagine when your credit card gives you the blue screen of death.  This is a predictable and foreseeable failure, and should they omit from doing any deal, Apple will continue to farm away market share.

Summary:  The ancillaries are enormous and together may be even more valuable than mobile payments.

 

Wrap Up

Oddly enough, I’m generally a PC guy.  However, I would be naive to deny the impact that Apple’s product line is having on the market.  To me, an acquisition of AMEX not only makes sense, the cost of NOT doing it is greater than the cost of pulling the trigger.  Steve Jobs, Tim Cook, Kenneth Chenault, give me a ring.  Let’s put together a deal.