China's Huge Online Retail Market Opens Up To American Express

May 31, 2018

• China is the largest e-commerce market in the world.
• In April, American Express became one of the only U.S. companies to get permission to enter the Chinese financial services market.
• AmEx has a joint venture with China's fourth largest mobile payments provider, putting it in a great position to enter China's electronic payment market.
• The loosening of Dodd-Frank regulations will give AmEx a cash windfall, which can be spent on stock buybacks and dividend increases.
• Millennials made up 36% of new accounts last year.

Online retail is huge, $4 trillion worldwide, and only getting bigger.

One only needs to look at Amazon.com (AMZN), then take a look at all the empty shopping malls across America to see what I’m talking about. But in China, e-commerce is massive. It’s the largest online retail market in the world totaling $672 billion in 2017, nearly twice the size of the U.S., according to Business.com.

China’s online market is expected to exceed $1 trillion this year and hit $1.7 trillion in 2020, according to a report from Goldman Sachs (GS), and American Express (AXP) is trying to grab some of that cash.

In April, the New York financial services company best known for its credit cards and travel-related services, succeeded after many years of effort to become the first U.S. card network to receive permission to offer services in China. The People’s Bank of China said American Express would be allowed to clear and settle domestic bank card transactions. This is a major step toward entering China’s expanding electronic payment market.

A big part of AmEx’s success was forming a joint venture with the Lianlian Group, a Chinese mobile payment provider. The approval is a huge win for AmEx, because despite talk by the Chinese authorities about opening up its financial sector to foreign companies, it hasn’t. Also AmEx is getting a head start on rivals Mastercard (MA), which began a joint venture with three Chinese companies, and Visa (V), which is trying to do it alone, but has not had their applications approved.

Founded in 2003, Lianlian Pay, is the fourth largest non-banking payment service provider in China. As one of China’s top mobile payment companies, it supports 19 currencies and works with all the major domestic banks. AmEx and Lianlian have been working together since 2012, when AmEx made an equity investment of $125 million in Lianlian Pay. At the same time, AmEx agreed to license its digital wallet, Serve, to the Chinese company.

At the end of 2016, China had 731 million Internet users, up 43 million from the previous year, according to the China Internet Network Information Center. Of those, 695 million are mobile Internet users, up 75 million from 2015, and 500 million of those are online shoppers, which is more than the population of the entire U.S. Those numbers show Internet penetration in China is only 53%, which means there is a huge amount of growth ahead.

The Goldman analysts predicted the number of Chinese consumers shopping online will surge by an additional 200 million by 2020. They also “expect online retail growth to sail on at 23% compound annual growth rate over 2016 to 2020, continuing to grow at nearly triple the pace of offline retail.”

The Goldman report predicted the next trends in online shopping will be more goods available online, more spending by consumers in small cities, online retailers partnering with brick-and-mortar stores, and sales of Fast Moving Consumer Goods (FMCG) – product categories such as groceries, personal care and healthcare, packaged foods and other everyday items typically found in supermarkets. This market could hit $2 trillion by 2020, and if people are paying by phone using an AmEx/Lianlian app, the cash will be falling to the bottom line.

But Amex isn’t just a China play.

After losing its co-branding deal with Costco (COST) and coming under fire for having a millennial problem, new Chief Executive Stephen Squeri has decided to go after the largest and newest generation of American consumers with a no-fee credit card.

It also recently partnered with the popular music and arts festival Coachella to offer eligible cardholders perks like access to an Uber priority lane and a complimentary Ferris wheel ride, as well as, complimentary food and beverages. It appears to be working, NerdWallet reported that millennials opened 36% of AmEx’s new accounts last year.

And it looks like someone is buying up the stock. Shares experienced a massive gap up of more than $8 to $102.37 on volume of 11.7 million on April 19 when it beat first quarter earnings estimates. Average volume for the stock is 3.5 million shares.

For the first quarter, AmEx earned $1.63 billion, or $1.86 a share, vs. $1.25 billion, or $1.35 a share, on revenue of $9.72 billion. The consensus estimate of analysts surveyed by Thomson Reuters was $1.71 a share.

Now the stock is back down to $99 a share. A much better buy.

Last week, President Trump signed the biggest rollback of bank regulations since the 2010 Dodd-Frank Act. The new law boosts the level of what’s “too big to fail” from $50 billion to $250 billion. This means AmEx is no longer considered a “globally systematically important” bank. It should save the company billions of dollars in compliance costs over the next 18 months, which it will probably use to buy back stock and increase the dividend. Even at $102, the stock had a market capitalization under $100 billion.

AmEx has 860 million shares outstanding. If we assume AmEx uses some of the Dodd-Frank compliance refund to buy back stock in the second half of 2018, say 20 million shares, then buy back another 65 million by 2020 that would be a 10% reduction in the float to 775 shares. We think earnings could be $10 in 2020, which would a 13 multiple of historical trailing P/E, for a $130 price target.

If we really want to think out of the box, Warren Buffett owns 151 million shares, or 17.5% of the company. Berkshire Hathaway (BRK.A) (BRK.B) currently has $120 billion of cash on its balance sheet that’s just burning a hole in Warren Buffett's pocket. In order to grow Berkshire’s book value at a higher rate, Warren Buffett needs to deploy the cash and make an investment that grows faster than the 1.75% he’s currently earning on the cash. He could buy the rest of AmEx for $70 billion at today’s price and still have $50 billion left on the balance sheet. 

Disclosure: The fund is long AXP.