Merging Two Iconic Brands: American Express And Goldman Sachs
Thesis:
- Combining these two Icnonic brands makes sense for investors for a number of reasons.
- The merged company would be able to achieve true organic growth.
- Cost synergies, especially in the consumer credit and lending businesses would be significant.
- A higher p/e of the combined company would create value for shareholders and a higher share price.
- The timing is good since both companies are undergoing a major change with the retirement of long-time CEO, Ken Chenault, as well as the announcement that Lloyd Blankfein will be leaving Goldman at the end of the year.
- A combined company would be able to deliver organic growth, which the companies have struggled to create on their own.
- Both companies are expanding into a credit & lending model. Risks, cross-selling, and synergies are discussed.
Goldman, Sachs: (GS):
Goldman Sachs Group, Inc. is a leading global investment banking, securities and investment management firm that provides financial services to a client base that includes corporations, financial institutions, governments and individuals.
Founded in 1869, the firm is organized in four different business segments: Investment Banking, Institutional Client Services, Investing and Lending, and Investment Management.
American Express: (AXP):
American Express was founded in 1850 and is one of the most valuable and recognizable brands in the world offering financial services, credit cards, and loyalty programs.
“Your margin is my opportunity.” -Jamie Dimon
The credit card business is an extremely competitive business. With the addition of the new Sapphire Reserve card from JP Morgan (JPM), costs have been rising for American Express.
The company is now in a battle to retain their high end Platinum Card customers.
“Cost of card member services in the quarter increased 31% reflecting higher engagement levels across our premium travel services including airport lounge access and cobrand benefits such as first bag free on Delta (D) as well as usage of the new Uber benefit on platinum.” -K. Chenault (Earnings CC)
New threats from companies like Paypal (PYPL) and services like Apple Pay (AAPL) are pressuring American Express to innovate. In addition, these competitors have hurt revenue and slowed growth.
Charlie Munger was recently quoted as saying AmEx investors are deluded if they think they know the payment industry’s future.
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P/E Expansion:
A combined company would receive a much higher p/e ratio along the lines of competitors like Visa (V) and Mastercard (MA). The earnings blend of the combined company would be much less volatile and attractive for investors.
The combined company would also be able to take advantage of cost synergies. Finally, this would be the rare situation where cross-selling would add to organic growth.
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Earnings Volatility:
One of the advantages of the credit card and consumer lending business is that there is less volatility. Goldman’s recent earnings were quite good and the market responded positively.
However, when we take a closer look, the earnings of each individual business unit were quite volatile which is typical of their current business mix.
- Investment Banking: +17%
- Institutional Client Services: (17%)
- Investment & Lending: +35%
- Investment Management: +3%
Worse, during the first half of this year, Goldman, normally dominant in bond trading, under performed most of its rivals. Last quarter, its trading revenue fell 40% while competitors gained.
Organic Growth:
Goldman, Sachs is an excellent company. However, the firm is having trouble creating organic growth. Headwinds include the lack of volatility in capital markets over the past few years. The issue for shareholders is how the company can create growth.
In an attempt to create growth, Goldman is expanding lending across the firm, including to smaller clients of its Marcus consumer loan and deposit business, to corporate clients and to private wealth management clients.
The firm is already trying to cut its reliance on volatile trading revenues with a shift to more stable businesses like investment management.
Lending:
In 2016, Goldman launched a new unit, Marcus which is focused on online lending. And American Express has also recently launched a similar initiative focused on personal loans.
“Of that $5 billion opportunity that we are pursuing over the next three years, $2 billion of it — $2 billion of the revenue opportunity annually relates to lending.” –Marty Chavez, GS CFO
The issue for investors is whether this new initiative can be successful. Goldman has capable and talented employees. However, this is not a traditional focus of the company. Analysts are mixed on whether this initiative will be successful. Conversely, American Express has much more experience in consumer credit.
“Goldman’s growth strategy is focused on penetrating new markets or client segments outside of the company’s traditional strengths, so we are somewhat skeptical of the management’s ability to hit these revenue targets,” -KBW analyst Brian Kleinhanzl
Timing:
Long-time American Express CEO, Ken Chenault is retiring effective Feb 1st. He’s had a 37 year career with the company and this is going to be a time of change for American Express either way. The timing for this proposed combination seems ideal in my opinion. In addition, it looks likely that Lloyd Blankfein will be leaving GS as well.
Synergies:
I believe the overlap in the lending and loans businesses present opportunities for cost reductions. I imagine cost reductions in the neighborhood of about $1B per year for the first five years of a combined entity. As stated previously, these are well-run companies. However, there is considerable overlap in lending and credit.
Risks:
As a large and influential shareholder of both companies, Warren Buffett (BRK.B) would likely need to approve this pairing. Obviously, I believe the idea has merit, and I wouldn’t want to speculate on how Buffett would view the benefits and risks.
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Certainly, blending two entrenched corporate cultures could prove to be problematic. Both companies have long and prestigious histories. However, both companies are heading in a similar direction: lending. So, the combination would seem to offer excellent possibilities and the ability offer shareholders organic growth.
Conclusion:
A combination of these two iconic brands makes sense to shareholders of both companies. Wall street is likely to reward the new company with a higher p/e based on a less volatile earnings profile. Cost synergies and cross-selling possibilities would be attainable. Risks include the blending of corporate cultures as well as the view of Warren Buffett. Overall, the combined companies would be able to generate organic growth and shareholders would be rewarded.
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