Last Friday, Warren Buffett was on CNBC for several hours in the morning answering questions on all sorts of topics with his usual reserved wisdom. If only I could get Warren to speak with me for three hours…
One of the big revelations was that Buffett has been adding to either Wells Fargo (WFC) or American Express (AXP) – both extremely large positions in the Berkshire Hathaway (BRK) portfolio. Earlier in the program, Buffett noted the macro slowdown had spread across demographics to impact even high-end consumers, as evidenced by the things American Express has been saying:
Well, it – obviously, I pay a lot of attention to what’s happening. And we’ll say at American Express – and Ken Chenault talked about that here a month ago – but they are experiencing credit deterioration and they’re experiencing it sort of in all segments. So they’re seeing the rich customers slow down in payments, slow down in purchases. And American Express can describe that rather than I, but I pay a lot of attention to that sort of thing. And incidentally, it will get cured at some time in the future, but right now the situation is getting worse and I would say that I don’t see any early end to that.
Overall, Buffett’s comments on the macro environment were quite negative, and on the whole he suggested that growth prospects would likely remain weak into 2009. The thesis of a weak consumer has led many people to bet against companies tied to consumer spending – particularly those like American Express which also carry credit exposure – and it even reached a point where recent debt issuances by the company were being priced at more than 400 basis points over Treasuries. According to Moody’s, the implied ratings put the company at close to junk status. But this is a company that BusinessWeek said was the 14th most valuable brand in the world, with a value of nearly $20 billion. With a market cap of $45 billion as of market close Friday and net tangible assets at the end of last quarter of $12 billion, American Express looks very inexpensive; but ignore the exact details for a moment. Even if you erase the tangible equity on the books, you’re still left with an immensely valuable company because of the network and customer base American Express has. The replication cost test – Buffett applied this to Coca-Cola (KO), saying that he couldn’t take the company’s dominance of soft drinks with $100 billion in capital – seems to apply to American Express as well. With $50 billion in capital, could you replicate the merchant relationships that American Express has, much less gain acceptance by such a large number of wealthy consumers? I think not.
I think American Express has a fantastic business model because it requires next to nothing in the way of capital expenditures to grow the business, allowing for a combination of high returns to shareholders through dividends and buybacks, as well as continued organic growth of the business. This isn’t to detract from Wells Fargo, but banking is a much more competitive sphere than credit card processing, and given the relative values of the two firms, I believe Buffett is more likely to be taking a long-term view that the American consumer will remain strong (a belief he reiterated numerous times) and purchasing one of the most beaten-down names that will – eventually – be due for a recovery.
As the chart below shows, Wells jumped substantially after a positively received earnings report, whereas American Express is still down somewhat and has more or less stayed in that range since July 1st, the earliest Buffett could have begun buying since a transaction like this was not reported in the last 13F.
On a related note, I found this table of US banks and their OTC derivative exposures to be revealing; the “spread vs. RBC (bps)” column on the far-right shows the percentage change in the marks on the derivatives needed to wipe out risk-based capital.
