|Shares Out. (in M):||750||P/E||8.0x||52.0x|
|Market Cap (in $M):||401||P/FCF||NA||NA|
|Net Debt (in $M):||4,900||EBIT||7,711||5,197|
American Express 6.8 % Fixed-to-Floating Rate Subordinate Debentures
This write up is going to be relatively short because it will focus simply on the notes rather than American Express's business as a whole. I point the reader to the various writeups on American Express common equity over the years done by Danarb, Spence and Neo. To those, I have very little to add.
American Express is a top rate company that did a bunch of dumb lending in 2006 and 2007 that they are clearly on the path to recover from. Their total risk book is going down and their credit metrics are stabilizing.
In the last couple of weeks the stock has approximately doubled and 5 year CDS has come in about 200 basis points.
During this same time, the piece of paper I am writing about, the 2066 AXP fixed-to-floating subordinate notes, have hardly moved in price. As of Friday, they were 48 bid by 53 offered and I have been able to buy them anywhere from 48 to 53 depending on the day. The official close was 53.5, which is what I am going to use for the write up. I think they can be had cheaper, but 53.5 is still a very good price.
I believe these notes trade inefficiently because they are a relatively small issue ($750 million). They are the only issue of its kind in the American Express structure (they trade a ratings notch below all other AXP debt) and the notes themselves are rather complicated. In a lot of ways they look like trust preferred securities but as I will describe, in my opinion they have much better protection than the typical trust preferred security and will likely be called by the company in 2016.
If they are called in 2016, these notes provide approximately an 18 percent yield to maturity. If they are not called, they are paying 12.7 percent for the next 8 years and then about 1.9* libor+ 416 thereafter. Either way, it is an awfully good return for the risk taken.
Features of the note:
The total interest on these notes is $51 million a year, which is rounding error in the scope of American Express. However, if the triggers are hit, the company is a forced seller of its own stock on the market, which is a relatively embarrassing outcome. In short, the triggers are such that any time that American Express might be tempted to suspend dividends, it probably won't.
Moreover, it is highly likely that these notes have totally outlived their usefulness for American Express. On page S-16 of the prospectus, American Express notes that the notes were "preliminarily classified as common equity" by the Securities Valuation Office of the National Asociation of Commissioners. As I understand it (and I could be wrong), this allowed American Express to count the notes as Tier 2 equity. Playing this close to the line on equity levels is an exercise that American Express has almost certainly abandoned given the market's current concern with capital adequacy.
Also, so far as I can tell, the covenants in these notes are different and in their own way more restrictive than the covenants American Express's other notes (which do not appear to have mandatory interest payment clauses). American Express would be buying itself several degrees of freedom by retiring these notes (which are trading way out of line with the rest of the capital structure). While such retirement may not be forthcoming as long as American Express is borrowing from the federal government, it would seem to be a clear priority to repurchase of stock both from a value standpoint and from simplifying the restrictions on the business.
I believe that the notes trade the way that they do because they are a small issue and because understanding them is complex. I also assume they get some discount because they are rated one notch lower than everything else in the American Express capital structure (which by the way is one more reason for American Express to want them gone) and could get cut to junk while every other instrument remains investment grade. Their current rating is A-, so that is still a distance away.
I expect that as the market rationalizes and people examine these notes, that they will quickly rise to a level more consistent with the rest of the American Express debt structure. If they do not do so, they should provide for an extremely satisfying return across a longer period of time.
Notes trading in line with other American Express instruments. Eventual cal of notes by the company in 2016
|Subject||RE: Cusip #|
|Entry||04/19/2009 07:33 PM|
Cusip is 025816AU3 . The prospectus can be found on the SEC website at http://www.sec.gov/Archives/edgar/data/4962/000095011706003217/a42324.htm
|Entry||04/19/2009 09:53 PM|
Thanks for this interesting idea.
Could you clarify your comments about reset assuming they are not called: "1.9* libor+ 416 thereafter"
I didn't quite follow.
|Subject||RE: rate reset|
|Entry||04/20/2009 07:18 AM|
Yes. If you pay 53.5, then the effective rate you are receiving is (1/.535) times the nominal rate of three month libot plus 222.75 bps. That works out to about 1.9*libor plus 416.
|Entry||04/20/2009 03:26 PM|
Where do you think these 2066s should trade today? With the 2038 8.15% senior notes at par, I figure 8.15% for 29 years would be similar to 10% until 2016 followed by 7% thereafter. This is about 68 for the 2066s, assuming LIBOR averages a bit under 3% full-cycle). Add 100bps of spread for the subordinated status and fair value is around 60. Could you give your thoughts on this approach to valuation?
It's the yield-to-call angle that makes this a potential home run. At face value it seems 3 month LIBOR+223 for 50 year deferrable sub notes seems extraordinarily cheap. Are the triggers problematic enough for them to call such cheap paper? Do they trigger in all cases or only if interest is deferred? If the latter it seems much easier to just pay the 51m and avoid the problem. Or are there scenarios where senior debt forces deferral of the 51m, which then forces the equity issuance? I can certainly see where they'd want to eliminate that possibility. Otherwise it's not clear to me they have much motivation to call in 2016.
Even if calling at par in 2016 does not make sense, repurchasing at 70 in 2012 might. That would still provide excellent ROI to you. Do you know if AXP is allowed to repurchase in the market and/or tender below par? Thanks in advance.
|Subject||RE: Fair Value|
|Entry||04/21/2009 07:38 AM|
I think that American Express is more likely than not to call this bond in 2016.
I thik that the reasons for calling it are that it is a small issue with relatively annoying covenants and the issue no longer serves its original purpose.
I think as American Express transitions its liability side to more bank deposits and as the credit crisis abates that libor plus 220 something will be a good rate for the company but not one so good that they won't give up the economics to have the piece of mind.
I don't think they will tender for the bonds, because getting 80 percent of them doesn't solve the problem that the bond would remain outstanding. I also don't think financial companies will be doing much tendering for their own debts outside of normal call schedules until TARP money has been repaid.
My view on this issue could be wrong and if it is wrong, then I still have the cheapest piece of paper in the American Express structure, which is a credit that I like at these prices regardless. I did not spend any time on it in the write up but American Express has the capacity to run a business model even if its costs of borrowing are higher than historical averages because so much of the profit comes from the transaction processing/membership rewards piece of the business as versus from lending.
I think the ultimate earnings and growth power of this model have been put somewhat into question by the credit issues they have encountered (ie I think that growth in the 05-07 period was inflated by credit that was too easy) but I believe that the franchise is valuable and can run at a serious profit even if it constricts its revolving credit severely. I think the market is overestimating credit risk at the company because it is a monoline business and that as the company brings down the size of its credit book, that these fears will abate.