November 16, 2008

BofA out Amex in

I am rolling my capital allocated to Bank of America into American Express (AXP).






I have been mulling getting out of BofA position for awhile. The buyout of Merill Lynch have changed my outlook on the bank. Mainly due to the integration risk and the diverse cultures of investment banking and retail. This merger would have been difficult to complete in normal circumstances but with the stress of bad economy and credit crises this could be impossible to pull off.

Also the financial landscape has changed a lot since my investment in BofA. BofA, as I reasoned when I made my investment, held a competitive advantage over its peers by being the largest retail bank with coast to coats network of branches, which ensured that it held a relative competitive advantage in its economies of scale to its peers. Now with the rapid continuing consolidation in banks, that is no longer the case. Other banks like JP Morgan and Wells Fargo achieved that position by buying Wachovia and Washington Mutual. So that relative competitive advantage disappeared, which can lead to margin compression over the long term.

Buffet also sold out of BofA so I get my confirmation to my thought process.

I am not saying BofA will perform badly, but there are more risks associated with the business. BofA management is still good and have a lot of experience with merger integration and the opportunistic acquisitions they made in the last 6 months can secure their position in the global banking industry. However the return is more speculative than say with AXP or JPM.

My cost basis for BofA is $42 per share I sold it at $18 for a loss of 57%. That hurts. But I will not dwell on it, as I need to find the best risk/reward proposition for my capital and at the moment BofA does not fit that bill. American Express, on the other hand, will offer me a better return, I think, once market settle down. I bought AXP at $20 per share.

AXP has several competitive advantages that makes it a unique investment.

  • brand: BusinessWeek ranks it 15th out of 100 most valuable global brands.
  • network that akin to toll bridge earning fees on transactions from retailers and interest and fees from users
  • retailers have limited bargaining power in this industry. Credit card networks can increase fees with little of resistance from retailers.
  • what will be good for BofA will be good for AXP, while the opposite is not true. BofA will have specific risks associated in its operations that can overwhelm its earnings.
  • Buffet ownership gives a backstop for any permanent loss of capital in AXP, while with BofA government involvement present a risk for permanent loss of capital, think of AIG.
  • With the sale of BofA i generate some tax loss amounts that will be used to offset some of my earlier capital gains in the year, something I think I will not discuss for awhile.

Here is a good case for AXP as undervalued investment by Vitaliy N. Katsenelson.

I think by redeploying capital from BofA into AXP I will be better served. I will sell my investments when I believe that I could redeploy the capital in investments that offer more attractive risk-reward profile. I will always be willing to sell an existing holding at a profit or a loss, if I can find a better use for the funds.


10 comments:

Jae Jun said...

I too have the same doubts with BAC. Sure they are are the largest retail bank, but with the entire financial industry changing, that advantage has shrunk dramatically.

The risk they took on with all those acquisitions would have to work out perfectly in order to gain confidence again.

Anonymous said...

I agree with your thoughts on BAC. Has your thesis changed for SHLD? If it hasn’t are you planning to buy more at these prices?

Sami said...

jae jun,
I think the largest retail bank is now a thing of the past JPM and WFC is very close to replicate the advantage that BAC had for a while. I agree that things have to be perfect to the letter for them to do well.

Anon,
My thesis had not changed for SHLD. I think they have some good assets and they are suffering a cyclical economic downturn but the value of the assets should be there over the long term. yes I will buy more at this price.

Anonymous said...

dwell, not duel.

Sami said...

anon,

fixed, thanks

Anonymous said...

I think you continue to buy companies with very high risk profile. AXP is paying the price of expanding dramatically during boom time and they will suffer more losses in the coming quarters. I would rather buy MSFT than AXP and the downside is much smaller and upside is about the same. MSFT definitely will survive this downturn with tons of cash. On the other hand, AXP has big exposure to consumer credits. It's possible that they will issue shares at lower level to offset losses just like CBG did. AXP upside is at most 30, which MSFT can easily achieve. Why put money in most risky area when there are plenty of safer blue chip companies. Your CBG, BAC pick already suffer huge loss during this credit crisis, credit card companis are next to issue shares at low price. I think you better to look beyond financials and buy cash rich companies instead. AXP made big mistakes this time and will pay the price accordingly as they are the only card company expand big time during boom time. I will look to buy AXP for a trade only when they report very ugly results next year. They just close one of my friend's account with credit score near 800, who paid off balance every month and has been using their card for more than 10 years. The only reason they close the account is to prevent my friend from getting about 800 dollar reward money. I bought some axp recent and sold it after I heard the story from my friend. I think AXP is now desperate to save any cash, even kicking out their more valuable customers. I expect very negative results from axp in next 2 quarters. I used to like AXP, but it doesn't seem to be the same AXP when buffet bought it. It's still a strong company, but I think AXP are paying big price for its mistakes. MSFT will make more money than AXP next year, why buy AXP when you can buy MSFT with similar price.

Anonymous said...

In the future, you need to discuss more about risks associated with your picks. It's best to discuss what can go wrong and what can go right. You only focused on pros of your pick, but not enough time to think about weakness of your picks. Investors in general focus on what can go right, but it's really what can go wrong kill the performance. Even blue chip like AXP is a high risk play when the root cause of this crisis is easy credit and AXP was lending out to higher risk customers in recent years to acheive growth and now they need to suffer the consequence. It will take at least 2 years to clean out the mess AXP made during last few years. In my opinion, it's a high risk, ok reward play at this level.

O&G Engineer said...

Hi Sami,

Sorry this is a little off topic but I would like to ask your opinion regarding your previous post:
http://myvalueidea.blogspot.com/2008/05/there-will-be-convergence-in-accounting.html

With the convergence of IFRS and US GAAP, I believe that US GAAP will copy the IFRS method of long-lived asset valuation. What this means is that under management discretion, assets can be revalued at fair value. Moreover,previous impairments can be restated if say business environment changes with an added bonus of a gain that flows to net income (to offset the initial impairment expense).

As you know quite well, an integral part of the value investing method is to search out companies that have assets priced at historical cost on the balance sheet that are severely understated as fair value is much higher. How do you think the convergence will affect this method? Will it be more difficult to search out bargains, or will irrationality (like now) continue to overcompensate for this change?

Thanks and keep up the great work! I continue read as they come out on RSS but I'm pretty silent as I'm caught up with the CFA exams.

Ali

Sami said...

Hi Ali,

IFRS does give management more discretion in valuation of assets and allowances. Asset valuation will be challenging depending on the disclosure of the assumptions used by management. I am going through some training on IFRS now so i do not have all the answers as I go through it I will post to what relevant to valuation.

good luck with your exam.

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