A Bit of History From American Express' Balance Sheet | Fox Business

When American Express CEO Ken Chenault was asked about the business opportunity in prepaid cards, he took analysts in the audience through a walk down memory lane.

In the late 1800s, American Express was just another express mail company. It made money moving stuff from A to B. It wasn't until it started moving money that it became a financial behemoth. The traveler's cheque is what put Amex on the road to becoming what it is today.

Traveler's cheques were enormously profitable. Nearly immune from competition -- it was a winner-take-all business, since people only want cheques that are redeemable in the most places -- American Express made a fortune selling traveler's cheques to the world.

American Express double dipped on the product. First, it collected a fee for each traveler's cheque it issued. Secondly, because of the delay between the sale and redemption of each cheque, American Express effectively borrowed billions of dollars at a negative interest rate.

In 1999, Amex reported traveler's cheque sales of $23.3 billion, and average balances of $6.2 billion, implying cheques were redeemed 97 days after purchase.

Suffice it to say that borrowing money at an effectively negative interest rate has stood the test of time as one of the truly great business models.

You can forget all about the well-known "Salad Oil Scandal." It was the float created by traveler's cheques that originally fomented Warren Buffett's interest in American Express. (The scandal simply made its shares cheap enough for the value-oriented investor.)

With the benefit of hindsight, we know how the traveler's cheque ultimately panned out. Electronic payment forms took over, and traveler's cheques declined all around the world. Before rolling over, it served one last and final purpose as a marketing tool for the credit card.

Chenault pointed out to a room of analysts that the traveler's cheque introduced Amex's brand to the world, giving it the upper hand as it transitioned toward credit cards.

He noted that the company's prepaid cards are something akin to the second coming of the traveler's cheque in that they introduce the American Express brand to consumers, regardless of their creditworthiness or current income. Once in the American Express funnel, he argued, these customers could be sold credit cards and other products as time goes on.

It's impossible to say if this sales funnel is moving the needle in cardmember growth today. American Express' prepaid business is still quite small, achieving a run-rate payment volume of $6 billion in the summer of 2014. By contrast, Amex's network processes more than $1 trillion in volume annually.

Financial disclosures aren't helpful is separating the opportunity from the hubris. On American Express' balance sheet, you'll find an entry for prepaid card balances. It's unfortunately commingled with other prepaid products, including the decaying traveler's cheque.

As best as I can tell, sales of the cheque peaked in the year 2000. (American Express excitedly described its growing business selling cheques over the Internet in its filings around the turn of the century.) Average balances apparently peaked in 1999, when it last reported average outstandings of $6.2 billion earning a whopping 8.8% tax-equivalent yield. Later filings would show higher balances, but declining sales of traveler's cheques, likely due to the rise of Amex gift cards ("Gift Cheques") during the 2000s.

It's notable that the float generated by prepaid cards hasn't yet eclipsed the float from other (declining) products. Perhaps it's because prepaid customers are unlikely to carry large balances, given few prepaid cards pay interest as traditional bank accounts do. Or maybe it's because prepaid users load only what they intend to spend in a short period of time. It's likely a combination. It's hard to say.

What isn't hard to say, though, is that Amex has some work to do in the prepaid card industry. The infancy of the prepaid card is best encapsulated by the fact that the float it generates has yet to offset the declining float from a now-obsolete Amex product first introduced in 1891.

The article A Bit of History From American Express' Balance Sheet originally appeared on Fool.com.

Jordan Wathen has no position in any stocks mentioned. The Motley Fool recommends American Express. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.