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A $210 million fraud scandal nearly sank American Express in 1963. As panic set in and investors rushed for the exits, Buffett made the biggest bet of his life.
Here’s the greatest “buy the dip” story:
In 1955, Tino de Angelis started the Allied Crude Vegetable Oil Refining Company to take advantage of the U.S. government’s Food for Peace program. The goal of the program was to sell surplus goods in the U.S. to Europe at low prices to help them rebuild the economy after World War 2. By 1962, Tino’s salad oil company was big enough to be involved in the commodities market.
By then, Tino had developed a cunning plan. He used his existing large inventory of salad oil as collateral to obtain loans from Wall Street firms and buy Oil Futures, so that he could drive up the price of his inventory. So, ships full of salad oil would dock in the port, and inspectors from the banks would certify the quantity of the cargo. Then, the banks would issue loans against these assets.
The inspectors just missed out on one simple thing: Oil floats on water.
Tino was fooling everyone by filling his tanks with water and then putting oil on top of it. If the banks had conducted even basic due diligence, they would have known that the total salad oil inventory reported by Tino exceeded the holdings of the entire country. By the time Tino’s gig was up, they were supposed to have $150M in inventories but only had $6M. The futures market crashed, wiping out the entire value of the loans that de Angelis had taken.
American Express funded a massive portion of the loans. When Allied filed for Chapter 11 bankruptcy, AmEx was on the hook for the loans issued. AmEx nearly went under, and its stock dropped more than 50% due to the scandal; that’s when Warren Buffett came in.
Buffett didn’t trust Wall Street’s panic. Instead, he visited restaurants and places that took Amex cards and traveler’s checks. He found out that brand perception for Amex hadn’t changed. The brand was so powerful that it could raise prices during the scandal without affecting its business.
In his own words, the tarnish of Wall St. had not spread to Main St.
This brand recognition of Amex directly translated into pricing power:
Traveler's checks? Amex charged 33bps vs. the banks’ 10bps.
Card membership? Amex charged $5 vs. the competition’s $3.
Card acceptance? Amex charged 4% vs. a market discount rate of 2-3%.
The best part was that, in addition to all this, Amex had incredible float. Customers paid Amex cash upfront for traveler's checks, but a check didn't return to the company for payment until about 45 days after it was issued. During that 45-day window, Amex invested this cash in treasury bills.
Float was Amex’s "real profit center." Where others saw uncertainty, Buffett saw an opportunity to bet big on trust. He worked "tirelessly to get as much as he could," and by June, he owned 70,000 shares at a $40 basis.
Amex had cost $2.8M and consumed 16% of Buffett Partnership Ltd’s capital.
What about the scandal? Here’s what happened as Buffett invested in Q1 1964:
A law change ended the assessment risk.
The $210M liability fell to $145M.
Amex offered $58M to settle.
As Buffett predicted, how Amex handled the scandal added to Amex’s stature. Even though Amex wasn’t responsible for the scandal, they paid out the creditors.
By early 1968, Amex's EPS doubled from $2.29 to $4.61, and its multiple expanded from 17.5X to 43.4X. Buffett's $40 stock was now worth $200. Over four years, Amex compounded at 50% - producing a 5X return.
Here’s a fun fact before you go:
Even though Buffett’s investment was an incredible success, what’s interesting is that AmEx has increased another 17x since Buffett sold his investments. The company has returned a CAGR of 13% compared to the 10% returned by the market. Buffett ultimately bought back into the company in 1998 and currently owns ~18% of AmEx. Even someone like Buffett, who is famous for holding on to his investments and loathes to sell, ended up selling too early.
We would love to hear what you think.
p.s. — If you liked this, you should check out the full story curated by Turtlebay