Capital One’s Acquisition of Discover
- Rohan Golla
- Aug 6, 2024
- 6 min read
Updated: Aug 9, 2024
Overview
Industry: Financial Institutions (FIG)
Acquirer: Capital One Financial Corporation
Target: Discover Financial Services
Total Transaction Size: $35.3 Billion
Announced Date: February 19th, 2024
Expected closing date: Q1 2025
Acquirer Advisors: Centerview Partners LLC (financial), Wachtell, Lipton, Rosen & Katz (legal)
Target Advisors: PJT Partners, Morgan Stanley & Co. LLC (financial), Sullivan & Cromwell LLP(legal)
On Monday, February 19, 2024, one of the US’s largest banks, Capital One Financial Corporation, announced that it intended to acquire Discover Financial Services, the US’s fourth largest payment network, for $35.3 billion in an all-stock deal. This move promises to position Capital One and Discover to compete with the credit card networks like Citigroup, or JPMG, making it the largest credit card company in terms of outstanding debt. By acquiring Discover, Capital One reduces its dependency on the other biggest payment networks like Visa and Mastercard. Discover also gets to use Capital One’s existing global platform to further increase the reaches of their own payment
network.
The merged entity is anticipated to gain $1.5 billion in cost savings by 2027, mostly due to the reduction of Discover’'s operations and marketing expenses. Additionally, the transaction is anticipated to be accretive to EPS, which translates into a positive internal rate of return of over 20% and a 16% return on invested capital.
The market regarded the Capital One deal this year at large as a sign of more favorable winds for M&A deals. Since then, 11 deals have been announced with over $10 billion in transaction value. Capital One and Discover both stand to gain a great deal from this, as the similarity in their industries and business models allow for a lot of synergy.
“Our acquisition of Discover is a singular opportunity to bring together two very successful companies with complementary capabilities and franchises, and to build a payments network that can compete with the largest payments networks and payments companies”
-Richard Fairbank Founder of Capital One
Company Details (Acquirer- Capital One)
Capital One is one of America’s largest and most well-known banks, currently sitting at being the 12th largest bank in the US in terms of total assets. As of December 2023, they hold $478 billion in total assets, reflecting a 5% growth since the previous year, leading to a ranking of 106th on the Fortune 500. Established in 1994 as a spin off of a current subsidiary of Wells Fargo, Capital One is known for its important role in the mass adoption of credit cards worldwide. Currently, they operate in Canada, the United States, and the United Kingdom, with 750 branches and 2000 ATMs.
The company’s three divisions are credit cards, consumer banking and commercial banking. The largest section of their balance sheet is credit card-related debt, and since COVID lockdown, this industry has only become more lucrative. Capital One focuses on its unique banking approach where it is more than just a bank or a credit card company to combine both businesses so it is more than just a sum of its parts. This combined with a work culture that routinely places Capital One in the Fortune 100 best places to work, makes them a bank with a motivated group of people to help it succeed.
Founded in 1994, Headquartered in McLean, Virginia
CEO: Richard Fairbank
Employees: ~51,000
Market Cap: $54.93 billion
Company Details (Target- Discover)
Discover Financial Services is one of America’s four homegrown payment networks along with American Express, Visa, and MasterCard. It is the newest among these and is quickly growing and has been since its inception in 1986. They have 70 million merchant acceptance points across 200 countries and territories making them one of the largest payment networks in the world. Not only are they known for their large payment network, but they also serve as a bank with a checking and savings side too. Unlike other banks however, Discover maintains an overwhelmingly large presence online, making it unique.
Discover has both a banking and credit card segment that bring in revenue. Its cards have enjoyed success thanks to both its excellent customer service, and its popular student card, which has a very low bar for entry. Compared to competitors, Discover has a high customer satisfaction rate thanks to a well maintained customer service system, known for its quick response time. The company is known for its community outreach activities where it has opened customer service centers in low income areas, providing employment to areas where other companies often haven’t, such as the South Side of Chicago. Discover also brings a uniquely technological approach to banking, setting it apart from other banks.
Founded in 1986, Headquartered in Riverwoods, Illinois
CEO: Michael Rhodes
Employees: 21,100
Market Cap: $31.5 billion
Projects and Assumptions
Short term effects
1. Competition
Capital One’s acquisition of Discover allows it to compete directly with one of their largest competitors: American Express. At the same time it allows Capital One to get over a dependency on the two other largest payment networks: Visa and MasterCard. This allows an increasing proportion of the merchant fees that Capital One can keep for itself, increasing revenue. Additionally, this allows them to bring their processing network in-house, potentially lowering costs, thus giving customers reduced fees and higher rewards.
2. Integration
Because Discover is such a large corporation (over 21,000 employees and $388 billion EBITDA), successful integration of operations will be both costly and difficult, making this deal potentially very risky. At deal end, three board members from Discovery will join the new Capital One Board of Directors. Capital One, however, has a considerable partnership network, allowing the combined entity to provide consumers with more benefits such as extended warranty, travel insurance and more.
3. Share Dilution
Further, in the short term, the issuance of additional shares could lead to dilution, which may upset shareholders. There could also be unforeseen complications and issues that could undermine the advantages of the deal.
Long term effects
1. Global Payments Network
In over 200 nations, Discover has established nearly 70 million merchant acceptance points, forming an advantageous worldwide payment network. In spite, out of the four global payments networks with US bases, it is the smallest. Through this deal, the Capital One network expands and the Discover network gains scale and investment, making it more competitive with the biggest payment networks and organizations. Richard Fairbank, the CEO and chairman of Capital One, has stated that the company intends to transfer its debit card operations to the Discover Signature line. It is projected that the combined firm will save $1.5 billion in costs by 2027, mainly because of Discover cutting back on operations and marketing expenses. Additionally, the transaction is expected to be accretive to adjusted non-GAAP EPS, which translates into a positive internal rate of return of more than 20% and a 16% return on invested capital.
It will continue Capital One's long-standing journey to work directly with merchants to leverage its existing customer base and combine the companies' technology and data ecosystem to drive more sales for the merchant and great deals for consumers and small businesses.
2. Brand synergy
Capital One and Discover both have extremely strong positive impressions from their customers thanks to good service records. At the same time both are known for their easy access to their services. For Capital One, it is known as the only US national bank with no fees, no minimums, and no overdraft fees. Discover is known for its transparent credit card policies, and easy to get cards (such as its extremely popular student credit card). With these brands being combined, and presumably offering each others services on their native platforms, Discover will gain access to Capital One’s physical infrastructure, and Capital One can leverage Discover’s innovative online approach to banking, increasing both their coverages massively.
Capital One also gains access to Discover’s own payment network as well as Pulse, Discover’s own interbank payment network. Both of these can be integrated into Capital One’s own services, adding incentives for customers to choose this new, consolidated platform, compared to other banks or credit card companies.
Risks and Uncertainty
1. Regulation
An important part of the deal is also the regulatory hurdles that this acquisition will have to face. Similar to other deals, this deal also faces strong scrutiny, as the Biden administration pays close attention to deals like Kroger’s and Albertsons, and Alaska Airlines and Hawaiian Airlines. The U.S. Office of the Comptroller of the Currency has also said it plans to institute a more complex, and slower process for bank acquisitions. Capital One's proposal faces standard regulatory procedures, so it’s unclear whether these stricter requirements would apply to this acquisition. This combined with the recent rejection of the JetBlue and Spirit deal might mean a difficult path to the deal.
2. Increased Interest to Cardholders
Due to the significant proportion of consumer and auto loans that Capital One has on its balance sheet—credit card loans accounting for 47% of the company's loan portfolio—concentration risk exists within the company's loan portfolio. Since credit card loans account for 79% of Discover's loan portfolio, a downturn in the economy would have a greater impact on the merged company's assets. Furthermore, with a third of its credit card loans going to near and subprime borrowers, Capital One has the highest default rates of any of the six major lenders (2.03% vs. 1.69%). This makes Capital One more vulnerable in the event of a downturn.
Sources
https://www.wsj.com/business/deals/giant-merger-deals-stage-a-comeback-a6827d4b?mod=Search results_pos1&page=1
