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When the bill comes due, Capital One Financial will need to show it has the funds. On Monday, the Virginia-based bank said it had agreed to acquire Discover Financial Services for $35bn, to be paid all in stock.
Discover is a combined credit card payment network and card-issuing bank. It ranks fourth as a network behind the titans Visa, Mastercard and American Express. However, Amex is the only other of these that is both a lender as well as network.
Capital One’s market cap is $52bn and it expects this combination to be transformative enough to boost earnings per share by more than 15 per cent in 2027. Digital commerce only continues to proliferate, making it increasingly lucrative to be a toll collector. But ambitious deals in financial services are never easy to pull off.
Visa and Mastercard collectively have an equity value of $1tn. Stripe, the payments plumbing company, at its private valuation peak clocked in at $95bn. Klarna, the money-losing buy now, pay later start-up, once hit $45bn. These companies may be simply rent seekers. Or they are enabling secure electronic transactions at light speed around the globe. But there is a clear sense that scale matters in payments and there will be big winners who take all.
Capital One itself has been a success story as an upstart lender. It has emphasised its technology prowess in building a digital-first bank. While it has a credit card loan book of $137bn, it also has issued a significant volume of auto and commercial loans.
Its shares have risen a healthy 69 per cent in the past five years — but vastly trailing Mastercard and Visa. And so to keep up, it will pay up. While Capital One trades at 1.4 times tangible book value, it will pay 2.6 times for Discover, inclusive of a 27 per cent premium owed to shareholders. (American Express trades at 6 times book value).
Capital One says it can wring out $2.7bn worth of annual efficiencies, roughly split between cost cuts and squishy “network synergies”. To judge the chances of achieving that, consider some history.
The defunct retailer Sears launched the Discover card in the 1980s, eventually appending it to the Dean Witter retail brokerage.
In the 1990s, the pair merged with the posh Morgan Stanley. Within a decade, Morgan Stanley had spun off Discover as a standalone consumer enterprise, acknowledging the benefits of the combination were not there.
Capital One and Discovery are a far more logical fit. Still, buyers’ remorse often sets in when the credit card bill arrives.
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