Capital One Financial (COF 0.12%) shocked the financial industry by announcing that it has agreed to acquire fellow credit card-focused bank Discover Financial Services (DFS 12.61%) in an all-stock transaction.
This deal combines two of the largest players in the credit card industry and creates some interesting possibilities for efficiency as well as long-term growth. Here’s a rundown of what investors should know about the acquisition and what it could mean over the long run.
Details of the deal
As mentioned, the deal is an all-stock acquisition. And as is the case with most acquisitions, the acquirer (Capital One) is paying a premium. Upon closing of the deal, which is expected in late 2024 or early 2025, Discover shareholders will receive 1.0192 shares of Capital One stock for every Discover share they own. For example, if you own 100 shares of Discover, you’ll have 101.92 shares of Capital One when the acquisition is done.
Based on Discover’s closing price prior to the announcement, this represents a 26.6% premium. The deal is structured so that existing Capital One shareholders will own 60% of the combined business, with Discover shareholders owning the other 40%.
What the combined business could look like
Capital One is already one of the largest credit card issuers in the United States, with popular products including the Venture line of personal credit cards and the Spark business cards. However, there’s a lot more to Capital One. With $479 billion in total assets as of the end of 2023, it’s one of the largest regional banks in the nation. It offers a full range of financial services to customers, and although it is an online-first bank, it operates hundreds of physical branches.
On the other hand, while Discover offers some additional financial products, such as high-yield savings accounts, its main business is credit cards. Discover has a network of 305 million cardholders (compared to a little over 100 million credit card customers for Capital One). And not only does it have a large cardholder base, but Discover is a closed-loop payment card company, meaning that it operates its own payment network, as opposed to being reliant on Visa or Mastercard. It’s important to mention that Capital One has said that it plans to keep the Discover brand, although it’s unclear exactly what that means at this point.
Opportunities and risks
There are several reasons Capital One might be excited to make this acquisition. For one thing, there are some big efficiency advantages that could be had. Not only are there likely synergies in combining some of the complementary businesses into one (both offer high-yield savings accounts, for example, in addition to their credit cards), but Capital One has a significantly lower average consumer deposit interest rate (3.03% vs 4.41% for Discover). In fact, Capital One expects $2.7 billion in synergies by 2027, and it says the deal should be more than 15% accretive to adjusted earnings per share (EPS) at that point.
Additionally, owning one of the four major payment networks allows the company to profit from high-margin interchange fees in addition to interest income. It also creates a massive opportunity to grow Discover’s payment network, which has historically been the smallest (behind Visa, Mastercard, and American Express). Capital One’s acquisition will immediately add scale, as the company expects to add its debit card volume and some credit card volume to the Discover network. There is also the ability to invest more heavily in growth than Discover could afford to do on its own.
On the other hand, it’s important to know that there are significant regulatory hurdles that will need to be overcome before the deal can be finalized. The credit card industry is already dominated by a handful of big players, and this could potentially be viewed as a competition-limiting deal. It’s rather likely that the merger will ultimately receive approval, but investors should be prepared for significant uncertainty.
American Express is an advertising partner of The Ascent, a Motley Fool company. Discover Financial Services is an advertising partner of The Ascent, a Motley Fool company. Matt Frankel has positions in American Express. The Motley Fool has positions in and recommends Mastercard and Visa. The Motley Fool recommends Discover Financial Services and recommends the following options: long January 2025 $370 calls on Mastercard and short January 2025 $380 calls on Mastercard. The Motley Fool has a disclosure policy.
