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US bank and card issuer Capital One has announced plans to acquire Discover Financial Services, in a bid to compete with rival issuers and larger card networks.
On Monday (February 19), Capital One announced that it has reached an agreement with Discover to acquire the company in an all-stock deal worth $35bn.
Under the terms of the agreement, Discover shareholders will receive 1.0192 Capital One shares for each Discover share they own.
Capital One shareholders will own 60 percent of the combined company, and Discover shareholders will own 40 percent.
Richard Fairbank, founder, chair and CEO of Capital One, said the deal will combine Capital One’s scale in credit cards and banking with Discover’s global payments network.
“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," he said.
The share swap ratio represents a premium of 26 percent on Discover’s closing price last Friday (February 16).
Discover shares reacted positively to the news, closing almost 13 percent higher in their first day of trading following the announcement, while Capital One shares remained flat.
Building a competitive payments network
In an investor presentation released on Tuesday (February 20), Capital One provided more details on the two main revenue streams it will benefit from following the acquisition.
The first is that it will inherit the Discover Global Network, and will be able to issue its own cards on Discover rather than on Visa or Mastercard.
The Discover Global Network is currently active in more than 200 countries, where it serves more than 70m merchants and 305m cardholders.
Capital One will also benefit from providing the network to other issuers, which will generate “significant revenue” without asset or credit risk, it said.
Similarly, by owning the network and by taking over a merchant acquirer, Capital One will be able to serve merchants more directly.
Out of the four card networks in the US, Discover is currently the smallest, which means there is significant market share to gain from larger rivals.
In 2023, excluding transactions made by Diners Club International cardholders, Discover processed $550bn of transactions in the US.
By 2027, Capital One said it intends to add $175bn in extra purchase volume and an extra 25m cardholders to the network.
Source: Capital One
Combining complementary card businesses
In addition to operating a global payments network, Discover also issues its own portfolio of credit cards.
These cards are known for their high cashback rewards programmes, which typically offer 5 percent cashback at selected retailers on a rolling basis.
These programmes have contributed to Discover’s long-standing success in the US credit card customer satisfaction rankings, as compiled by market research firm J.D. Power.
For the past 17 years, Discover has ranked as either the number one or number two credit card issuer in the US, based on customer satisfaction.
The total spend on Discover-issued credit cards is relatively small compared with that of J.P. Morgan, Amex, Capital One and Citi.
Source: Capital One
However, when combined with the total spend on Capital One cards, the two portfolios put together would come within $303bn of Amex’s.
Corrie Menary, a partner at Kirtland Capital Partners, said the acquisition makes sense due to the strength of Discover’s credit card portfolio.
“When I think of the consumer card landscape in America, there are not a lot of pure-play card assets to acquire, as most are buried within larger banking organisations,” she told Vixio.
“If Capital One wants to grow via acquisition, there are not a lot of good options out there, so it’s not surprising that Discover would be of interest.”
Menary, who disclosed that she is a 15-year “loyal” customer of Discover, said the brand has a “solid lock” on the cashback rewards market, and that is part of the appeal to Capital One.
She added that the greatest drawback of using Discover is that it is less widely accepted than Visa or Mastercard, but this could change due to the increased leverage that Capital One will gain among merchants by owning the network.
Will regulators approve?
Capital One said the acquisition is expected to be completed in late 2024 or early 2025, subject to regulatory approval.
Although the Biden administration has blocked several high-profile mergers in the past year, including a proposed merger of JetBlue and Spirit airlines, sources who spoke with Vixio said the acquisition is likely to stand.
Once Capital One takes over the Discover network, it will become a direct competitor of Visa and Mastercard — both of which currently serve as network providers for Capital One credit and debit cards.
As Visa and Mastercard no longer issue cards, and Amex only issues cards on its own network, Capital One will be the only issuer in this position.
Gary Prince, CEO of UK e-money institution The Payments Firm, suggested that Visa and Mastercard are unlikely to want a rival network having access to their infrastructure.
As noted, Capital One has said it would aim to migrate its card portfolio to Discover to take advantage of cost savings, but that would not happen immediately.
Nonetheless, sources agree that from a competition and antitrust perspective, the acquisition will be seen as compliant.
Francesco Burelli, a partner at Arkwright Consulting, said that as long as merchants still have the option of accepting Visa, Mastercard and Amex, it is difficult to argue that the acquisition will distort competition.
Likewise, issuers will still have the option of Visa or Mastercard, as they do today.
“Capital One’s portfolio may run on Discover’s network in the US and compete with other schemes, but ultimately it is about issuers’ preference,” he said.
“Capital One may own a scheme, but it is still a competitor to other issuers.”
