Warren Buffett-backed Capital One plans to buy Discover Financial in a $35.3 billion all-stock deal that would form the sixth-largest U.S. bank by assets and create a credit card giant with its own payments network. Analysts believe the deal will allow Capital One to better compete with its rivals Visa, Mastercard and American Express. But it still needs the blessings of regulators.
New Payments Behemoth
Capital One is offering a 27% premium to Discover's Friday closing price of 110.49 and will pay 1.0192 shares for each DFS share. The two companies expect the deal to close in late 2024 or early 2025, pending regulatory approval. Once completed, Capital One shareholders would own 60% of the combined company with Discover shareholders owning the remaining 40%.
Capital One is the ninth largest U.S. bank and one of the largest credit card operators. However, Capital One currently uses Visa and Mastercard payments networks for most of its cards. Discover operates its own payments networks, which is key driver for the deal. Capital One will switch at least some of its cards to the Discover network if the deal goes through.
"We believe Capital One plans to invest further in Discover's network to be more competitive versus its largest peers," William Blair analyst Christopher Kennedy wrote in a Tuesday research note, first reported by Barron's. Discover is currently accepted at about 70 million merchants, compared to Mastercard at around 100 million and Visa's 130 million, making it the smallest of the four U.S.-based global payments networks.
Synergies
Meanwhile, Capital One ranked as the fourth largest U.S. credit card company by volume in 2022 while Discover ranked sixth, according to Nilson Report.
If combined, the two companies would make up the largest U.S. credit card issuer with a 20% share of the market for outstanding consumer loans, according to BofA analyst Mihir Bhatia, who wrote the transaction offers "good strategic optionality" for Capital One in a Tuesday research note. The combined Capital One would also surpass JPMorgan Chase and Citigroup in U.S. credit card loan volume, according to Bloomberg Intelligence.
Capital One expects the deal to provide $1.2 billion in network synergies in 2027 and cost synergies of $1.5 billion.
Citi analyst Arren Cyganovich agrees having its own credit card network — a "scarce asset within the U.S." — would be a major boon to Capital One, according to a Tuesday research note. Outside the financial impacts and valuable payments network, Citi says that Discover provides tech-forward digital banking capabilities that may unlock greater additional value than what either could achieve individually. Cyganovich believes the deal is a long-term net positive, but shares may lag in the near-term depending on upfront share dilution. Citi maintained a buy rating and $152 price target on COF stock.
Antitrust Concerns
However, the deal will likely face intense scrutiny from regulators. The Justice Department in June 2023 said it would broaden its scope when reviewing bank mergers — beyond traditional metrics like overlapping branches and deposit concentration to include fees, interest rates, customer service and other factors that analyze "relative competition." The DOJ is also moving away from branch divestiture agreements between merging banks.
"We expect a significant amount of regulatory scrutiny given we have not seen a bank merger of this size in several years, excluding forced mergers of failing banks," Kevin Barker, managing director for Piper Sandler wrote in a late Monday note reported by Yahoo Finance.
Capital One CEO Richard Fairbank in an investor call Tuesday said, "We believe that we are well positioned for approval but of course we can't discuss our conversations with our regulators."
Big Credit Card Deals
The acquisition is the biggest deal for a credit company in history, surpassing Bank of America's purchase of MBNA Corp. for $35.19 billion in 2005, according to Dealogic data cited by Reuters. It's the most recent major payments deal since GE spun out Synchrony Financial in 2015 for $21.63 billion. The purchase also overtakes Discover's 2007 spinout from Morgan Stanley for $21.25 billion, formerly the third largest deal for a credit card company in history.
Capital One's deal is also the latest bank buyout since JPMorgan's rescue purchase of First Republic Bank for $16 billion in late April 2023, following the string of bank failures in March.
Capital One, Discover Stock Action
COF stock reversed up a fraction on Tuesday after falling below its its 50-day moving average and daily technical lines in early trade. Capital One hit a 52-week high at 140.86 on Jan. 29. Shares climbed 4.7% so far this year.
Berkshire Hathaway is Capital One's seventh-largest shareholder with a 3.28% stake.
Discover stock leapt 12.6% Tuesday to 124.44, gapping up above 113.42 buy point from a cup-with-handle base. DFS stock gained 10.7% so far this year, despite a 10.8% fall on Jan. 18 after reporting tumbling Q4 earnings. Discover Financial has been finding support at a rising 50-day line since then.
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