Why Capital One is acquiring Discover in the largest merger ever in 2024

capital one’s It recently announced a $35.3 billion acquisition. Discover Finance It’s not just about getting bigger, or gaining ‘scale’ in Wall Street parlance, but rather an effort to protect itself from growing fintech and regulatory threats.

This is the chess move of Capital One CEO Richard Fairbank, one of the smartest long-term thinkers in American finance. As co-founder of one of the top 10 U.S. banks by assets, his tenure is a rarity in a banking world dominated by institutions such as: JP Morgan Chase Its origins begin immediately after the signing of the Declaration of Independence.

Fairbank, who became a billionaire by building Capital One into a credit card giant after its 1994 IPO, said acquiring rival card company Discover would better position the company for the dark future of global payments. I am confident that it will be. The industry is a dynamic web, with all kinds of players – from traditional banks to fintechs and tech giants – trying to carve out a place in a market worth trillions of dollars, eating up share from incumbents in a fast-moving economy. The growth of e-commerce and digital payments.

“This deal gives the company greater strength to take on other banks, fintechs and tech giants,” said Sanjay Sakhrani, a veteran retail finance analyst at KBW. “The more you separate yourself from the rest of the pack, the more equipped you are for the future.”

If this transaction is approved, Capital One will be able to make JP Morgan the largest credit card company based on loans and solidify its position as the third largest credit card company based on purchase amount. Additionally, Discover’s digital banks will secure a total of $109 billion in deposits, adding strength to Capital One’s banking operations and helping the combined entity achieve $1.5 billion in cost savings by 2027.

But what Fairbank repeatedly praised Tuesday when analysts asked him about the strategic merits of the deal is Discover’s payments network, a “railway” that shuffles digital dollars between consumers and merchants and collects tolls. There are only four major card networks. Visa and MasterCardThen american express Finally, the smallest group is Discover.

“That network is a very rare asset,” Fairbank said. “We have always believed that being an issuer with your own network and being able to deal directly with sellers is the holy grail.”

Fairbank said that from the time Capital One was founded in the late 1980s, the idea was to create a global digital payments technology company by owning the payment rails and dealing directly with merchants. In the decades that followed, Capital One stayed ahead of the average bank and earned a reputation in the tech world for its forward-thinking and early adoption of cloud computing and agile software development.

But the company’s growth has depended on Visa and Mastercard, which accounted for the majority of payments last year, processing nearly $10 trillion in the United States.

Capital One plans to strengthen its Discover network, which processed $550 billion in transactions last year, by quickly shifting all debit transaction volume there and increasing the share of credit card transactions over time.

By 2027, the bank expects to add at least $175 billion in payments and 25 million cardholders to the Discover network.

But the real potential of the Discover deal, according to analysts, is what Capital One could do in the future if it owned the toll road.

By creating an end-to-end ecosystem that is more of a closed loop between shoppers and sellers, you can fend off competition from fast-moving fintech players. block it and paypalYou can also purchase now and pay the company later. check and Klarna, which has a presence among both merchants and consumers.

Capital One aims to deepen relationships with sellers by showing them how to increase sales, prevent fraud and provide data insights, Fairbank said Tuesday. Some of the network fees could be used to create new loyalty plans, such as debit rewards programs, or to underwrite merchant incentives or experiences, according to analysts.

“Owning a network allows you to deal more directly with sellers rather than with network intermediaries,” Fairbank told analysts. “We create more value for merchants, small businesses and consumers and unlock additional economics through vertical integration.”

This is a coveted feature for technology or fintech companies. If the Discover network were to be sold alone, it would be worth up to $6 billion. alphabet, apologize or FiservSakhrani wrote in a research note Tuesday.

The Capital One-Discovery combination could strengthen the credit company against another potential threat from Washington.

A bill proposed by Senator Dick Durbin aims to limit the fees charged by Visa and MasterCard, potentially destroying the economics of credit card rewards programs. If the proposal becomes law, it would suddenly improve the competitive position of the Discover network, which is exempt from the restrictions, according to Brian Graham, co-founder of advisory firm Klaros Group. This mirrors what previous legislation, known as the Durbin Amendment, did for debit cards.

“There are a lot of things that are aimed at card networks and ecosystems in some way,” Graham said. “This pressure could be one of the things that creates opportunities in the future if Capital One can get control of this network.”

The biggest question for Capital One, its customers and investors is whether the merger will ultimately be approved by regulators. Fairbank said it expects the deal to close in late 2024 or early 2025, but industry experts said it was unclear whether the deal would be blocked by regulators, following a series of high-profile acquisitions between banks, airlines and technology companies. said.

On Tuesday, Democratic Sen. Elizabeth Warren called on regulators to quickly block the deal, calling it “dangerous.” Senator Sherrod Brown, chairman of the Senate Banking Committee, said he would be watching the deal “to ensure that it does not enrich shareholders and management at the expense of consumers and small businesses.”

The survival of the Discover deal will depend on whether the deal is seen as strengthening a failing payments network or creating more concentration among already dominant card lenders. This is another reason why Fairbank emphasized the importance of networks.

“Which one you care more about will determine whether you think this is a good deal or a bad deal from a public policy perspective,” Graham said.