Buy Capital One

The stock market has taken a huge hit since Tuesday. Capital One Financial (NYSE:COF), one of the largest banks in the United States, announced an agreement to be acquired. Discover Finance (NYSE:DFS) is one of the four major payment processing companies. The deal, valued at $35 billion, is the largest in the credit/debit card sector.

Of course, the deal must be approved by regulators, but if it goes through, it could have a major impact on the industry for years to come.

Discover’s stock price soared on the news, rising about 14% on Tuesday to $126 per share. On this day, Capital One’s stock price was relatively flat at about $138 per share.

Only one chance

To understand the impact of this potential deal, it’s helpful to know how these two companies differ and where they intersect.

Capital One is the ninth-largest bank in the United States, with approximately $476 billion in assets, but is primarily known as one of the largest credit card issuers in the United States. The majority of its revenue comes from credit cards, as opposed to other types of banking services. As an issuer, it is a credit card lender to the networks of two major credit card companies: Visa (NYSE:V) and Mastercard (NYSE:MA).

Discover is also a much smaller bank, with about $149 billion in assets. Although it provides consumer financial services, it generates most of its revenue as a credit card issuer and processor. Discover is one of the four major companies with its own credit card network, along with Visa, Mastercard, and American Express (NYSE:AXP). However, like American Express, Discover has a closed-loop network. This means that it issues cards, lends funds, processes claims, and collects interest and fees all within its own credit network.

The $35.3 billion all-stock deal will result in Capital One shareholders owning approximately 60% of the company and Discover shareholders owning approximately 40%.

“The acquisition of Discover is a unique opportunity to bring together two highly successful companies with complementary capabilities and franchises and to build a payments network that can compete with the largest payment networks and payment companies,” said Richard Fairbank, Founder, Chairman and CEO. said: Capital One.

I have a lot of questions

In a video message released Monday, Fairbank called Discover a “valuable and rare asset” that accelerates Capital One’s “long journey of working directly with merchants.” He said it would also “add scale” to Discover’s global network of 70 million merchant-accredited locations in 200 countries.

While synergies certainly exist, it’s not yet entirely clear how these two companies will come together. In addition to strengthening its Discover network, Capital One will likely continue to issue cards in collaboration with the Visa and Mastercard networks.

According to Reuters, a Mastercard spokesperson said the partnership with Capital One is “long-term.” Reuters was unable to contact Visa, and the two companies recently re-established their deal with Capital One.

“It is not uncommon for companies to be competitors and customers of each other, and we do not see this as a problem,” Fairbank added in the Reuters article.

It’s a big deal

The opportunities here appear plentiful for both companies. The combined company will be the sixth-largest bank in the U.S. with more than $625 billion in assets. For Discover, this deal could be game-changing for the credit card space. It’s currently ranked fourth out of four, but with the added scale and reach of Capital One, it could become a major player. Both Mastercard and Visa stocks traded lower on Tuesday.

Additionally, the combined company is expected to generate $1.5 billion in cost synergies in 2027 and $1.2 billion in network synergies in the same year. Additionally, adjusted earnings per share are expected to grow by more than 15% in 2027.

The companies are confident of obtaining the necessary approvals and expect to close by late 2024 or early 2025. It’s certainly not a slam dunk, as many analysts say the deal would face scrutiny not only from antitrust concerns but also from regulators concerned about big bank mergers in general.

There is still a long way to go before this becomes a reality, and there are many questions that need to be addressed. But the initial takeaway is that this could be a big problem on several fronts. Stay tuned.