Capital One-Discover Deal Updates

Capital One (NYSE: COF)  announced last week that it had received approval from the Office of the Delaware State Bank Commissioner on Wednesday to acquire Discover Financial (NYSE:DFS). This is seen as one of the key regulatory hurdles in the all-stock merger valued at $35.3 billion which was announced back in February. Federal regulators will be the next stop as the deal moves toward closure, which is anticipated to be around early 2025. The re-election of Donald Trump to the U.S. presidency should help the deal move forward as the new administration is expected to cut financial regulation and potentially bring in a softer antitrust climate compared to a Democratic administration. Capital One stock has gained over 38% year-to-date, as compared to the 23% rise in the S&P 500 over the same period. Discover stock is up by over 50% over the same period. So what are the benefits of the deal for both companies?

Both Capital One and Discover are banks that issue credit cards and together account for under 20% of consumer credit card balances, which would make them the largest U.S. credit card company by loan volume. That said, the most attractive part of the deal would be Discover’s proprietary card network, which charges merchants a fee for processing credit card transactions. Capital One presently uses Visa and Mastercard, which dominate the card payment network market. See What’s New With Mastercard Stock? As the acquisition closes, Capital One could switch some of its business toward the Discover network. Separately, if you want upside with a smoother ride than an individual stock, consider the High Quality portfolio, which has outperformed the S&P, and clocked >91% returns since inception.

To be sure, Discover’s merchant acceptance is lower compared to Visa and Mastercard. Discover is accepted at about 70 million merchant acceptance points compared with Visa’s roughly 130 million and Mastercard’s 100 million. It’s quite likely that a bulk of Capital One’s business will remain with Visa and Mastercard even post a deal. However, the deal could give Discover better leverage in negotiating prices with the two dominant network players. A deal could also give Capital One opportunities to expand and enhance Discover’s merchant network. For instance, Capital One’s strong capabilities in credit card fraud protection and detection could be deployed more widely across the Discover Network.

The deal allows Capital One to cross-sell a wide range of financial products including checking and savings accounts, and personal and automotive loans to Discover’s loyal base of cardholders. This could drive up revenues for the combined entity.

The increase in COF stock over the last 4-year period has been far from consistent, with annual returns being considerably more volatile than the S&P 500. Returns for the stock were 49% in 2021, -34% in 2022, and 44% in 2023. In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, is considerably less volatile. And it has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Given the current uncertain macroeconomic environment around rate cuts and multiple wars, where does COF stock stand

We value Capital One stock at about $162 per share, slightly below the current market price. See our analysis of Capital One Valuation for a closer look at what’s driving our price estimate for the company. See What’s happening with Visa stock?

[1] Returns as of 12/23/2024
[2] Cumulative total returns since the end of 2016

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