Capital One Financial Corp.’s $35 billion deal for rival credit card provider Discover Financial Services is more than an opportunistic move on a rival that had a lamentable 2023. The takeover reinforces the impression that corporate leaders are willing to take risks on big M&A again.
The logic of the tie-up is simple: scale. Much of Discover’s cost base in systems and marketing will become redundant. Acquiring Discover’s network also reduces its suitor’s reliance on Visa and Mastercard. Capital One pivots toward the prime end of credit card lending. It will become the largest issuer of credit card loans in the US and the transaction overall “makes a lot of sense strategically,” say analysts at Goldman Sachs Group Inc.
But recent history is relevant too. Discover’s stock fell sharply in July on revelations it had misclassified some of its credit cards, prompting a regulatory investigation. The shares have underperformed Capital One’s since, making the all-stock acquisition more affordable. The terms give Discover shareholders 40% of the combination. A deal struck at a comparable premium before the bad news would have meant Capital One paying away closer to 50%.
All the same, Discover stock is well off its lows and its shareholders are unlikely to feel like they’re doing a deal at the trough. Plus they’re getting a $7 billion premium over the market capitalization at the end of last week.
For Capital One holders, the financials are more nuanced. Certainly, the stated synergies are large, assuming they can be realized. Cost savings are projected to be worth $1.5 billion annually. Taxed and put on a multiple of 10, these crudely cover the takeover top-up. Further synergies are forecast from shifting some of Capital One’s activity to the Discover network. The buyer reckons the deal will enhance its earnings per share by 2027 and generate an impressive 16% return on invested capital that year.
