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February 21, 2024

Breakingviews: Capital One will struggle to cash in M&A rewards

by Breakingviews.

The appeal of credit cards is making a purchase now and settling up the bill later. Capital One Financial’s $80 billion merger with rival Discover Financial Services offers a similar benefit. The deal perks will be huge, if and when they can be redeemed.

Combined, the two companies would be the biggest U.S. plastic purveyor, with $250 billion of the country’s $1.3 trillion credit-card debts, overtaking JPMorgan’s $211 billion at the end of 2023. Yet customers of the bank led by Jamie Dimon spend more, giving Capital One CEO Rich Fairbank a plausible argument that the deal increases competition rather than squashing it.

The big attraction for Capital One, however, is Discover’s payments network, a service hard to build from scratch. In theory, if it slaps the Discover logo on the back of its own cards, Capital One can stop paying rival networks to use theirs. The savings would be a big, albeit distant, prize because consumers for now prefer the Visa and Mastercard brands.

As with credit-card rewards themselves, the potential deal goodies are lavish. The two companies expect to generate about $2.7 billion in extra pre-tax profit, worth some $20 billion in today’s after-tax dollars, once the merger is operational. Add that to their combined market capitalizations on Friday, and the enlarged company would be worth at least $100 billion.

Little of that extra value turned up on Tuesday, with the stock prices implying they’re worth only $84 billion together. There are good reasons to be skeptical. The companies will face political objections, given the White House’s crusade against so-called junk fees. Mergers among banks also take a long time to complete, and sometimes come with burdensome conditions from the Federal Reserve and Office of the Comptroller of the Currency.

Discover also brings its own special headaches: It has been criticized by regulators for its poor compliance processes, and last year owned up to overcharging merchants. In one sense, that may be an opportunity: Discover’s CEO quit last year, and his replacement only just started.

Just like buying things with a credit card, these are problems for another day. At worst, if the deal collapses, Discover will be left to clean up its own messes, and Capital One will keep paying fees to bigger peers. Given the size of the prize, however, the companies can be forgiven for racking up some charges.

Context News

Capital One Financial and Discover Financial Services said on Feb. 19 that they had agreed to merge in a deal that would create the largest credit-card operator in the United States with $250 billion of loans. Under terms of the transaction, Discover shareholders would receive a little more than one Capital One share for each Discover share they hold, giving them around 40% of the combined company. The share swap values Discover at about $35 billion, the companies said, or a nearly 27% premium to where its stock was trading on Feb. 16. Capital One expects to generate $2.7 billion of pre-tax savings from the deal by 2027. Capital One Chief Executive Rich Fairbank would retain the role at the enlarged company while also serving as its chairman. Three directors from Discover are to join Capital One’s board, which currently has 12 members. Centerview Partners is advising Capital One while PJT Partners and Morgan Stanley are advising Discover.

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