U.S. consumer bank Capital One, backed by Warren Buffett, intends to acquire Discover Financial Services, a U.S. credit card issuer, in an all-stock deal valued at $35.3 billion. The announcement was made on Monday, with the goal of creating a global payments giant. The transaction, which is anticipated to face rigorous antitrust examination, aims to establish the sixth-largest U.S. bank by assets and a substantial U.S. credit card entity that will rival JPMorgan Chase and Citigroup.
Despite Discover having a presence in 200 countries and territories, its size remains notably smaller compared to Visa, Mastercard, and American Express. The acquisition is seen as an opportunity to enhance Discover’s competitiveness within the expansive payments network. According to the companies, Discover shareholders are set to receive 1.0192 Capital One shares for each Discover share, representing a 26.6% premium over Discover’s closing price on the previous Friday.
Upon completion, Capital One shareholders will hold a 60% stake in the combined company, leaving the remaining 40% for Discover shareholders. Baird equity research analysts noted the “significant strategic merit” of the Capital One/Discover merger, citing potential cost reductions through increased scale and the advantages of integrating Capital One credit cards with Discover’s network.
The companies anticipate achieving $2.7 billion in pre-tax synergies by 2027, incorporating both cost-cutting measures and network savings. Capital One, valued at $52.2 billion, holds Berkshire Hathaway as its seventh-largest shareholder with a 3.28% stake. In 2022, Capital One ranked fourth in the U.S. credit card market by volume, while Discover secured the sixth position, as reported by Nilson.
The composition of the new board remains unclear, with three members to be appointed by Discover. The deal is expected to undergo regulatory approval in late 2024 or early 2025, amid a backdrop of increased focus on promoting competition across various sectors of the economy under the Biden administration.
Jeremy Kress, a business law professor at the University of Michigan, predicts significant pushback and heightened regulatory scrutiny for the deal. He believes this will be the first major test of bank merger regulation following the 2021 executive order on promoting competition by the Biden administration. Democratic progressives, concerned about increased systemic risk and reduced lending for consumers, have long opposed bank consolidation.
Regulatory attention on credit card fees, coupled with the Consumer Financial Protection Bureau’s strict proposed rules, adds another layer of complexity to the situation. The potential Justice Department investigation would likely focus on the companies’ positions in the credit card issuer market and their impact on competition, along with potential barriers to entry for new market entrants.
Discover’s recent regulatory challenges, including a review over misclassified credit card accounts and an agreement to enhance consumer compliance, may pose obstacles to the deal. However, regulatory hurdles are generally more manageable when the target company faces issues, and the acquiring entity is perceived as a responsible actor.
Both Discover and Capital One reported profit declines in the fourth quarter, with banks increasing provisions for potential losses from bad loans. Rising interest rates have raised concerns about consumer defaults on credit card debt and mortgages. The deal, if approved, will undoubtedly face a complex regulatory landscape, reflecting the broader push for increased competition and oversight within the financial sector.
