Capital One's Takeover of Discover: All you Need to Know

This week we heard Capital One is set to acquire Discover Financial in what would represent one of the biggest deals in financial services in recent years. 

The US$35.3bn, all-stock transaction would bring together two of the largest credit card companies in the US, positioning the newly-formed entity closer to credit-lending leaders JPMorgan and Citigroup.

It is also being seen as a threat to payments giants Visa and Mastercard given Discover’s existing payments network.

"From Capital One's founding days, we set out to build a payments and banking company powered by modern technology,” said Richard Fairbank, Founder, Chairman and CEO of Capital One, as the prospective acquisition was announced. 

“Our acquisition of Discover is a singular opportunity to bring together two very successful companies with complementary capabilities and franchises, and to build a payments network that can compete with the largest payments networks and payments companies.”

Why is Capital One looking to buy Discover?

At the heart of Capital One’s bid to purchase Discover Financial is an attempt to protect itself against rising competition from fintechs, as well as fellow financial institutions as they invest in increasingly sophisticated technological capabilities. 

Capital One has outlined its desire to build a “globally-competitive” payments network, taking advantage of Discover’s existing base of 70 million merchant acceptance points in more than 200 countries and territories. 

Despite this, it remains the smallest of the four US-based global payments networks, behind Visa, Mastercard and American Express. 

Capital One’s goal is to inject the necessary scale and investment to bring Discover up to the level of its competitors, fulfilling its own quest to build a global payments company. 

In the credit card space, it is hoped the combined business would be in a stronger position to deliver products and experiences spanning the credit card marketplace, including consumers, small businesses and merchants.

Who’s behind the deal?

As CEO of Capital One since its IPO in 1994, Fairbank has built the organisation into the credit card powerhouse it is today.

He has also helped position the company as a data and technology trailblazer, adopting cloud computing much earlier than most. 

Amid global payments’ uncertain future, the deal to acquire Discover is a bold attempt from Fairbank to position Capital One as an industry leading light with a broad range of capabilities and offerings. 

His hope is to deal more directly with merchants, forming relationships built around trust and added-value. 

He continues: “Through this combination, we're creating a company that is exceptionally well-positioned to create significant value for consumers, small businesses, merchants and shareholders as technology continues to transform the payments and banking marketplace.”

Is there much opposition to the deal?

Capital One has said it expects the deal to be completed by early 2025, with Fairbank set to submit official applications to the US’ Federal Reserve and Office of the Comptroller of the Currency over the next couple of months. 

However, there exists plenty of doubt as to whether the transaction will enjoy a smooth path towards regulatory approval, especially given recent challenges to major deals including Microsoft’s acquisition of Activision Blizzard. 

Despite the prospect of a united Capital One and Discover rivalling Visa and Mastercard in the payments space, concerns persist in regards to competition, with around 90% of the overall credit card market in the US controlled by just 10 companies. 

Senator Elizabeth Warren is among the most vocal critics of the move, labelling it as “dangerous” and a threat to working people. 

She said: “The merger of Capital One and Discover threatens our financial stability, reduces competition and would increase fees and credit costs for American families. Regulators must block it immediately.”

How does the deal impact credit ratings?

Michal Selbka, Associate Director at S&P Global Ratings, believes the benefits to Capital One from its acquisition of Discover in terms of market share and profit synergies are roughly balanced against a higher concentration in credit cards and considerable execution risk.

As a result, the agency has affirmed its long-term 'BBB' issuer credit ratings on Capital One and 'BBB+/A-2' issuer credit ratings on its bank subsidiary, as well as the existing issue ratings on its outstanding senior unsecured, subordinated, and preferred debt instruments.

He adds: “Our stable outlook reflects our expectation that Capital One will successfully complete its acquisition of Discover despite possible execution challenges, and that it will mitigate its higher concentration to credit cards through conservative capital management and credit reserving policies over the next 12-24 months.”

Pending approval, Capital One’s takeover of Discover would result in a consolidated entity with more than US$630bn in assets.

S&P Global Ratings has therefore placed its 'BBB-' issuer credit rating on Discover Financial Services and 'BBB' issuer credit rating on Discover Bank, as well as all related issue ratings, on CreditWatch with positive implications.

Mayan Abraham, Senior Analyst at S&P Global Ratings, explains: “Once the acquisition closes, we would expect to raise our ratings on Discover Financial Services by one notch to the same level as the ratings on Capital One.”

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