The Capital One Discover merger is a big deal, here’s why

What’s in your wallet? In the not-too-distant future, that could be a card issued by the combined Capital One Financial Corp. entity. NYSE:COF and Discover financial services NYSE:DFS.

Capital One has offered to buy Discover for $35.3 billion in an all-stock deal. This would be a very successful agreement in the financial services field, with effects throughout the sector.

A big investor in Capital One is Warren Buffett, and analysts believe he could be among those pushing for the company to become a bigger player in the growing and competitive business of credit card transactions.

Rival of existing financial giants

The acquisition, if approved by regulators, would make Capital One a rival to more than just credit card processing giants Visa Inc. NYSE:V and Mastercard Inc. NYSE: MAbut they also put it on the same level as American Express Co. New York Stock Exchange: AXPwhich operates both as a bank and a processing network.

Credit card stocks are trading lower

Visa and Mastercard were left speechless at the news of the proposed acquisition; American Express traded lower, but found support at its 10-day moving average.

The Capital One chart shows the stock initially falling on the news, which often happens to stocks of an acquiring company. However, as the market digested the deal’s potential, Capital One stock closed higher and is finding support near its 10-day line.

On the Discover Financial Services chart, you will see the stock up 12.61% on the news. Shares of a takeover target often pile up when a deal is announced, as investors bid up shares near the buyer’s offer price, which in this case is $140 per share.

On Feb. 21, Discover shares were trading between $122 and $123.

Here are 3 reasons why Capital One’s acquisition of Discover would be significant among financial stocks.

1. Expanding the Discover network

One of the main goals of the deal is to grow Discover’s payment network, which is currently smaller than that of Visa or Mastercard.

In a call with investors, Capital One CEO Richard Fairbank said that all Capital One debit cards will eventually move from Mastercard’s network to Discover’s. That’s one reason Mastercard has been very tight-lipped about the news; Capital One currently issues cards using the Mastercard network.

This transition will take some time, as Discover doesn’t have the same foothold outside the US as Visa and Mastercard.

2. A breakthrough in regulatory oversight

The Biden administration’s antitrust regulators have been active in showing disapproval of mergers.

At first glance, it might appear that Washington is balking at the idea of ​​a collaboration between two financial services giants, but the picture may be rosier than it seems.

According to researcher Nilson, Visa, Mastercard and American Express together hold 96% of the market share for credit card transactions.

If the federal government is interested in spreading wealth among multiple companies rather than concentrating it, this merger proposal is a giveaway.

There’s the question of whether the proposed merger will result in higher tariffs for consumers, which is something Washington will examine. However, Capital One does not have a history of stealing from customers.

Capital One bills itself as “the only major bank with no fees, no minimums and no overdraft fees.”

According to the press release issued by Capital One and Discover:

• The transaction is expected to generate spending synergies of $1.5 billion in 2027.
• That’s 26% of Discover’s operating expenses, plus 10% of Discover’s marketing expenses.
• The acquisition is expected to generate network synergies of $1.2 billion in 2027, driven by the addition of Capital One debit purchase volume and select credit card purchase volume to the Discover network.

The companies are fully aware that these claims are a signal to regulators in Washington that the intent is to pass the cost savings on to consumers.

Additionally, some analysts believe the combined entity could bring more rewards points to Discover cardholders.

3. Similarities to American Express

Discover operates a third-party network, meaning its cards rely on an underlying bank. Since Capital One is a bank, the combination of the two companies opens up product opportunities currently available only to American Express.

This makes Capital One a large, vertically integrated consumer financial services company, analogous to American Express.

American Express, for example, has made a name for itself with premium products, something neither Capital One nor Discover have focused on. The merger, which brings significant combined capabilities, could change that.

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