Discover Below Capital One Value Price

Capital One is acquiring Discover in a $35.3 billion all-stock deal that would create the most prominent U.S. credit card issuer. Discover's share price got a bump, but will it keep momentum given the uncertainty around gaining regulatory approval?

Deal Details and Reasoning

Capital One announced that it will acquire Discover Financial Services in an all-stock transaction valued at $35.3 billion on Monday. It follows mixed Q4 results amid challenging conditions, with revenue rising 1% to $9.5 billion and net income falling to $706 million due to rising expenses and credit losses. The offer makes sense as Discover has attractive margins and returns, whilst its share price has underperformed recently. The deal is expected to generate $2.7 billion in cost synergies and be over 15% accretive to Capital One's EPS by 2027. The company said the deal aims to help compete with larger players it already uses, Visa and Mastercard, as it plans to switch some cards to Discover's network after the deal.

The acquisition is expected to close in late 2024 or early 2025, pending regulatory and shareholder approvals from both companies. Some analysts predict regulators may approve the merger due to benefits for competition, as it could strengthen Discover's credit card network against Visa and Mastercard. However, regulators may challenge the deal due to Capital One gaining so much power; it would create a bank with over $600 billion in assets. Elizabeth Warren and Sherrod Brown, Democrats, oppose the merger, as does Republican Josh Hawley. Others note that the Biden administration is divided on bank consolidation, with some officials like Treasury Secretary Janet Yellen seen as more open to mergers than antitrust officials. The lengthy review process means the merger's fate depends on who wins the 2024 presidential election, with a Trump victory seen as more likely to allow the deal to proceed.

Reactions So Far

The proposed merger between Capital One and Discover would create the sixth-largest bank in the U.S. by assets, giving the credit issuer the top position in the U.S. with a 22% market share. It comes when regional banks face pressure to grow, while Discover does not have the same issues. The merger would give Capital One access to Discover's over 300 million cardholders, in addition to Capital One's existing 100 million customers. Although some argue the merger could benefit consumers by boosting Capital One's resources and competition, potentially leading to lower costs and more consumer benefits, the company must convince regulators it will share some of the $2.7 billion in projected cost savings from the merger with consumers.

Under the terms, Capital One shareholders will own around 60% of the combined company, with Discover shareholders owning the rest. Discover shareholders will receive 1.0192 Capital One shares for each Discover share. Discover shares rose 14% on the news, while Capital One shares increased 1% as the deal values Discover around 1.75x its tangible book value, higher than Capital One's valuation of around 1.2x. However, Discover shares traded at a discount to the deal value on Tuesday, indicating some investor uncertainty about the deal's completion due to regulatory risks.

DFS Breaks Long-Term Flag

The share price of Discover, DFS, has exited a long-term flag pattern following the recent announcement. Should buyers retain control and avert declines through support points of $113 and $104, a return to record highs would be feasible in the short term. Regardless, a decline to test support within the $96 to $104 region cannot be entirely ruled out and would substantially reduce the prospects of a continuation higher. Conversely, a decisive break above $135 could encourage additional buying interest towards the round levels of $140 and $150 in subsequent weeks.

Source: SpreadEx / DFS

Key Takeaways

Capital One announced plans to acquire Discover in an all-stock deal valued at $35.3 billion. However, the deal faces regulatory risks given Capital One's increased market power. The companies expect to achieve $2.7 billion in cost synergies by 2027 and for the deal to be over 15% accretive to Capital One's EPS. The acquisition is not expected to close until late 2024 or early 2025, pending reviews. Discover shares rose on the news but traded below the offer value, reflecting deal uncertainty.