Wall Street is taking a cautious view on the prospects for Capital One Financial’s deal for Discover Financial that would create the country’s largest credit-card lender. The $35 billion transaction is likely to garner significant antitrust scrutiny, with Discover Financial trading at about 11% below the current value of Capital One’s all-stock offer.
Investor Confidence Impacting Deal’s Regulatory Prospects
If investors were more confident about the deal’s regulatory prospects, the spread between the two stocks would likely be tighter. However, considering the raw spread without factoring in relative dividends or short position rebates, professional arbitragers could potentially capture the spread by buying Discover Financial and selling short Capital One.
Current Stock Performance
Capital One shares closed Tuesday at $137.39, up 0.1%, while Discover Financial stock finished at $124.42, up $13.93 or 12.6%. The current value of Capital One’s offer, approximately 1.02 of its shares for each Discover Financial share, amounts to $140.
Deal’s Symmetric Potential for Discover Buyers
For Discover buyers, the deal presents a symmetric outlook with similar potential upside if the deal materializes and downside if it falls through. Assuming Discover would return to its pre-deal price in case of a transaction failure, it might even trade higher due to Capital One’s indication of its value. While another bidder emerging for Discover is possible but not likely, arguments can be made on both sides.
Financial Viability and Analyst Insights
Financially, the deal appears sensible as Capital One would gain additional scale, an upgraded customer base, and access to Discover’s valuable payments network. Projected expense savings of $1.5 billion by 2027 and network synergies of $1.2 billion by the same year indicate strategic benefits. KBW analyst Sanjay Sakhrani projects “pro-forma” earnings of $18 per share for Capital One in 2025, assuming the merger occurs, compared to the current consensus of $16 per share. Discover Financial is estimated to be around $14 per share in 2025, suggesting that Capital One could be trading at under eight times the KBW 2025 estimate post-merger.
Potential Financial Implications of the Deal
One potential financial negative is that the deal would be dilutive to Capital One’s tangible book value, a widely followed capital measure for banks. Goldman Sachs analysts led by Ryan Nash, stated that while the deal makes strategic sense, there could be some impact related to TBV dilution. Goldman sees potential earnings of $22 a share or more in 2027.
Deal Closure and Regulatory Hurdles
Capital One expects to close the deal in late 2024 or early 2025. Analysts project that if the deal happens, it could take about a year before it closes. However, the deal faces an “inordinate” amount of regulatory and legislative scrutiny. It needs approval from the Federal Reserve and Office of the Comptroller of the Currency and will likely face scrutiny from the antitrust division of the Department of Justice.
Public and Regulatory Response
Massachusetts Sen. Elizabeth Warren, a consumer advocate and critic of big banks, quickly spoke out against the deal as “dangerous” and harmful to working people. She urged regulators to block it immediately. The Biden administration, known for taking a tough stance on big mergers, is expected to closely scrutinize this deal, especially in light of the upcoming presidential election.
Strategic Impact of the Deal
If successful, this deal would propel Capital One to the No. 1 position in credit-card loans outstanding, surpassing current leader JPMorgan Chase with $249 billion in loans compared to $211 billion. This move would mark a significant milestone for Capital One founder and CEO Richard Fairbank, who transformed the company from a monoline credit-card business in 1988 to one of the largest U.S. banks today.
Conclusion
The proposed merger represents a pivotal moment in Capital One’s history, potentially solidifying its position as a major player in the financial industry. However, with impending antitrust scrutiny and regulatory obstacles, the outcome remains uncertain for Fairbank and the company’s future.
