Capital One Financial Corp. agreed to buy Discover Financial Services in a US$35 billion all-stock deal to create the largest US credit-card company by loan volume, giving the combined entity a stronger foothold to compete with Wall Street’s behemoths.  

Capital One will swap 1.0192 of its own shares for each Discover share, a 26.6 per cent premium over the Feb. 16 closing price, the McLean, Virginia-based company said in a statement. The transaction, first reported by Bloomberg News, is expected to be completed in late 2024 or early 2025, assuming it can pass antitrust reviews and win shareholder approvals.

The purchase of Discover ranks as the world’s biggest merger this year, surpassing Synopsys Inc.’s roughly $34 billion acquisition of software developer Ansys Inc. announced in January. It will bring together two storied consumer-finance brands, a combination that will surpass rivals JPMorgan Chase & Co. and Citigroup Inc. by US credit-card loan volume, according to data compiled by Bloomberg Intelligence. The deal will also give Capital One a foundation in the world of payment networks.

It’s a “singular opportunity” to bring together two companies that can compete with the largest payment networks, Capital One Chief Executive Officer Richard Fairbank said in the statement.

The combined size of the company is likely to draw scrutiny from antitrust regulators, analysts said Tuesday.

“They will hear from progressives about how this would hurt competition,” said Ian Katz at Capital Alpha Partners. “In fact, they already have. But if they were to reject the deal they would be accused of protecting Visa and Mastercard, which is often referred to as a duopoly.” Katz said he leans slightly toward thinking the deal will be approved, “but not before the November elections.”

Opposition emerged almost immediately from Democrats in the US Senate, where Ohio’s Sherrod Brown, chair of the Senate Banking Committee, took a dim view of the deal’s size and Elizabeth Warren of Massachusetts expressed outright opposition. 

“A rubber-stamped merger that makes powerful financial companies even bigger and more powerful will do nothing for families,” Brown said in a statement. “We will be monitoring all developments to ensure that this merger doesn’t enrich shareholders and executives at the expense of consumers and small businesses.”

Warren said the deal should be blocked because it “threatens our financial stability,” cuts competition and brings higher costs for families. Fairbank told analysts during a conference call that the bank is “well-positioned for approval.”

Historically, Capital One has had to rely on Visa Inc. or Mastercard Inc. to issue its credit cards. With Discover in hand, the company would be able to cut out those two middlemen and have more control over the prices merchants are charged each time a consumer swipes one of the firm’s cards at checkout.

Mastercard is more likely to feel the merger’s impact than Visa, according to analysts, but there was also skepticism that Capital One’s deal will be a game-changer. While there may be “some low-hanging synergies,” said Trevor Williams at Jefferies, “we doubt the combination makes Discover any more formidable as a competitor.”

Discover shares jumped 12.6 per cent in Tuesday’s trading, while Capital One was little changed. Capital One holders will own about 60% of the combined company, according to the statement. The acquisition will generate pretax synergies of $2.7 billion. 

“Credit-card companies have large fixed costs for information technology, partly for algorithms aimed at fraud prevention, so bigger is better,” said Jay Ritter, finance professor at the University of Florida. “This fact has been reshaping many industries for many years, and I see no reason to think that the trend toward fewer, but larger, firms will end.”

Prime Customers

Capital One is known for its commercials featuring celebrities like Taylor Swift, Jennifer Garner and Samuel L. Jackson that ask, “What’s in your wallet?” The company, led by 73-year-old CEO Fairbank, has historically catered to subprime consumers who carry a balance on their cards each month.

Fairbank said on an earnings call in January that delinquencies had stabilized after reporting net charge-offs that were higher than analysts expected as borrowers fell behind on their credit-card and auto loans.

In recent years, Capital One has been trying to attract more premium customers who tend to be heavy spenders and more loyal. It agreed to buy the digital concierge service Velocity Black last year, pushing deeper into luxury markets dominated by firms such as American Express Co. and JPMorgan.

Discover owns three different payment networks: Discover Network, Diners Club International and its Pulse debit network. The company has spent years trying to expand acceptance and usage of the offerings, though they’ve long lagged behind the reach of Visa and Mastercard.

Capital One is the third-largest issuer of Visa and Mastercard credit cards in the US, accounting for roughly 10% of US credit-card spending, according to Mizuho Securities USA’s Dan Dolev.

“The combination could prove to be more competitive for Visa/Mastercard,” Daniel Perlin, an analyst at RBC Capital Markets, said in a note to clients. “At a high level, the risk to the networks is simple — can Capital One monetize Discover’s network capabilities, which historically have not gained much market share versus the networks?”

Discover said in January that its fourth-quarter profit dropped 62% as the company continued to grapple with the fallout from compliance and risk-management lapses. The company halted buybacks last year and has been seeking a buyer for its student-loan business. In December, Discover appointed Toronto-Dominion Bank’s Michael Rhodes as its new CEO, lining him up to take over by early March.