Richard Fairbank, CEO and Chairman of Capital One.
Marvin José| The Washington Post | fake images
capital one recently announced the $35.3 billion acquisition of Discover Finance It's not just about growth (gaining “scale” in Wall Street parlance), but an attempt to protect itself against a rising tide of regulatory and fintech threats.
It's a chess move by one of the smartest long-term thinkers in American finance, Capital One CEO Richard Fairbank. As a co-founder of one of the top 10 U.S. banks by assets, his tenure is a rarity in a banking world dominated by institutions like JPMorgan Chase which have their origins shortly after the signing of the Declaration of Independence.
Fairbank, who became a billionaire by turning Capital One into a credit card giant since its initial public offering in 1994, is betting that the purchase of rival card company Discover will better position the company for the murky future of global payments. The industry is a dynamic network in which players of all types (from traditional banks to fintech and technology giants) seek to gain a foothold in a market valued at trillions of dollars, eating into the share of traditional players amid the rapid growth of electronic companies. . Digital commerce and payments.
“This deal gives the company a stronger hand to fight other banks, fintechs and big tech companies,” said Sanjay Sakhrani, the veteran retail finance analyst at KBW. “The more they can separate themselves from the rest, the more they can prepare for the future.”
The deal, if approved, will allow Capital One to overtake JPMorgan as the largest credit card company by lending and solidify its position as the third largest by purchasing volume. It also adds weight to Capital One's banking operations with $109 billion in total deposits from Discover's digital bank and helps the combined entity save $1.5 billion in expenses by 2027.
'Holy Grail'
But it's Discover's payments network — the “rails” that shuffle digital dollars between consumers and merchants, collecting tolls along the way — that Fairbank repeatedly praised Tuesday when asked by analysts about the strategic merits of the deal. There are only four major card networks: giant Visa and MasterCardso American Express and finally the smallest of the group, Discover.
Capital One and Discover credit cards arranged in Germantown, New York, USA on Tuesday, February 20, 2024.
Mordant Angus | Bloomberg | fake images
“That network is a very, very rare asset,” Fairbank said. “We have always believed that the Holy Grail is to be able to be an issuer with your own network to be able to deal directly with merchants.”
From the time of Capital One's founding in the late 1980s, Fairbank said, he envisioned creating a global digital payments technology company by owning payment lanes and dealing directly with merchants. In the decades since, Capital One has been ahead of heavier banks, gaining a reputation in technology circles for its forward-thinking and early adoption of cloud computing and agile software development.
But its growth has been based on Visa and Mastercard, which accounted for the vast majority of payment volumes last year, processing almost $10 trillion between them in the United States.
Capital One intends to boost the Discover network, which transacted $550 billion last year, by rapidly moving all of its debit volume there, as well as an increasing proportion of its credit card flows over time. .
By 2027, the bank expects to add at least $175 billion in payments and 25 million cardholders to the Discover network.
Own the toll road
However, the real potential of the Discover deal is what it allows Capital One to do in the future if it owns the toll road, according to analysts.
By creating an end-to-end ecosystem that is more of a closed loop between buyers and merchants, it could fend off competition from rapidly changing fintech players like Block and PayPalIn addition to buy now and pay later, companies like Say and Klarna, which have made inroads with both businesses and consumers.
Capital One aims to deepen relationships with merchants by showing them how to increase sales, helping them prevent fraud and giving them valuable information, Fairbank said Tuesday, all of which makes them harder to dislodge. According to analysts, you can use some of the network fees to create new loyalty plans, such as debit rewards programs, or subscribe to incentives or merchant experiences.
“Owning a network allows us to deal more directly with merchants than with a network intermediary,” Fairbank told analysts. “We create more value for merchants, small businesses and consumers and capture the additional economics of vertical integration.”
It's a capability that technology or fintech companies likely covet. The Discover network alone would be worth up to $6 billion if sold to Alphabet, Apple either FiservSakhrani wrote Tuesday in a research note.
Will regulators approve it?
The Capital One-Discover combination could strengthen the company against another potential threat: that of Washington.
Legislation proposed by Sen. Dick Durbin, D-Ill., aims to limit fees charged by Visa and Mastercard, which could blow up the economics of credit card rewards programs. If that proposal becomes law, the competitive position of Discover's network, which is exempt from the limitations, will suddenly improve, according to Brian Graham, co-founder of the advisory firm Klaros Group. This mirrors what a previous law known as the Durbin amendment did for debit cards.
Chairman Dick Durbin (D-IL) speaks during a United States Senate Judiciary Committee hearing on Supreme Court ethics reform, on Capitol Hill in Washington, DC, on May 2, 2023.
Mandel Ngan | AFP | fake images
“There are a lot of things aimed, in one way or another, at the card networks and that ecosystem,” Graham said. “Those pressures could be one of the things that creates an opportunity for Capital One in the future if they have control over this network.”
The biggest question for Capital One, its customers and investors is whether regulators will ultimately approve the merger. While Fairbank said it expects the deal to close in late 2024 or early 2025, industry experts said it was impossible to know whether it will be blocked by regulators, like a series of high-profile acquisitions between banks, airlines and technology companies.
On Tuesday, Democratic Sen. Elizabeth Warren of Massachusetts urged regulators to quickly block the deal, calling it “dangerous.” Sen. Sherrod Brown, D-Ohio, chairman of the Senate Banking Committee, said he would keep an eye on the deal to “ensure that this merger does not enrich shareholders and executives at the expense of consumers and small businesses.”
The survival of the Discover deal may depend on whether it is seen as boosting a payments network it also manages, or allowing an already dominant card lender to move up in size, another reason Fairbank may have highlighted the importance of the network.
“What you're most concerned about will define whether you think it's a good deal or a bad deal from a public policy standpoint,” Graham said.
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