Capital One CEO and Chairman, Richard Fairbank.
Marvin Joseph| The Washington Post | Getty Images
Capital One’s recently announced $35.3 billion acquisition of Discover Financial is not only about getting greater — gaining “scale” in Wall Street-speak — it is a bid to guard itself against a rising tide of fintech and regulatory threats.
It is a chess move by one of the savviest long-term thinkers in American finance, Capital One CEO Richard Fairbank. As a co-founder of a top 10 U.S. bank by assets, his tenure is a rarity in a banking world dominated by institutions like JPMorgan Chase that trace their origins to shortly after the signing of the Declaration of Independence.
Fairbank, who became a billionaire by constructing Capital One right into a bank card giant since its 1994 IPO, is betting that buying rival card company Discover will higher position the company for global payments’ murky future. The industry is a dynamic web where players of all stripes — from traditional banks to fintech players and tech giants — are all in search of to stake out a corner in a market price trillions of dollars by eating into incumbents’ share amid the rapid growth of e-commerce and digital payments.
“This deal gives the company a stronger hand to battle other banks, fintechs and large tech firms,” said Sanjay Sakhrani, the veteran KBW retail finance analyst. “The more that they’ll separate themselves from the pack, the more they’ll future-proof themselves.”
The deal, if approved, enables Capital One to leapfrog JPMorgan as the biggest bank card company by loans, and solidifies its position as the third largest by purchase volume. It also adds heft to Capital One’s banking operations with $109 billion in total deposits from Discover’s digital bank and helps the combined entity shave $1.5 billion in expenses by 2027.
‘Holy Grail’
However 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 analysts queried him on the strategic merits of the deal. There are only 4 major card networks: giants Visa and Mastercard, then American Express and eventually the smallest of the group, Discover.
Capital One and Discover bank cards arranged in Germantown, Recent York, US, on Tuesday, Feb. 20, 2024.
Angus Mordant | Bloomberg | Getty Images
“That network is a really, very rare asset,” Fairbank said. “Now we have at all times had a belief that the Holy Grail is to find a way to be an issuer with one’s own network in order that one can deal directly with merchants.”
From the time of Capital One’s founding in the late Eighties, Fairbank said, he envisioned creating a world digital payments tech company by owning the payment rails and dealing directly with merchants. In the many years since, Capital One has been ahead of stodgier banks, gaining a repute in tech circles for being forward-thinking and for its early adoption of cloud computing and agile software development.
But its growth has relied on Visa and Mastercard, which accounted for the overwhelming majority of payment volumes last yr, processing nearly $10 trillion in the U.S. between them.
Capital One intends to spice up the Discover network, which carried $550 billion in transactions last yr, by quickly switching all of its debit volume there, in addition to a growing share of its bank card flows over time.
By 2027, the bank expects so as to add no less than $175 billion in payments and 25 million of its cardholders onto the Discover network.
Owning the toll road
The true potential of the Discover deal, though, is what it allows Capital One to do in the future if it owns the toll road, in response to analysts.
By creating an end-to-end ecosystem that is more of a closed loop between shoppers and merchants, it could fend off competition from rapidly mutating fintech players like Block and PayPal, in addition to buy now, pay later firms like Affirm and Klarna, who’ve made inroads with each businesses and consumers.
Capital One goals to deepen relationships with merchants by showing them find out how to boost sales, helping them prevent fraud and providing data insights, Fairbank said Tuesday, all of which makes them harder to dislodge. It will possibly use some of the network fees to create latest loyalty plans, like debit rewards programs, or underwrite merchant incentives or experiences, in response to analysts.
“Owning a network allows us to deal more directly with merchants somewhat than a network intermediary,” Fairbank told analysts. “We create more value for merchants, small businesses and consumers and capture the additional economics from vertical integration.”
It is a capability that technology or fintech firms probably covet. The Discover network alone can be price as much as $6 billion if sold to Alphabet, Apple or Fiserv, Sakhrani wrote Tuesday in a research note.
Will regulators approve?
The Capital One-Discover combination could fortify the company against one other potential threat — from Washington.
Proposed laws from Sen. Dick Durbin, D-Unwell., goals to cap the fees charged by Visa and Mastercard, potentially blowing up the economics of bank card rewards programs. If that proposal becomes law, the competitive position of Discover’s network, which is exempt from the limitations, suddenly improves, in response to Brian Graham, co-founder of advisory firm Klaros Group. That mirrors what an earlier law generally known as the Durbin amendment did for debit cards.
Chairman Dick Durbin (D-IL) speaks during a US Senate Judiciary Committee hearing regarding Supreme Court ethics reform, on Capitol Hill in Washington, DC, on May 2, 2023.
Mandel Ngan | AFP | Getty Images
“There are a bunch of things aimed, in a technique or one other, at the card networks and that ecosystem,” Graham said. “Those pressures may be one of the things that creates a chance for Capital One in the future in the event that they have control over this network.”
The biggest query for Capital One, its customers and investors is whether the merger will ultimately be approved by regulators. While Fairbank said he expects the deal to be closed in late 2024 or early 2025, industry experts said it was unattainable to know whether it should be blocked by regulators, like a string of high-profile takeovers amongst banks, airlines and tech firms.
On Tuesday, Democratic Sen. Elizabeth Warren of Massachusetts urged regulators to swiftly block the deal, calling it “dangerous.” Sen. Sherrod Brown, D-Ohio, chairman of the Senate Banking Committee, said he can be watching the deal to “be certain that this merger doesn’t enrich shareholders and executives at the expense of consumers and small businesses.”
The Discover deal’s survival may hinge on whether it’s seen as boosting an also-ran payments network, or allowing an already-dominant card lender to level up in size — another excuse Fairbank can have played up the importance of the network.
“Which thing you’re more concerned about will define whether you’re thinking that this is a great deal or a foul deal from a public policy point of view,” Graham said.
Don’t miss these stories from CNBC PRO: