Will Capital One benefit from network effect with Discover acquisition?

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Capital One Financial Corporation (NYSE: COF) has received regulatory approval for its acquisition of Discover Financial Services (NYSE:DFS) and the deal is set to close later this month. The $35.3 billion acquisition, announced last February, will enable Capital One to benefit from Discover’s payments network (which has more than 300 million cardholders), and further leverage off its technology, customers and data, among other benefits. The acquisition is also set to make Capital One the biggest issuer of credit cards in the U.S. by loan volume. The combined company would hold assets of more than $637 billion, making it the eighth-largest insured depositary institution in the U.S. and place it sixth in the nationally chartered U.S. bank space.

The deal valued each Discover share at 1.0192 Capital One stock, making for a 26.6% premium on Discover’s closing price of about $110 on February 16, 2024, just prior to the deal announcement. Discover stock has narrowed the gap since then, closing at about $190 on May 5, compared to Capital One’s closing price of about $187 on that day. Capital One, which provides financial services to consumers and businesses and also issues credit cards, tends to see itself as a technology-driven company that happens to be in the banking sector. With a “digital first” approach, the bank has more than 250 branches and more than 50 limited-service “Capital One Cafés” in large metro areas. The Capital One business model is based on leaner economics from not having a lot of physical bank branches and the company passes on the benefits to customers through more aggressive pricing for its services.

Founded in 1988 by its Chief Executive Officer Richard D. Fairbank, who had previously worked in the financial services sector, the McLean, VA-based company had its initial public offering in 1994 at $16 per share (the split-adjusted price is $5.33). This multibagger stock is also on the S&P 100 index. Discover Card was launched nationally by Sears, Roebuck and Co.’s Dean Witter Financial Services Company in 1986 and became an independent public company in 2007. Looking ahead, will the combined company benefit from a network effect through the acquisition and continue to reward shareholders?