Capital One's Discover Acquisition Sets Stage for Continued Growth, Cramer Says

Capital One's acquisition of Discover Financial Services gives the company more reach and earnings power, according to CNBC's Jim Cramer. The deal, valued at $35.3 billion, allows Capital One to scale up and become a truly global payments platform, reducing its reliance on MasterCard and Visa. Cramer expects the deal to boost earnings per share 15% by 2027 and unlock new international opportunities. He believes the stock has more room to run and is still undervalued at 11 times next year's earnings.

Capital One Financial Corporation (COF) has announced its decision to wind down the home equity lending business it acquired as part of its purchase of Discover Financial Services. The news was first reported by Banking Dive. According to a spokesperson for COF, the company conducted an extensive strategic business review of Discover's home equity and refinance loan business to better understand its position and potential within Capital One's business portfolio. In late June, COF made the difficult decision to exit this business, focusing on supporting its customers and associates through the transition.

While COF is shutting down the originations pipeline for the home equity lending business, it will continue to service the existing portfolio and assess strategic options for sale and servicing. The number of employees affected by this move is not yet known. Most employees are expected to take on other roles within the company or assist in the wind-down process, while some positions may eventually be cut.

The acquisition of Discover Financial Services was a significant event in the credit card industry, reshaping the landscape and creating a behemoth. The deal, valued at $35 billion, allowed Capital One to capture a larger share of spending on cards and compete with well-known card issuers. By controlling Discover Financial's payments network, one of only four in the United States, COF can generate greater revenues from interchange fees and operate independently from the Visa-Mastercard duopoly.

The path to the deal's completion was not smooth. While Capital One and Discover Financial shareholders approved the transaction in February, the deal underwent extensive regulatory scrutiny. Final approval came in April from the Federal Reserve and the Office of the Comptroller of the Currency, after the U.S. Department of Justice opted not to challenge the merger. However, the approval came with conditions: Capital One must address outstanding enforcement issues tied to Discover Financial. In 2023, Discover revealed that it had overcharged merchants on certain credit card transactions since 2007, drawing regulatory attention and requiring corrective action.

Over the years, COF's revenues have been driven by opportunistic acquisitions. Before acquiring Discover Financial, Capital One bought Velocity Black in 2023, bolstering the delivery of exceptional consumer experiences through innovative technology. While the company's revenues declined marginally in 2020, the metric witnessed a five-year (2019-2024) compound annual growth rate of 6.5%. Revenue prospects look encouraging, given Capital One's solid credit card and online banking businesses, the Discover Financial buyout, and decent loan demand.

So far this year, shares of Capital One have gained 22.3% compared with the industry's 21.9% growth. Currently, COF carries a Zacks Rank #3 (Hold). Morgan Stanley has resumed coverage of Capital One with an Overweight rating, considering the benefits of the Discover acquisition and that the stock is not fully priced. Shares were +0.83% pre-market to $219.30.

Inorganic growth efforts by other finance firms also highlight the industry's focus on strategic acquisitions. Last month, Glacier Bancorp, Inc. (GBCI) entered a definitive agreement to acquire Guaranty Bancshares, Inc. (GNTY), the bank holding company for Guaranty Bank & Trust, N.A., a leading community bank headquartered in Mount Pleasant, TX. The all-stock transaction is valued at $476.2 million and is expected to be immediately accretive to Glacier Bancorp’s earnings per share. The deal is projected to generate an internal rate of return of 20% by the end of the first year after closing.

References:
[1] https://www.nasdaq.com/articles/capital-one-decides-wind-down-discover-home-equity-business
[2] https://finance.yahoo.com/news/capital-one-decides-wind-down-151600136.html
[3] https://seekingalpha.com/news/4466143-morgan-stanley-resumes-coverage-of-capital-one-financial-with-buy-equivalent