Now that the priciest U.S. bank merger of the last 15 years has closed, Capital One Financial has begun the process of integrating Discover Financial Services. It will be a marathon, not a sprint.
The merger, valued around $35 billion
While Capital One and Discover both
“Overall, it’s a big deal, and it’s a complex deal,” said Paul Nary, an assistant professor of management at University of Pennsylvania’s Wharton School.
Capital One
Big-lift integrations can often get bogged down by one-time costs and other pitfalls, hindering the push to gain competitive ground, Nary said.
But the benefits of Discover’s payment network could be worth the work in the long term.
Capital One CEO Richard Fairbank said during a call with analysts last month that the payment network is “the key way the Discover acquisition is going to help turbocharge our national bank.”
The merger “combines proven and complementary banking and credit card businesses with a global payments network,” Fairbank said. “It leverages Capital One’s technology transformation and digital capabilities across a significantly larger customer franchise.”
The acquisition of the Discover network will reduce the fees Capital One has to pay to other networks and give the bank valuable data about its customers’ spending patterns, Kyle Sanders, an analyst at Edward Jones, wrote in a research note. But it will take years for the benefits to fully vest, he said.
“We think these benefits will improve profit growth over the long term; however, the acquisition brings near-term uncertainty,” Sanders wrote. “Integration of the two firms will be complex, which could result in cost overruns or delays.”
One of Capital One’s earliest tasks will be to move its debit account holders from the Mastercard and Visa payment networks to Discover’s. Jefferies analyst John Hecht said the first step of the integration is relatively straightforward but not easy.
Jefferies hired a payment technology consultant to help run its own due diligence on the merger, and the firm was able to identify more than 90% of the $1.2 billion in network synergies that Capital One has projected, Hecht said.
Converting debit card accounts to Discover’s rails would make up a major chunk of that forecast, Hecht said. The process should take one to two years, he added, in line with Capital One’s guidance.
“The first phase of integration is just achieve the fundamental and financial goals that are consistent with other mergers, as well as would be consistent with the straightforward math of migrating the debit volume onto the Discover network,” Hecht said.
The trickier part of the integration will be taking advantage of Discover’s payment network to grow revenue opportunities, Hecht said.
Capital One has said it expects to move more than 25 million of its cardholders — representing at least $175 billion of its total purchase volume across debit and credit — to the Discover network by 2027.
Discover holds a sliver of the payment network market share, which is dominated by industry heavyweights Visa, Mastercard and American Express.
Discover has said its cards can be used at 99% of U.S. merchants that accept credit cards, but its global acceptance rate is lower. Bolstering international acceptance of the Discover network is a priority for Capital One — and arguably a necessary step before it can migrate the bulk of its legacy credit cards to Discover.
Fairbank acknowledged in April that the investment in Discover’s payment network will be a long haul, “measured in a whole bunch of years.”
He said Capital One is new to running a payment network — a business that’s “very complex, and very high stakes.”
Hecht said the migration will be “a multi-year journey to show the retailers or merchants that you have a presence, and then to convince them that they’re going to be better off being on your network than another network.”
Combining the companies — which created a $660 billion-asset entity — already made Discover’s network more relevant, but Hecht said it’s too early to price in the possibility of the payment network running in the same league as Visa and Mastercard.
Still, the possibility of the deal transforming the industry is “in the back of peoples’ minds,” Hecht said.
If Capital One has some success, “I think it becomes a very, very interesting and really important transaction,” he said. “People are hopeful that this will gain momentum … because I think people are very interested to see how it transforms the payment space, in terms of pricing and competition.”
The migration of Capital One’s credit cards to the Discover network will have to be done with patience and sensitivity. Cardholders could flee if they suddenly find themselves holding cards that no longer work in as many locations as they did previously, particularly overseas.
One way that Capital One could ease the transition for its legacy customers is by offering them more perks, but that strategy would require Capital One to provide more financial consideration to merchants.
“There would have to be extra concessions and deals that Capital One would have to provide both merchants and customers,” said Seoyoung Kim, a finance professor at Santa Clara University’s Leavey School of Business.
As opposed to megabanks like JPMorganChase that provide more robust suites of banking services, Capital One has fewer customers that use it as a one-stop shop, which makes it easier for its cardholders to leave.
The upshot is that the McLean, Virginia-based company may have to sweeten the pot to hold onto customers it’s hoping to move to the Discover network, Kim said.
Nary noted that Visa, Mastercard and Amex won’t let Capital One take market share without responding with their own competitive plays.
But Hecht said there’s space for Capital One to edge in.
“They want to become a fourth competitive network. There is room for a fourth network. They have to build the capabilities and the brand and obviously the competitive advantages in certain categories … then hopefully we’ll see the benefits,” he said.
One potential long-term benefit of the deal involves Capital One’s ability to add more card-issuing banks to the Discover network, Hecht said.
He said it’s never easy to put two companies of this size together, but Capital One has a track record of integrating acquisitions and scaling up its technology.
“Given Capital One’s history, and looking at other integrations of bank mergers of this type, you’re probably going to have certain things that do that go faster and better than expected, and certain things that go slower and worse than expected,” Hecht said.
What will happen to Discover cardholders?
Existing Discover cardholders are not expected to be affected by the merger. Capital One plans to offer Discover-branded credit cards as well as Capital One-branded ones. “We intend to preserve the Discover brand,” Capital One says on its website.