The bank's deal for Discover is looking like a good bet for investors, creating a new financial giant that will control both ends of the card business. By Emily Dattilo

Stop by an airport and you may notice a polite scrum to get into a Capital One lounge. Inside, you'd see why: There's an espresso bar, "signature" cocktails, and a gourmet menu featuring the likes of tapas, Thai shrimp, and vegan chorizo hash.

The lounges are a perk of Capital One's Venture X card and its $395 annual fee. But luring customers with high-end freebies isn't the bank's only playbook. It's aiming to close a deal for Discover Financial Services, buying the country's fourth-largest card network in an all-stock deal worth an estimated $52 billion. Shareholders are expected to approve the deal in a vote on Feb. 18.

Assuming it goes through -- regulators still need to approve the deal -- the merger would upend the card industry. It would forge a new kind of card giant -- blending a major bank with a card network like those of Visa and Mastercard, controlling both sides of the debit/credit business.

Announced about a year ago, the deal has been terrific for Discover stock, sending shares up 81% through the end of January. It also looks good for Capital One, whose stock has responded positively. Capital One has said it expects to close the deal early this year, though the companies extended the agreement to May 19 amid lawsuits and potential regulatory delays.

The combined entity would become the largest U.S. card company, with $250 billion of card loans and an estimated 20% market share, according to J.P. Morgan analyst Richard Shane. Capital One is offering about 1.02 shares for every Discover share, valuing the deal at $52 billion based on recent prices for its stock around $200. The bank says it expects Discover to add at least 15% to adjusted earnings per share in 2027.

Capital One should benefit in multiple ways. For one, it will have far more control over the card business, issuing debit and credit cards to its customer base, while also owning several payment and debit networks. That will help it collect card fees from merchants and, ideally, reduce the fees that Capital One now pays to Visa and Mastercard for debit/credit transactions.

There are also cost savings or "pre-tax synergies" amounting to $2.7 billion, according to Capital One. And there should be lots of cross-selling to Discover's customer base, whether it's bank accounts, mortgages, auto loans, card services, or credit -- all supporting more profit growth than Capital One would have earned on its own.

For all of those reasons, Wall Street is on board. "Rare is the transformational story in banks that goes from 'good' to 'great,' " wrote UBS analyst Erika Najarian in a note, adding that she sees a "rare opportunity for investors to own a vertically integrated payments platform and card juggernaut."

Still, Capital One is plowing far deeper into the card world with Discover, and will have to manage both its loan portfolio and network for the merger to pay off. While Discover is widely accepted in the U.S., it isn't nearly as prevalent abroad, which could prove problematic, as Capital One plans to gradually migrate its cardholders to the Discover network.

Discover has attractive assets. Its loan portfolio of $121 billion includes about $103 billion of credit-card debt, mostly above a 660 credit score, considered a fair threshold for quality. While Discover saw some credit metrics deteriorate in recent years, its net charge-offs have been falling and delinquencies have stabilized, a good sign for the rest of the year, says Jefferies analyst John Hecht.

Its card networks, including Discover, Pulse (debit), and Diners Club, processed $622 billion of transactions in 2024, bringing in $345 million of transaction revenue. Discover overall brought in $17.9 billion of revenue last year and net income of $4.5 billion.

The upshot for Capital One is that it will be getting a sizable new asset base, along with new source of steady fee income that isn't as cyclically sensitive as bank lending. And it will have far more customers and assets to fund loan growth, which may help improve its net interest margins.

Building something like Discover now would "be prohibitively expensive," says Deutsche Bank analyst Mark DeVries.

Capital One has said the Discover brand will survive, with plans to keep offering Discover-branded cards and maintain the name for the network. The bank plans to move its entire debit business to Discover's network and some of its credit cards over time. "We're going to crab walk our way, lifting one leg at a time, so to speak," said Capital One CEO Richard Fairbank at a conference in December.

Capital One and Discover declined to comment on the merger.

So far, the deal appears to be making it through the regulatory process, with the Trump administration expected to sign off. "There's every reason in the world for this transaction to be approved," says TD Cowen analyst Moshe Orenbuch. By that, he means the Office of the Comptroller of the Currency and the Federal Reserve, the two key regulators, aren't likely to block it.

Some antitrust experts raise concerns, though. Jeremy Kress, a University of Michigan business law professor who has advised the Fed on bank mergers, says this one is different because it isn't focused on local-market deposit concentration -- Discover operates only one branch, and Capital One has very few. The bigger issue, he says, is about vertical integration, combining Discover's network with Capital One's cards, giving the bank more market power over merchants.

Capital One will have to turn Discover from a fourth-place player in card networks to a more formidable foe against Visa, Mastercard, and American Express. It's buying a card network at a time when the industry is trying to protect its oligopoly power. Tech companies are circling, and battles with merchants over card fees remain an overhang.

Getting more consumers and merchants to use Discover's cards and network will be key. Capital One has a strong consumer brand, and it has built a marketing machine around lounges, Capital One cafes, and other initiatives -- all great for cross-selling to Discover. But internationally, Discover's brand awareness "drops off a cliff," according to Jefferies' Hecht. And Discover's transaction volumes are far below those of Visa and Mastercard.

Capital One is also buying a card network as the industry faces more competition from tech companies. Apps like Apple Pay, Alphabet's Google Pay, PayPal/Venmo, and Block's Cash App and Square are all trying to siphon consumers and merchants. When you use Visa or Mastercard for credit or debit, it usually runs over their networks. But payments made through apps may cut out the middlemen. As more consumers do business on their phones, the card networks will have to find new ways of keeping them using credit and debit cards or networks, as will Capital One/Discover.

Merchants, meanwhile, are trying to persuade Congress and regulators to crack down on card fees. Every time a card is swiped for credit, Visa and Mastercard take a 2% to 3% cut, according to Sen. Richard Durbin (D., Ill.), who has sponsored a bill to increase card network competition. The bill may not have much chance of passing Congress or being signed by President Donald Trump, though it could be positive for Discover (and Amex) by requiring banks to offer at least one more network for cards.

What it's all worth for Capital One? It's tricky to determine, since Capital One may soon be a hybrid of bank and card network without comparable peers. But the stock does look inexpensive at nine times estimated 2027 earnings. That's well below American Express at 15 times and far cheaper than Visa and Mastercard at 23 to 26 times. It also much cheaper than JPMorgan Chase, a primary competitor in cards, trading at 12.8 times.

Whether the stock is really a bargain will depend on Discover getting a new lease on life in Capital One. One potential casualty: Those swanky lounges could get more crowded if Discover's cardholders join the party.

Write to Emily Dattilo at emily.dattilo@dowjones.com

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February 14, 2025 21:30 ET (02:30 GMT)

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