Wall Street's Verdict on Capital One's Discover Deal

Wall Street is approaching the prospects for Capital One Financial's deal for Discover Financial Services with caution. This deal, which would result in the country's largest credit-card lender, has raised concerns about potential antitrust scrutiny. Discover is currently trading at a significant 12% below the value of Capital One's all-stock offer, indicating investor uncertainty regarding the deal's regulatory outcome.

Market Response and Arbitrage Analysis

As of Friday's closing prices, the arbitrage community is indicating less than a 50/50 chance of the deal being completed. Discover shares closed at $121.71, up by 10% for the week, while Capital One closed at $135.52, down by 1%. The current value of Capital One's offer stands at approximately $138 per share, offering potential gains for investors if the deal goes through.

Investment Potential and Risk Assessment

From an investment standpoint, Discover appears to be undervalued, with investors potentially making $16 per share if the deal is finalized within a year. In case the deal falls through, Discover's stock could trade in the $110 to $115 range, offering an attractive risk-reward profile. Despite trading at $110 pre-deal announcement, the stock could see an uptick if the deal is abandoned due to heightened awareness of Discover's franchise value.

Analyst Insights and Financial Implications

According to KBW analyst Sanjay Sakhrani, the deal makes financial sense for both parties. If completed, Capital One would benefit from increased scale, an enhanced customer base, and access to Discover's valuable payments network. Sakhrani predicts "pro forma" earnings of $18 per share for Capital One in 2025 post-deal, compared to the current consensus of $16 per share. Similarly, Discover Financial is estimated to achieve around $14 per share in the same timeframe. This evaluation positions Capital One's current valuation at under eight times the KBW 2025 earnings estimate, assuming successful integration of the two companies.

The Future of the Credit Card Industry

In the world of finance, major mergers and acquisitions often attract intense regulatory and legislative attention. The recent agreement between Discover and Capital One is no exception, as it faces evaluations from various bodies such as the Fed, the Office of the Comptroller of the Currency, and the antitrust division of the Department of Justice.

Mixed Reactions

While voices like Sen. Elizabeth Warren raise concerns about the potential risks to consumers and working-class individuals, others argue that the deal could actually benefit consumers. Discover's position as one of the top credit-card processing networks, alongside Visa, Mastercard, and American Express, presents an opportunity for Capital One to enhance competition in the market.

Shifting Power Dynamics

Should the merger proceed, Capital One would secure the top spot in terms of credit-card loans outstanding, surpassing current leader JPMorgan Chase. This shift in industry rankings could lead to significant changes in the competitive landscape. However, the possibility of increased market concentration raises questions about antitrust issues and the overall impact on consumers.

Uncertain Future

As the Biden administration maintains a strict stance on large-scale mergers, the fate of the Discover-Capital One deal remains uncertain. Despite its potential advantages for consumers and the industry as a whole, regulatory approval is crucial for its completion. The coming months will reveal whether this deal will reshape the credit card industry or face further scrutiny.

Stay tuned for updates on this developing story.