Wall Street Cautious on Capital One Bid for Discover Amid Antitrust Scrutiny

 If investors were more confident of the deal’s regulatory prospects, the spread likely would be tighter. 

Barron’s is looking at the raw spread and not factoring the relative dividends on the two stocks or the short rebate that professional arbitragers would get on their short position in Capital One. The arb trade would be to buy Discover Financial and sell short Capital One to capture the spread.

Capital One shares ended Tuesday at $137.39, up 0.1% while Discover Financial stock finished at $124.42, up $13.93, or 12.6%. The current value of the Capital One offer of roughly 1.02 of its shares for each Discover Financial share is $140. 

For Discover buyers, the deal looks symmetric with similar amounts of upside if the deal happens and downside if the deal dies. 

 This is based on an assumption that Discover would trade at its pre-deal price if the transaction doesn’t occur. It actually might trade higher since Capital One has highlighted the value of the company and it’s possible—but not likely—that another bidder emerges for Discover.

It isn’t easy to put percentages on deal odds but they appear to be about 50/50 now.

Financially, the deal looks sensible. Capital One would get additional scale, an upgrade to its customer base and Discover’s valuable payments network. Capital One sees $1.5 billion of expense savings by 2027 and $1.2 billion of what it called network synergies by 2027.

KBW analyst Sanjay Sakhrani wrote Tuesday that he sees “pro-forma” earnings of $18 a share for Capital One in 2025, assuming the deal occurs, against a current consensus of $16 a share—and around $14 a share for Discover Financial. This means that Capital One trades for under eight times the KBW 2025 estimate assuming the two companies combine.

One potential financial negative is that the deal would be dilutive to Capital One tangible book value, a widely followed capital measure for banks.

“So ultimately, while we believe the deal makes a lot of sense strategically, there could be some impact related to TBV dilution,” wrote Goldman Sachs analysts led by Ryan Nash earlier Tuesday. Goldman sees potential earnings of $22 a share or more in 2027.

Capital One said it expects to close the deal in late 2024 or early 2025. Analysts are assuming that if the deal happens, it could be about a year before it closes. 

As Barron’s wrote earlier, the deal faces an “inordinate” amount of regulatory and legislative scrutiny. It needs the approval of the Federal Reserve and Office of the Comptroller of the Currency and likely will get scrutiny from the antitrust division of the Department of Justice.

Massachusetts Sen. Elizabeth Warren, a consumer advocate and a critic of big banks, quickly posted on X that the deal is “dangerous and will harm working people” and that regulators “must block it immediately.”

The Biden administration has taken a tough stance generally on big mergers and this deal undoubtedly will be no different, particularly given the consumer angle and this being a presidential election year.

The deal would vault Capital One into the No. 1 position in credit-card loans outstanding at $249 billion, against $211 billion for the current leader,
JPMorgan Chase,
according to Goldman analysts.

The transaction would be a capstone to the career of Capital One founder and CEO Richard Fairbank, 73, who built one of the largest U.S. banks since he founded Capital One as a monoline credit-card company in 1988. The company went public in1994. That’s a feat and makes Capital One a rarity among big banks, several of which date back to the 19th century.

But given the likely antitrust scrutiny it seems like a coin flip whether Fairbank gets this deal done.

Write to Andrew Bary at [email protected]

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