Wells Fargo & Discover: A Deal Waiting To Materialize?

by Trefis Team
Wells Fargo & Co.
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Late last week, a research report by the Susquehanna Financial Group got the market talking about the possibility of Wells Fargo (NYSE:WFC) acquiring Discover Financial Services (NYSE:DFS). [1] Such an acquisition would no doubt be in line with Wells Fargo’s strategy of focusing on traditional banking services for growth. And the bank has made it clear in the recent past that it will not shy away from opportunities to grow inorganically. So, is there really value to be gained from such a merger between the fourth largest U.S. bank in terms of assets and the fourth largest payments firm?

We maintain a $38 price estimate for Wells Fargo’s stock, which is around 10% above the current market price. We also have a $39 price estimate for Discover’s stock, which is close to its current market price.

See our full analysis for Wells Fargo | Discover

Discover Is Unique, Is Growing And Is Willing To Talk To Acquirers

Discover operates the fourth largest payments processing network after Visa (NYSE:V), MasterCard (NYSE:MA) and American Express (NYSE:AXP). [2] And the company also has a decent share of the number of credit cards in circulation. Discover is also eying various international markets with recent tie-ups to issue credit cards in foreign countries (see Discover Enters Russia En Route To $39), and has also looked to diversify beyond credit cards and payment offerings as is evident from the acquisition of a student loan portfolio and platform from Citigroup (NYSE:C).

Sources suggest that the company is ready to negotiate with potential acquirers approaching them with “the right price and cultural fit.” [1]

Certainly Looks Like A Win-Win Deal

Credit Cards constitute a small portion of Wells Fargo’s enormous business model, with the cards business contributing to less than 7% of its total value, according to our analysis. In comparison, credit cards contribute to more than a quarter of JPMorgan Chase’s (NYSE:JPM) value. The business cannot be easily ignored owing to the huge yield margins in credit card loans with respect to other consumer loans.

Wells Fargo had about $21.5 billion in outstanding card loans at the end of 2011. This is but a fraction of the $189 billion card loan portfolio its biggest rival JPMorgan boasts of. A Wells Fargo-Discover deal would boost the bank’s card portfolio by more than $45 billion – making the combined entity the fifth-largest card issuer in terms of card loans outstanding. In fact, in terms of the number of cards in circulation, the combined entity would be second only to JPMorgan.

As for Discover, the deal would mean an almost complete hold on the credit cards issued by one of the largest, and arguably the most profitable, of the U.S. financial giants. Not to mention the nearly limitless low-cost funding that would be made available to the card business from the bank’s huge deposits business.

So, how much would the deal be worth?

The complementary nature of Wells Fargo’s credit card business and Discover’s business model allows for a considerable amount of synergies in terms of increased interest margins, wider geographical reach as well as reduced operating overheads.

Our analysis values Discover at nearly $20 billion – close to its current market cap. We would allow for as much as a 10% increase in this value from faster growth in the loan base, besides improved margins and costs from a potential acquisition. That would make the Discover acquisition for Wells Fargo a profitable one, provided the going price is kept below $22 billion.

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  1. Wells Fargo a Logical Buyer of Discover – Analyst, NASDAQ, Sep 5 2012 [] []
  2. Market Share By Credit Card Network, CardHub []
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