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What Does the Capital One-Discover Deal Mean for Visa and Mastercard Investors?

Motley Fool - Mon Feb 26, 6:36AM CST

On Feb. 19, Capital One(NYSE: COF) announced it would acquire Discover Financial Services(NYSE: DFS) in an all-stock transaction valued at over $35 billion. The move could make Capital One the largest credit card issuer in the U.S. and create greater competition for Visa(NYSE: V) and Mastercard(NYSE: MA), whose stocks fell following the news announcement. Here's what it could mean for investors in those companies.

Capital One could become the largest card issuer in the U.S.

Capital One provides its customers with various financial and banking services and is the ninth-largest bank in the U.S. The company's bread-and-butter business is issuing branded cards through Visa and Mastercard. It's the fourth-largest card issuer in the U.S., according to The Nilson Report.

This deal is turning a lot of heads, and for good reason. Capital One issues debit and credit cards through Mastercard and Visa, with its transactions running through their networks and earning them fees on every swipe. Meanwhile, Capital One holds on to this credit card debt and services these loans. The merger could make Capital One the largest credit card lender in the U.S., pushing it ahead of JPMorgan Chase, which currently holds that title.

In addition, it would provide Capital One with Discover's payment networks, including Discover Network, Diners Club, and Pulse debit network, which have struggled to compete with Visa and Mastercard for payment volume. If the deal goes through, Capital One could move its cards to Discover's network and create a closed-loop payment network that better competes with Visa and Mastercard.

Person in bar paying with card.

Image source: Getty Images.

This is where things get interesting with regulators. On the one hand, they have expressed concern about Capital One being the largest card issuer in the U.S. On the other hand, those same regulators want more competition from different payment networks to better contend with Visa and Mastercard, who they claim have a duopoly over payment processing.

According to data from The Nilson Report, Visa processed $11.6 trillion in payment volume in 2022, while Mastercard had $6.6 trillion. American Express had $1.5 trillion. In comparison, Discover's networks processed $243 billion, or only 2% of Visa's payment volume.

Here's how the deal could affect Visa and Mastercard

According to analysts with Morgan Stanley, Capital One's existing debit card portfolio is primarily Mastercard-branded, where it does about $100 billion in volume annually. In addition, it has about $75 billion in credit card volume between Visa and Mastercard.

Those analysts say that if Capital One were to move its volumes over to Discover, it would have a 0.2% effect on Visa and a 2.1% effect on Mastercard's payment volume. Any effect on Visa's or Mastercard's bottom line would likely be negligible.

The deal faces intense scrutiny from lawmakers

Before the Capital One-Discover deal can go through, it must face heavy scrutiny from lawmakers and consumer groups. For example, Senator Elizabeth Warren (D-Mass.) said that the merger "threatens our financial stability, reduces competition, and would increase fees and credit costs for American families," and asked regulators to "block it immediately."

In addition, Senator Josh Hawley (R-Mo.) said, "This merger will create a new juggernaut in the credit card market, with unprecedented powers to extort American consumers. That cannot be allowed to happen." With opposition from both sides of the aisle, the deal will likely face significant headwinds before any approval.

Here's what investors should do

The Capital One-Discover deal would be the fifth-largest bank merger in U.S. history. If it goes through, Visa and Mastercard would certainly feel some effects, although it wouldn't put too big a dent in their earnings. However, the deal has significant hurdles to overcome and its approval could hinge on election results in November, so a decision likely won't be made until later this year or 2025.

Investors should continue to monitor this deal. It could create an intriguing investment opportunity in the combined Capital One-Discover company. However, Visa and Mastercard investors shouldn't rush to the exits, as these companies will likely remain dominant players in the payment networks industry.

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JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Discover Financial Services is an advertising partner of The Ascent, a Motley Fool company. Courtney Carlsen has positions in Morgan Stanley. The Motley Fool has positions in and recommends JPMorgan Chase, Mastercard, and Visa. The Motley Fool recommends Discover Financial Services and recommends the following options: long January 2025 $370 calls on Mastercard and short January 2025 $380 calls on Mastercard. The Motley Fool has a disclosure policy.

Paid Post: Content produced by Motley Fool. The Globe and Mail was not involved, and material was not reviewed prior to publication.

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