Wall Street Discovers a New Darling: Payment Card Networks

Less than a year ago, the only publicly traded payment card network stock was that of American Express Co. With Tuesday's announcement by investment-banking giant Morgan Stanley that it will spin off its Discover Financial Services LLC unit, the No. 4 network, there could be four. MasterCard Inc.'s May initial public stock offering is widely regarded as a success, with the share price having more than doubled. Visa, meanwhile, has drawn investor kudos for its recently announced plans to reorganize and do an IPO in a year to 18 months (Digital Transactions News, Oct. 11). “Given the record results and significant momentum both in our securities business and our cards and payments business, we have concluded, after our most recent strategic review, that they can best execute their growth strategies as two stand-alone, well-capitalized companies with independent boards of directors focused on creating shareholder value,” Morgan Stanley chairman and chief executive John J. Mack said in a statement. “The spin-off will allow Discover to continue building on its strong brand and significant scale. We also believe the spin-off will unlock considerable value for the shareholders of Morgan Stanley.” “I absolutely agree with that,” says consultant and former Discover executive James D. Higgins, now head of Hoffman Estates, Ill.-based Jim Higgins & Associates Inc. Higgins was a member of the original Sears, Roebuck and Co. team that developed Discover as a general-purpose credit card that was launched nationwide at the January 1986 Super Bowl. Besides running with a favorable Wall Street wind, Riverwoods, Ill.-based Discover will escape the culture clash that has been present ever since highbrow Morgan Stanley in 1997 bought the former Dean Witter, Discover & Co., an amalgamation of consumer-oriented brokerage, credit card, and other financial businesses that Sears spun off in 1993. “There was always a question of a strategic fit for Discover Card, which was considered a downscale consumer product,” says Higgins. An independent Discover also might be able to better leverage its network of 4 million-plus acceptance locations, adds payments consultant Allen Weinberg, managing partner at Glenbrook Partners LLC, Menlo Park, Calif. “The value of the network is tremendous,” he says. Discover has strengthened its network muscle over the past two years by buying the Pulse EFT network and striking deals with entities such as General Electric Co.'s GE Money unit, which issues a Discover-branded card for Wal-Mart Stores Inc. Discover also is signing banks to issue debit cards and merchant acquirers to offer Discover acceptance to small and medium-sized merchants. The spin-off represents a reversal of recent Morgan Stanley strategy. The company had considered selling Discover once before under former chief executive Philip J. Purcell, who resigned under pressure in 2005, but Mack took the idea off the table after assuming his post. Morgan Stanley reported Tuesday that Discover recorded fiscal 2006 charge volume of $96.6 billion, up 12% from $86 billion in fiscal 2005. Discover, which has about 50 million cardholders, is generating 1.4 billion transactions annually, while Pulse is doing 1.9 billion, according to a Morgan Stanley document. Total network volume was up 14% over nearly 2.9 billion transactions in fiscal 2005. Discover posted pre-tax earnings of $199 million for its fiscal fourth quarter ended Nov. 30, up from $65 million a year ago when earnings were depressed by a spike in bankruptcy filings. Segment revenues grew 39% to $963 million over $694 million in the year-earlier quarter. But when bankruptcy losses are excluded, pre-tax income actually declined by 19% because non-interest expenses rose 21%, twice the 10% increase in revenues. For the year, however, Discover posted record pre-tax earnings of $1.6 billion, up 72% from $921 million in fiscal 2005, on revenues of $4.3 billion, up 24% from $3.5 billion in 2005. Morgan Stanley said it hopes to complete the planned tax-free spin-off in 2007's third quarter.