Spinoff of Credit-Card Division May Challenge Visa, asterCard;
Some Experts See Hasty Decision
By ROBIN SIDEL
Staff Reporter of THE WALL STREET JOURNAL
April 8, 2005; Page C1
The web of fragile relationships that stretches across the credit-card industry may soon get even more entangled.
As Morgan Stanley prepares to divest its Discover Financial Services unit, the rest of the credit-card industry is assessing potential implications for the $3 trillion in plastic charges that are racked up each year by U.S. consumers and businesses. The move could have a wide impact on card associations such as Visa USA Inc., banks that issue cards and companies that process those transactions, such as First Data Corp.
"With the right people and the right funding, there are a lot of interesting things that Discover can do," says Duncan MacDonald, an industry consultant. "They can put a real scare into the other networks."
Earlier this week, Morgan Stanley said it plans to spin off Discover to shareholders, marking a reversal of the investment bank's longtime strategy to keep the business in-house. Details of the plan weren't disclosed and many analysts viewed the move as a hasty decision tied to recent management upheaval at the securities firm. The move immediately triggered speculation about a potential sale of Discover, or even a break-up of its two main businesses: card issuance and transaction processing.
While Morgan Stanley is intent on putting Discover in the hands of shareholders, each of those scenarios could further upset an industry already roiled by a slew of recent legal and competitive battles.
Long under the umbrella of the big investment bank, Discover, based in Riverwoods, Ill., hasn't been much of a threat to its competitors over the years. It ranks a distant seventh among U.S. card issuers and is widely thought of as a slow-growing business that issues cards for middle-of-the-road consumers who keep low balances. One of its biggest successes was a rewards program, launched in the late 1980s, that gave back cash to cardholders, but that has been copied by rivals. Its network that processes card transactions also has trailed competitors.
In recent months, however, Discover has been getting more aggressive. Much of its new-found boldness comes from the end of a long-running legal battle between the Justice Department and Visa and MasterCard International Inc., the two card associations that are owned by thousands of banks. As a result of the decision -- which allows banks that issue cards through Visa and MasterCard to also now work with Discover and American Express Co. -- competition has been thrown open in the industry.
So far, Discover hasn't snared any big banks as new partners. But it recently established relationships with 4,100 midsize banks when it bought Pulse EFT, which processes debit-card transactions for financial institutions.
At the same time, Discover is cozying up to merchants, many of whom are bristling at rising fees they must pay to accept Visa and MasterCard. The card associations and banks don't disclose the fees that they charge merchants, but Discover is widely known to be less expensive than Visa and MasterCard. Earlier this year, for example, Discover teamed up with Wal-Mart Stores Inc. to launch a credit card issued by GE Consumer Finance and cleared on the Discover network.
Roger Hochschild, president of Discover, doesn't anticipate major changes to accompany a spinoff. "It's not as if we were being held back" by Morgan Stanley, he says. "Discover on its own has what it takes to compete and win."
Still, if it stays on track to become an independent company, Discover is likely to soon come under shareholder pressure to fine-tune its strategy, says Gwenn Bézard, research director at Aite Group, a consulting firm.
"The main challenge Discover has is they are in a middle position," Mr. Bezard says, noting that Discover's efforts to woo merchants with lower fees is likely to upset the banks that it also is courting.
The prospect for a suitor to swoop in for the credit-card unit remains uncertain even though a number of financial institutions, including J.P. Morgan Chase & Co., Bank of America Corp., the consumer-finance arm of General Electric Co., and foreign banks, would likely be attracted to the business.
Part of the uncertainty stems from the large potential tax bill that Morgan Stanley would incur if it sells Discover outright. By spinning it off, Morgan Stanley would likely avoid that hit. Tax rules typically require a spun-off entity to remain independent for two years if the parent company wants the tax benefit from the transaction.
"Once the company stabilizes its funding profile and has a chance to operate independently and work on its strategic challenges, which include sub-par growth, we believe it, too, becomes takeover bait," wrote David Hendler, an analyst at bond-research firm CreditSights Ltd. in a report issued yesterday.
In addition to the tax implications, any purchase of Discover by a financial institution could raise anticompetitive issues. The Justice Department might not look kindly on a bank buying Discover's network and potentially closing it off to other banks. Also, Visa and MasterCard might not want one of their member banks to own a competing network. |
