Since its spinoff from Morgan Stanley in 2007, Discover Financial Services (NYSE:DFS) has done very well for its shareholders recently, having rebounded from its financial crisis low of $4.73 to its current level of just under $40. However, with slow growth expected over the next few years, should investors cash in and take their profits, or does the number four credit card issuer have an ace up its sleeve to boost profitability and shareholder value?
Discover Financial Services (Discover) is primarily known as a credit card issuer, but also banking services such as savings accounts, CD’s, and personal and student loans. Discover Financial Services (NYSE:DFS) operates through two segments, Direct Banking and Payment Processing, with Direct Banking accounting for the majority of revenue (95%).
Speaking of which, acquisitions and partnerships have been major parts of Discover’s growth strategy over the past few years. In addition to Diners Club, major acquisitions include the Student Loan Corporation in 2010, which gave Discover an established student loan platform as well as an established relationship with the schools.
About a year ago, Discover revealed its plans to shift its focus to direct banking, offering more traditional banking services to consumers. Its credit card network gives it a unique direct marketing opportunity for its other banking services, which I think will give the company an advantage in implementing new services. For example, Discover began its home loan business this past year, originating conventional and FHA mortgages. Through its credit portfolio, Discover should be able to produce quality leads to build and maintain a mortgage portfolio of high credit quality.
As far as partnerships go, I am very curious to see how the “mobile wallet” partnership between Discover and eBay Inc (NASDAQ:EBAY) plays out. The two companies announced a deal last August that would extend PayPal’s (owned by eBay Inc (NASDAQ:EBAY)) services to 7 million merchants on Discover’s payment network. This is absolutely huge. Think of how many people you know who use PayPal. All of those consumers will be able to use their PayPal accounts to make payments at retail stores that accept Discover cards starting in April of this year. In my opinion, this could make Discover’s Payment Processing segment a major profit source for the company. We’ll just have to wait and see how well it catches on…
Because of the relatively slow growth rate analysts are calling for, Discover trades at a seemingly low valuation of just 8.7 times earnings. I personally think that Discover stands more to gain from the PayPal deal than the market is anticipating, and I believe that earnings will grow accordingly. Discover has also proven to be a very shareholder-friendly company through buybacks. In fact, the number of outstanding shares has declined from 548.8 million in 2010 to 497.5 million currently, a reduction of 9.3% in just over two years.
