n April 4, 2005, investment banking firm Morgan Stanley announced plans to "spin off" its Discover Financial Services division, which includes the Discover card and Discover network. As a result of the spin off, Discover will be a separate company owned by Morgan Stanley shareholders.

Discover is among the largest credit card issuers in the United States, with more than 50 million card members and $48 billion in managed loans. It also has the largest proprietary U.S. merchant network, with more than 4 million merchant and cash access locations, according to the company.

Discover reported an estimated $1.3 billion in profits (20% of Morgan Stanley's net revenue) for the last fiscal year.

Beth Metzler, Discover's Director of Corporate Communications, said the time is right for Discover to be on its own. "We feel that as a stand-alone company, we could compete and win in the credit and payments business."

Over the next three to six months, Morgan Stanley management will research the best possible avenues for the spin off. Metzler said the company is considering two different paths, but she could not comment on them.

"The management at Morgan Stanley will research the best possible action and report back to the board," Meltzer said. "When it does happen, Discover will be a stand-alone company with its own staff, management and Board, and issue its own stock."

Philip J. Purcell, Morgan Stanley's Chairman and Chief Executive Officer, said one of the reasons for the spin off is to allow shareholders to maximize value in the Discover Card division by capitalizing on "the momentum, both in performance, and in the opportunities opening up in the payments market."

On February 1, American Express Co. (AmEx) announced plans to spin off its financial advisors unit. The company will do this to focus on its card payments and network processing businesses, AmEx Chairman and CEO Ken Chenault said.

The growing market opportunities for these card brands stem from an October 2004 U.S. Supreme Court refusal to hear an appeal from Visa U.S.A. and MasterCard International in the six-year-old antitrust suit AmEx and Discover brought against the card Associations.

AmEx and Discover claimed Visa's and MasterCard's rules, which prevented member banks from issuing other card brands (like AmEx and Discover), violated antitrust laws (see "Supreme Court Decides Against Visa, MasterCard in Six-year Antitrust Suit" The Green Sheet, Oct. 25, 2004, 04:10:02).

In order to compete as card issuers, AmEx and Discover have operated what is called a "closed-loop network." Acting as their own acquirers, they sign up merchants themselves, issue cards directly to customers and process the transactions. (Both Discover and AmEx have built their card customer base from the ground up. Discover has targeted lower- to middle-income consumers, while AmEx has pursued a smaller, yet more affluent market.)

But with the Supreme Court's decision, which effectively breaks down the barriers between bankcard issuers and Discover and AmEx, this is all changing. In November 2004, MBNA Corp. began issuing AmEx cards. A month later, Citigroup Inc. also agreed to begin issuing AmEx cards.

In January 2005, Discover inked a deal with issuer General Electric Consumer Finance and Wal-Mart Stores Inc. to provide Wal-Mart- and Sam's Club-branded credit cards.

"The Supreme Court decision will make Discover a much stronger competitor as an independent company," said Robert Dodd, an analyst with investment firm Morgan Keegan. "They will be much more aggressive in [obtaining] share from the card Associations. As an independent [company], they will be more of a threat to Visa and MasterCard than the actual issuers."

However, Discover is an attractive candidate for acquisition with its large profits, ownership of PULSE EFT Association, which processes debit transactions for 4,100 small banks and credit unions (Discover acquired PULSE in January), and recent partnerships with card issuers.

According to Dodd, Morgan Stanley's spin off of Discover will have very little impact on the market. He said Discover will continue to be aggressive in obtaining other issuers, which means more opportunity for processors.

A shakeup, however, would occur if an issuer purchases Discover. Since Discover processes its own transactions, a bank's ownership of Discover could circumvent the need for outside transaction processors.

In equity research group Thomas Weisel Partners LLC's April 8, 2005 "Financial Products Update," analyst Mark Sproule said the most widely speculated purchaser of Discover is Bank of America Corp. (BofA).

BofA "would be able to utilize the 54.4 million cardholders to cross-sell numerous other products as well as expand the network by issuing its own Discover cards," Sproule wrote.

Sproule added that BofA would also "likely be able to dramatically expand the number of outlets that accept Discover."

Speculations on other potential buyers include First Data Corp. and even Wal-Mart, which has wanted to break into the banking and financial services industries for years. Estimates on shareholder earnings for the sale of Discover are as high as $9 - $10 billion.

According to Dodd, there are many theories about who will buy Discover and when a sale might occur. However, Dodd said, "I suspect for tax reasons that Discover will not be bought by anyone new. I doubt that First Data or even Bank of America will buy."

Timeline

October 2004:

• Supreme Court decision opens up opportunities for Visa and MasterCard member banks to issue American Express (AmEx), Discover and other third-party card brands.
• Discover files suit against Visa and MasterCard for damages stemming from antitrust violations.

November 2004:

• Discover announces plans to acquire PULSE EFT Association.
• MBNA Corp. begins issuing AmEx-branded cards.

December 2004:

• Citigroup agrees to issue AmEx-branded cards.

January 2005:

• Discover closes acquisition of PULSE EFT Association.
• Discover partners with GE Consumer Finance and Wal-Mart to issue Wal-Mart-branded cards.

February 2005:

• AmEx announces plans to spin off its financial advisors unit and focus on the card business.

April 2005:

• Morgan Stanley announces plans to spin off Discover.