Discover Spin-Off Adds a New Pure Play to Credit Card Sector

Leadership at investment bank Morgan Stanley had a change of heart regarding its Discover Bank credit card unit. The company announced yesterday as a part of its earnings release that it would spin off the business in 2007. The market reacted mostly positively to Morgan’s news, as the company indicated it is sufficiently strong from a financial perspective to do well without needing the cash that Discover provides. Moody’s Investors Service seemed to back that view, as it reaffirmed its rating on Morgan Stanley, but it had a less sanguine view of Discover as a standalone company, indicating it might cut the rating on Discover.

The business has long been considered a rather unattractive #4 among the top credit card brands in the industry. Discover doesn’t have the cache of charge card leader American Express, nor of credit card giants MasterCard and soon to be public Visa. Indeed, Discover — though a worthwhile financial contributor to Morgan Stanley — has continued to give up market share to its larger rivals over the years.

Does the imminent standalone status of Discover change much for the industry? Not really. Analysts expect that Discover will become somewhat more aggressive in the pursuit of growth once it is on its own, but it is not as though the industry suddenly has a new competitor on the block. If the success of the MasterCard IPO is any indication, the market has shown it has a hankering for credit card stocks, but Discover’s debut as a separate company could coincide with a downturn in credit quality that might diminish investor appetites. That, along with its so-so brand recognition, means the firm isn’t the best armed to be taking on its rivals more aggressively.

Interestingly, the spin-off of Discover raises the question of how long it will be on its own. We don’t see a premium rival like Amex or MasterCard buying Discover, but it could be of interest to a major issuer with whom it would make a better fit than it did at Morgan Stanley. America’s leading banks are all interested in adding new accounts, and if Discover is looking value priced, any one of them might be compelled to swoop in for the business. We’ll keep an eye on that as the spin-off nears; as for the implications for rivals, we don’t see Morgan’s decision causing a material change in the industry landscape.

American Express is a Bull Market Report Recommended List stock. No member of The Bull Market Report editorial staff contributing to this article has any long or short positions in any company mentioned. Indie Research has a disclosure policy.

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