Credit cards are a
trillion dollar industry.
In 2018, they were swiped nearly
45 billion times, paying for
products and services worth just
under four trillion dollars.
Americans owe around one point one
trillion dollars in credit card
debt, about five thousand
seven hundred dollars each.
The US consumer is
doing very, very well.
Strong consumer sentiment, strong
retail spending, very low
unemployment. All of those things are
great for the credit card
industry. Giants like MasterCard, Visa
and Amex dominate the network
market. Chase, Citi, Amex and Capital
One are the biggest issuers.
A quiet but a steady and
perhaps lesser talked about competitor is
Discover. We're not one of the
companies that's always out there
talking about how great we are.
The number one performing stock of all
financials in the S&P for a 10
year period is not
just an average company.
Discover has the 10th largest credit
card portfolio in the world,
despite a smaller footprint
outside of the U.S..
Still, there are 57 million
Discover cards out there.
It's not really for the kind of
people that want to fly first class
to the Maldives. Discover really is
kind of for the masses.
When you think about the average
consumer and likely where they
borrow and what their FICO scores
are, I think that they're right
smack in the middle
of all these issuers.
The Discover credit cards
topped the J.D.
Power Customer Satisfaction
Survey in 2019.
So how did they win
over the American middle class?
To understand the credit card industry,
it's important to know the
difference between a credit card
network and an issuer.
The network is basically the digital
rails on which transactions are
processed. A card issuer is the
company who actually takes on the
credit risk. Discover and American Express
are both an issuer and a
network. That gives them some
diversity in their business model.
It also gives them a really stable
source of revenue, at least from
the processing side.
Very different from the credit side
of the equation where that could
be a lot more profitable if they're
charging you 18, 20, 25 percent
interest. But there's
also risk there.
And it's also less predictable in
terms of the transactors and the
revolvers. You know, people who are
paying their bills in full or
people who carry debt
from month to month.
Forty percent of
Americans are transactors.
60 percent carry debt
from month to month.
We spoke with Discover CEO
Roger Hochschild over the phone.
Our model is lend focused.
We're looking for people and we make
most of our money from people
who borrow money. American Express' model
is much more spend focused.
For issuers American
Express and J.P.
Morgan Chase interchange the top two
slots on purchase volume and
outstanding debt.
Citibank, Bank of America and Capital One
fill up slots 3 to 5.
Discover is sixth.
The Discover credit card was launched
in 1986 by Sears Roebuck, the
largest retailer at the time.
Back then it was part of Dean
Witter, which was part of Sears, and
they launched during
Super Bowl Twenty.
They had this commercial back
in early nineteen eighty six.
They talked about the dawn of
Discover and they really pioneered two
main categories cashback and
no annual fee.
Sears wanted to expand into financial
services and decided to accept
only this year's Discover
card at its stores.
Many merchants actually viewed them as
a threat and they thought that
accepting a Discover card meant they
were helping their rival Sears.
So that actually really led to a
lot of hesitation and difficulty for
Discover establishing itself.
In 1993, Dean Witter Discovering
Company became a publicly traded
company when it spun
off from Sears.
Sears eventually filed for
bankruptcy in 2018.
But that's another story.
In 1997, Dean Witter Discovering
company merged with Morgan Stanley.
The mid 2000s were eventful for
Discover and the barrier to entry
didn't end at Sears front door.
MasterCard and Visa were established
in the industry and Discover
wanted in. In 2004, the Supreme
Court upheld a ruling in Discover's
favor. Discover claimed that MasterCard
and Visa had harmed its
business by preventing their member
banks from issuing credit cards
from the Discover Network.
They did everything they could,
including reaching out to merchants
to tell them that taking
Discover would help S ears.
After the Supreme Court ruling
Discover's business started taking
off. G Consumer Finance Wal-Mart and
Sam's Club became card clients
and pulls a debit card network was
acquired with more than 50 million
cardholders, the company had
become a major player.
In July 2007, only six months
before the Great Recession, Discover
severed ties with Morgan Stanley and
started trading on the New York
Stock Exchange as DFS.
We just set up or our
finance department our treasury function.
Luckily, we had a heritage that goes
all the way back, the Sears are
being conservative lenders.
In the midst of the downturn
t he company received welcoming news.
Visa and MasterCard paid Discover nearly
$3 billion in damages after
finally settling the lawsuit.
Discover strategy remains simple charge
no annual fee, offer simple
rewards like cashback, conduct all
business online 24/7 u.s.-based
customer service and acquire and keep
the customers who will revolve
a balance every month.
There is a relentless focus here at
Discover on a limited set of
businesses. You compare us to most other
banks that are big in credit
cards the've got commercial real estate
, they have small business
lending. We're focused
on consumers.
That consumer is a prime borrower.
81 percent of Discover's customers have
a FICO score of 660 and
above. Competitors like American Express
caters to a more affluent
customer base with a higher average
FICO score and Capital One serves
subprime borrowers with an average
score below that of Discover's
customers. We might be more like
Toyota and American Express, maybe
more like Mercedes.
I would say the typical Discover
customer is probably a little bit
more likely to be middle class or
even lower middle class, maybe more
likely to be a parent, maybe more
likely to live in middle America.
You know, we're not necessarily
talking about the affluent urban
professionals that are more likely to
gravitate to, let's say, an
Amex card or a chase card.
According to the J.D.
Power Customer Satisfaction Survey, Discover
has been voted number
one every year since 2014,
except for in 2017.
It's very difficult in this stage of
the game in the United States in
a very mature market to grow
your business because so many people
already have a card.
But it's doing a really, really good
job of keeping the customers it
has very satisfied with with
the value proposition that it's
offering. I think sometimes these airline
mile cards get a lot more
attention because that's just a
sexier kind of redemption, right?
It's first class airport lounge,
all that fancy stuff.
The fact is, though, we found that
about two thirds of credit card
rewards chasers prefer cashback.
Discover's balance sheet, reflects the
companies improving finances s
ince the 2008 recession.
The investors that are here looking
for, you know, high capital
return, I mean, they've been roughly
around that 70 percent plus
payout to investors through
dividends, share repurchases.
And so it's about
having a high R.O.T.C.E.
Having a very stable
but growing business model,.
Maybe it's the Midwest heritage, we're
not one of those companies,
that's always out there talking
about how great we are.
And there are others who
do much more of that.
But the last few years haven't stocked
up for the Discover stock in a
one year and a
five year comparison.
It underperformed that of the
S&P 500 and multiple competitors.
On January 24, 2020, a day
after the company's earnings call the
stock fell by 11 percent, the most
it had done in 10 years.
It was announced that their share
of high risk customers, something
called troubled debt restructurings, increased
by nearly 50 percent,
something that has
worried investors.
In an email to CNBC, the
Discover CEO Roger Hochschild said the
market and individual stock prices can
be volatile from time to time.
Our focus is on continuing to build
the long term value of the
Discover franchise, which we believe will
be reflected in a stock's
valuation over time.
Data show that younger generations
aren't as enthused about credit
cards, and though people as a whole
spend more and more on credit
cards, revolving debt has declined nearly
every year in the past two
decades, potentially hurting companies like
Discover, who depend on
finance charges.
If you want to continue to talk
to your shareholders and give them a
successful story, you're gonna have to
come up with something that's
going to look better than
just steady as it goes.
It would not be surprising if in
time we see Discover either making
an acquisition through merger with
another credit card issuer or
being acquired by somebody bigger.
In this day and age, it's hard to
know what's going to happen, but I
would say, we have
a complete business model.
We're strong on both sides of the
balance sheet, if you think about
our lending products, but
also our deposit products.
So I feel very good
about how Discover's positioned.
