Morgan Stanley's decision to spin off its Discover Financial Services LLC unit advances the emergence of a new breed of independent, pure-play payments companies.
It also may finally consign credit card-wealth management pairings to the financial industry's scrap heap of failed synergies.
Discover's chief executive David Nelms said that independence will give its issuing business more latitude to make partnerships and the company as a whole new flexibility to expand abroad. On the negative side, he said that separating from the New York investment bank would drive up Discover's cost of funding.
Overall, he predicted little in the way of directional change. "To a large degree the strategy will stay the same as we become an independent company.
"We never claimed that we were planning to do lots of cross selling between wealth management and Discover," he said. "What we see are great opportunities in the payments and card space ... and that may not be totally unlike what American Express concluded when they decided they were going to focus more exclusively on the cards and payments business as well."
American Express, a New York charge card giant, spun off its Ameriprise Financial Inc. financial planning unit in September 2005.
Chris Blum, a research analyst at Edward D. Jones & Co. LP, said the fact that few synergies exist between credit card companies and brokerages was worsened by the divergent mix between Morgan Stanley's high-net-worth wealth management clients and the less valuable demographic that makes up Discover's core customer base.
"The brand is such, and the businesses are such, that the synergies are not there," Mr. Blum said. "If you're a high-net-worth customer, are you going to be pleased carrying a Discover card in your wallet? Is that what you're looking for from your financial organization? The answer is 'probably not.' "
Edward Neumann, the managing director of the banking practice at CC Pace, a financial services consulting firm in Fairfax, Va., said that the investment bank "never integrated Discover into the larger Morgan Stanley." The two operations "never seemed to be a good fit," he added.
Mr. Nelms said that separating from Morgan Stanley would help Discover pursue partnerships, a strategy it has already adopted. The card company has long been known for handling its own merchant acquiring, but this year it has announced several acquiring alliances, with companies including U.S. Bancorp's Nova Information Systems, First Data Corp., and Total System Services Inc.'s TSYS Acquiring Solutions. The alliances are meant to boost the number of merchants that accept Discover cards.
"We've been finding a lot of partners," Mr. Nelms said. "I think it makes that much easier to do when you are your own company."
He also said that a spinoff could help Discover's international ambitions. Discover has announced important deals with foreign payments companies in the past two years, including acceptance partnerships with the Japanese issuer JCB Co. Ltd. and the Chinese card network China Union Pay. Mr. Nelms said that he expects international business "to become a larger share of Discover" after the spinoff.
Without the backing of the investment bank, Mr. Nelms said, he expects the card company will have to spend $85 million to $95 million more per year to get funding, though he hopes to find ways to offset this. "We'll lose that synergy," he said. "But on the other hand, we see opportunities to reduce some expenses."
The spinoff announcement came as part of Morgan Stanley's yearend financial results. Discover reported pretax income of $1.5 billion for the fiscal year ended Nov. 30, up 72%, on record revenue of $4.3 billion, up 24%.
In the fourth quarter, it generated pretax income of $199 million, up 206% from the year earlier, on revenue of $963 million, up 39%.
Morgan Stanley also reported record results for the year. Its income was $7.5 billion, up 44%, and revenue was $33.9 billion, up 26%.
Though strong, Discover's fourth-quarter numbers were down from the third quarter, when the unit reported income of $368 million, on revenue of $1.05 billion.
Mr. Nelms said the drop was mainly due to the waning influence of last year's tough new bankruptcy law. "None of us expected bankruptcies to stay as low as they have in this country," he said. "They should return closer to more normal levels over time."
Morgan Stanley considered spinning off Discover in the summer of 2005, as part of a management shakeup that had John J. Mack coming aboard as chairman and CEO to replace Philip Purcell.
Mr. Mack said during a conference call with analysts Tuesday that, at the time, the company "was really in turmoil, and Discover was one of our best businesses."
But both Discover and Morgan Stanley's other units are thriving, he said. "I think both Morgan Stanley and Discover can go on their own."
"Discover has made significant progress in growing acceptance in its strong U.S. card business," Mr. Mack said. "It has expanded its international presence. It has laid a strong foundation for expanding payments and debit business. This is a promising asset, given the market interest in payments companies."
And with MasterCard Inc.'s initial public offering in May and Visa U.S.A.'s announcement that it would follow suit, the Discover spinoff plan comes at a time when the markets are clearly receptive to publicly traded card networks.
Mr. Nelms said that the success of MasterCard's IPO did not go unnoticed. The Purchase, N.Y., card company's shares debuted in the $40 range but are now trading above $90.
"Certainly one of the considerations is the fact that we do think we will be well received by investors," he said. "To some degree investors have not had that many options for investing in the payments business and card business. We are going to be providing them with another great investment option."
Tony Hayes, the managing director of Dove Consulting Inc.'s financial services practice, a division of Hitachi Consulting, said there would be "no downside" for Discover.
The company will get "direct access to the capital markets and can use that to acquire its own companies and invest in other deals," he said. "They will not have to compete for capital with other parts of Morgan Stanley."
