Why Discover Is Friending Facebook and PayPal

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Discover's (DFS) recent agreement to be the network behind Facebook's (FB) new gift card suggests the company is plowing ahead with plans to, well, friend innovative companies.

The Riverwoods, Ill., company is intent on leveraging its network to bring what have strictly been online businesses into the real world, says Diane Offereins, Discover's president of payment services. Facebook is just the latest example.

In August, PayPal (EBAY) announced that it would extend its reach through Discover's network and give consumers direct access to its mobile wallet at more than seven million American retailers. That plan is set to go into effect sometime this spring.

Discover was an early partner to Isis, the telecom consortium for mobile payments. And, at one time, there were even rumors that the company was working with Google to create a card for the search engine giant's digital wallet.

"We are staking out a position where we feel where we have very unique assets and we are going to use them with partners," says Offereins.

That could mean moving beyond just tech companies, and perhaps working with groups of merchants.

There is a real possibility that the Merchant Customer Exchange, the joint venture between retailers that is working with banks to provide a retailer-friendly digital wallet, could begin working with Discover, says Wedbush analyst Gil B. Luria.

Merchants "see Visa, MasterCard as the enemy," he says. "Discover isn't as much of an enemy. That could go in a lot of different ways. One of the ways it could go is they could try and leverage Discover's network to better compete."

The possibilities for those partnerships, Offereins says, are endless.

Indeed, while Discover isn't desperate for business, it is hell bent on growing.

"Discover has an incredible valuable asset, it has one of the only four networks that is connected to most merchants," says Luria. "And it's being underleveraged right now, because their market share is relatively low and they know it. So they are going enter into these partnerships; without having to invest in anything additional they can get more volume." These deals aren't the only way Discover wants to expand its business.

For instance, in December, the company said it has plans to begin offering a checking account this year, but offered few details on a fourth quarter earnings call with investors.

"I think the online bank strategy is a very sound one," says Sanjay Sakhrani, an analyst with Keefe, Bruyette & Woods. "Historically they really relied on broker deposits, which are more expensive and less dependable. There is a secular trend toward online banking and direct banking, so I think it makes sense. It also helps promote their brand, which is kind of similar to what they are already doing."

Still, Discover's position as the smallest of its small group of peers could make it more willing to work with others that Visa (V), American Express (AXP) or MasterCard (MA) might scoff at.

"Discover is a kind of fourth network out of four networks, in an environment where the networks are feeling a bit of pressure," says Ron Shevlin, a senior analyst at Aite Group. "Discover has to find a way to get cards into the hands of more people, get top of wallet and drive purchase volume. They will enter into lots of different partnerships that will help them do that."

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