Merchant Support Bolsters Discover

  Morgan Stanley's recent announcement that it plans to spin off its Discover Financial Services unit leaves the company's future ownership unclear. But the legal and marketing victories of 2004 positioned Discover well for growth in 2005.
  Last October, the U.S. Supreme Court refused to overturn lower court rulings to allow member issuers of Visa and MasterCard to issue other cards as well, including Discover cards. "It really opened up a whole new world of opportunities for Discover to participate in the payments business," says Roger Hochschild, Discover president and chief operating officer.
  Discover soon after the Supreme Court decision cozied up to the world's largest merchant, Wal-Mart, and GE, the nation's largest provider of store card programs, when the three came out with a co-branded card in February. They expanded their relationship in March with the launch of two Sam's Club cards, one for business and one for consumers. Both carry no annual fee and offer up to 2% cash back on purchases.
  The deal marked Discover's first offering of a business card, which includes a $1 million spending limit and itemized billing statements for Wal-Mart and Sam's Club purchases.
  Discover also grew its acceptance base with KinderCare Learning Centers, Dollar General Corp. and other smaller merchants, bringing the total number of locations that accept Discover cards to more than 4 million, a Discover spokesperson says, declining to provide specific location data.
  Discover's relatively low interchange rate has won favor with merchant groups such as the National Retail Federation, particularly in the wake of Visa's and MasterCard's rate increases in April. The federation now promotes Discover's acceptance to its members.
  Discover seized the opportunity to enter the debit market when it closed on a $311 million purchase of the Pulse electronic funds transfer network in January. Pulse, which is supported by 4,100 members, mostly small financial institutions, is the nation's third-largest PIN-debit network.
  Consumers spent $99.6 billion with Discover cards in fiscal ended Nov. 30, up 1.7% from $97.9 billion in fiscal 2003. The company continued to tidy up its portfolio, dropping its 30-day delinquency rate to 4.55% of managed loans at the end of the fiscal year. The 2004 rate was 23.8% lower than in the previous fiscal year, when the delinquency rate was 5.97%. The net chargeoff rate in 2004 was 6%, down slightly from 6.6% in 2003.
  Receivables totaled $48.3 billion in fiscal 2004, almost the same as they were in 2003, when receivables totaled $48.4 billion. The number of active accounts dropped to 19.7 million, down 5% from 20.8 million the previous fiscal year. At the end of 2004, Discover had 46.2 million cardholders, virtually unchanged from 46.1 million in 2003.
  The company's 2004 pretax earnings were $1.27 billion, a 16.5% increase over last year's $1.09 billion. Net revenues were $3.6 billion in 2004, up 6% from $3.4 billion in 2003.
  Discover's improved portfolio helped fuel months of rumors that Morgan Stanley was preparing to sell Discover. In April, the blue-chip investment firm announced its intentions to spin off the middle-market card company, sparking a requisite flurry of speculation about whether Discover would really become a standalone company or be bought up by someone else (see CardWatch, page 6).
  Hochschild says the company's wins of 2004 led Morgan Stanley to believe that Discover would fare better as an independent. "It was probably the most significant year in Discover's history since it was launched," he says. "The momentum that happened in 2004 is why the Morgan Stanley board felt that the value of Discover was not being adequately recognized in the Morgan Stanley stock price and asked management to pursue spinning off Discover."