Discover Financial

1
Discover Financial

• NYSE DFS

Phil Rosen Tim Tyson Xiaoting Yang Presented,
4-15-2008
2
Overview

• Macro Overview
• Industry Analysis
• Company
• Comparative and Banking Analysis
• Stock Performance
• Recent Events
• Recommendation

3
Macro Overview

• Unemployment
• Consumer Confidence
• Retail Sales
• Consumer Credit
• Housing Problems

4
Unemployment

• Upward trend since early 2007 (Current 5.1)

http//www.forecasts.org/unemploy.htm, Accessed
14 Apr 08
5
Consumer Confidence

• Dropped to 64.5 in March from 76.4 in Feb
• 25.4 Business conditions are "bad (Up from
  21.3)
• 25.1   Jobs are "hard to get" (Up from 23.4)

http//www.conference-board.org/economics/Consumer
Confidence.cfm, Accessed 14 Apr 08
6
Retail Sales

• Declining in recent months
• Recent Bankruptcies (LIN, SHRP)
• Stimulus Checks start getting mailed in May

7
Consumer Credit

• Consumer credit increased at an annual rate of
  2-1/2 percent in February
• Revolving credit increased at an annual rate of 6
  percent

http//www.federalreserve.gov/Releases/g19/current
/, Accessed 14 Apr 08
8
Housing Environment

• Increased mortgage delinquency
• Rising foreclosures

9
Industry Analysis

• Different models operate in the industry

10
Discover vs Visa/Master Card
RCMP Presentation on DFS, Dec 2007
11
Company

• Spun off by Morgan Stanley June 2007
• Operations
• Discover Payment Network
• Pulse ATM Network
• Discover Bank

12
Discover Card

• Discover cards issued on Discover Network
• 6th largest issuer
• 47.5B receivables
• 105.9B total volume
• 3rd largest U.S. merchant network

Discover Financial Services Financial Community
Briefing Presentation, http//library.corporate-i
r.net/library/20/204/204177/items/284599/InvestorD
ay_032008.pdf, Accessed 14 Apr 08
13
Discover Financial Services Financial Community
Briefing Presentation, http//library.corporate-i
r.net/library/20/204/204177/items/284599/InvestorD
ay_032008.pdf, Accessed 14 Apr 08
14
Discover Financial Services Financial Community
Briefing Presentation, http//library.corporate-i
r.net/library/20/204/204177/items/284599/InvestorD
ay_032008.pdf, Accessed 14 Apr 08
15
Discover Financial Services Financial Community
Briefing Presentation, http//library.corporate-i
r.net/library/20/204/204177/items/284599/InvestorD
ay_032008.pdf, Accessed 14 Apr 08
16
Discover Bank and Insurance

• Offer typical bank savings products
• CDs
• Money Market Accounts
• Offer several insurance products
• Auto Insurance
• Homeowners
• Term Life
• Home Warranty

17
Revenue Streams
Problems Securitization of loans
Consumer loan defaults
18
Discover Financial Services Financial Community
Briefing Presentation, http//library.corporate-i
r.net/library/20/204/204177/items/284599/InvestorD
ay_032008.pdf, Accessed 14 Apr 08
19
Managements Outlook

• Continued rise in delinquencies and charge-offs
  (4.75-5.00 full year)
• Spreads should widen as cost of funds decreases
• Funding environment choppy ABS available, but
  remain at wider spreads
• Maintain lower balance transfer volumes/loan
  growth
• Maintain prime underwriting focus
• Remain conservative on liquidity and capital
• Aggressive focus on payments opportunities

Discover Financial Services Financial Community
Briefing Presentation, http//library.corporate-i
r.net/library/20/204/204177/items/284599/InvestorD
ay_032008.pdf, Accessed 14 Apr 08
Discover Financial Services Financial Community
Briefing Presentation, http//library.corporate-i
r.net/library/20/204/204177/items/284599/InvestorD
ay_032008.pdf, Accessed 14 Apr 08
20
Comps Analysis

• Only one close competitor (Capital One)
• Hard to develop a useful model

Stock Price based on Comps Analysis Using
P/E 11.33 Using P/Bv 8.91
21
Banking Analysis

• Rising Delinquency Rates (Domestic)
• 30 Days increased 7 in 2007
• 90 Days increased 10 in 2007
• Shrinking Net Interest Margin

(COF NIM 5.3 in 2007)
22
Loan Loss Allowances
23
Stock Performance
http//finance.yahoo.com/q/bc?t1ysDFSlonzm
qlcc5EGSPC, accessed 14 Apr 08
24
Recent Events

• Sold off Goldfish Division in Feb 2008
• Acquired Diners Club Company
• CEO Purchased 15,000 share on April 11th

25
Recommendation

• Sell 201 shares at the market
• Securitization Problem
• Rising Delinquency Problem
• Shrinking Net Interest Margin
• Consumer Spending

26
Appendix

• Diners Club
• Purchased for 165m in cash
• 2-3 years to integrate systems
• 10-15m in annual revenue expected
• DFS will not issue cards or service loans (Citi)
• Will promote Discover Card internationally
• Will allow use of either card on both networks

27
Appendix

• Gold Fish
• U.K.-based credit-card business
• Acquired 2 years ago for 1.7 billion
• Sold in Feb 2008 for 70 million
• Sold due to large loses and write downs