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Discover Financial Services this week announced plans to buy the Diners Club International brand and franchisor network from Citi for $165 million in cash as it expands its payment network beyond the United States.
Discover, which said it expected the acquisition to close within 90 days, would gain the Diners Club International network with more than $30 billion in charge volume outside North America, the Diners brand, trademarks, employees and agreements with 44 network licensees, which issue cards and maintain an acceptance network of more than 8 million incremental merchant and cash access locations in 185 countries. Discover said it intended to strengthen the brand, but integrate the networks during the next two or three years to offer cardholders global interoperability.
Discover also would garner more than 80,000 commercial card accounts--a market it never tried to reach. Discover in June 2006 introduced a small business card and one designed to reward frequent travelers, but it offered nothing to larger corporate businesses.
Citi would secure needed cash and retain ownership of 13 of 44 Diners licensee territories, including the United States, Canada, Europe and Japan. "They are certainly the largest by volume. By far, it is to remain the largest of the franchisees," Discover CEO David Nelms said of the long-term contract with Citi during an analyst briefing on the deal Monday. Excluded for now, the Diners Club assets and employees in France are expected to be included in the Discover acquisition shortly, the companies said.
But Nelms left little doubt that global expansion was the prime motivator for this deal. "It represents a unique opportunity for Discover to move systematically and predictably toward global acceptance of Discover Network cards at an attractive level of investment," he said. One analyst asked Nelms if this was a game changer for him: "Absolutely," he replied. "It changes us from a regional network to a global network; it opens up additional opportunities. When asked about acceptance in the past, I've said completing our new strategy to fill out U.S. and North American acceptance is Job 1, it's not that global acceptance wasn't important, it just wasn't particularly achievable at a reasonable cost and timeframe until now. This changes all that."
Discover on March 31 completed the sale of its money-losing United Kingdom credit card business, Goldfish, to Barclays Bank Plc for $70 million. Barclays acquired the portfolio of 1.7 million Goldfish and affinity card accounts and $3.9 billion of receivables as Discover reported a loss on discontinued operations of $158 million in the first quarter. Last year, it wrote off $391 million on the international segment after a review that began in August found that operating costs were greater than fair value of that business.
Once the Diners acquisition closes, Discover said it would begin to integrate during the next two to three years the Diners and Discover payment networks to allow Discover cardholders to use their cards on the Diners network outside North America and Diners cardholders to use their cards on the Discover network in North America. Even after the investment, Nelms said he expected the Diners acquisition to add $10 million to $15 million a year in profits to the Discover bottom-line.
"Had we owned Diners in 2007, on a business as usual basis, it would have generated over $75 million in incremental revenue for the payment segment," Nelms said. Discover also expected to "increase our third-party payments volume by about 30 percent and our revenues by about 60 percent," he added. The higher spending volume, higher-cost travel and entertainment transaction fees and increased currency conversion fees are all seen as a boon to Discover's network financials.
In the United States, Citi in 2004 co-branded the Diners Club card with MasterCard to process most of the transactions on that network. While that relationship is expected to continue for U.S. cardholders, Nelms said that transactions of international cardholders in the United States would transition to the Discover network over the next two to three years. A Discover spokesperson said that after the transition, such transactions would process on the Discover Network.
Citi has revealed little about its Diners assets or investments in recent years. But since the company--then called Citibank--acquired Diners in 1981, industry analysts have noted the substantial revenues generated from the franchisee fees and royalties. In 2005 financial reports, Citi reported that it "repositioned its Diners Club business in EMEA." In 2003, then known as Citigroup, it said it acquired the "remaining stake in Diners Club Europe, adding 1 million accounts and $0.6 billion of receivables."
Discover's acquisition of Diners is one of contrasts. Founded in 1986, Discover is the youngest card issuer and network; Diners is the oldest founded in 1950. Discover is issued only in the United States and accepted in few places outside; Diners is issued and accepted in more than 185 countries, but is actually stronger outside the United States. Diners offers specific card programs for travel and entertainment, group meetings and procurement and offers ghost card programs, while Discover's offerings all involve plastic on a consumer card platform.
Discover's deal for Diners was announced just days after American Express on March 28 completed its $1.1 billion cash acquisition of GE Money Corporate Payment Serviceswith 2.5 million MasterCard commercial cards and a patented electronic payment and settlement tool.
It's clear that payment will remain in the headlines this year: Discover in financial reports said it expected no later than this fall the trial to begin on lawsuits it filed against Visa and MasterCard to seek "substantial damages for the market foreclosure caused by their anticompetitive rules." The lawsuits were filed in 2005 after the U.S. Department of Justice prevailed in the antitrust litigation that challenged the exclusionary practices of Visa and MasterCard. Discover since 2005 has incurred more than $101 million in legal expenses on the suit and said the 2008 costs would be "slightly lower than 2007 expenses" of $42 million. The courts had ruled that Diners couldn't sue for damages in this matter.
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