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Discover Could Sell Payment Network to Unlock Value

"If we assume our premise that offline penetration is important and necessary, we wonder if one of the aspiring wallets might want more control of the network," Sakhrani wrote.

A tech player looking for more control of its mobile payments business could certainly make excellent use of Discover's payment processing networks, and even cut its risk by making partnerships with payment processors unnecessary. A potential buyer could also benefit by keeping competitors from using Discover's network.

"[W]e do not believe there is a whole lot of value being ascribed to the Discover network when considering the valuation of DFS shares and in a takeout scenario, [and] we believe DFS shares at this point in the cycle are worth a lot more than current levels," Sakhrani wrote. He estimated Discover's combined payment network, including Diners Club and PULSE, to be worth $3 billion to $4 billion, or $6 to $8 a share.

The big question for Discover is whether the payment network's value will be considerably higher as the mobile payment space develops, or whether this is the ideal time to sell. "The argument could be made that you can scale that network significantly more than they have," Sakhrani says, however. "the strategy they have embarked on hasn't materialized -- maybe someone else can take that strategy further."

When asked if Discover could still achieve its high double-digit ROE without the payment processing network, Sakhrani says "A big part of their profitability comes from their lending businesses, so probably. The idea over time as they grow out this business is that they should enhance the returns. To the extent they do something with the excess capital, that could be accretive as well."

In addition to the three companies above, Sakhrani believes Apple (AAPL - Get Report) could be a potential buyer, as could Microsoft (MSFT).

"Neither they [Microsoft] nor Apple have articulated a payments strategy, but the idea is that if mobile payments are the way we are going, and you own the phone or the operating system on the phone, you're a player in payments potentially.
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