Lately, all the headlines have been about acquisitions and stock buybacks -- headlines about companies (and huge chunks of companies) disappearing from the market into private or larger corporate hands.So when a big company spins off a smaller company, especially just before the market doldrums of the Fourth of July week, it doesn't get much fanfare. Such was the case when financial services giant Morgan Stanley ( MS) spun off the bulk of its Discover Financial Services ( DFS) to its shareholders on Friday, July 2. And little fanfare can mean lots of opportunity for the
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- Attractive niche: Discover appeals to a wealthier clientele attracted to the "cash back bonus" incentives of 1% or more, among other things. As a result, DFS is more immune to credit-risk issues and write-offs affecting the industry at large.
- Loyal customers: A recent study by industry service provider Cardweb showed Discover cardmembers hold their cards for an average of 8.6 years vs. a 6.2-year industry average. The 4.5% attrition rate is half the industry average. The lower customer churn keeps costs down and gives better opportunities to grow cardholders into more profitable customers.Discover also recently won the "Brand Keys" Customer Loyalty award for the credit card industry for the 10th straight year. It is also indicative of -- or probably a result of -- better customer service, which I can attest to from my own experience. Better customer service in any commodity industry is a competitive advantage.
- Strong cash position and cash flow: According to filings, the company generates some $1.5 billion in cash flow on a market cap of about $12 billion, a price-to-cash-flow ratio of 8. Although there isn't much data to go on, the
price-to-earnings ratio looks destined for the 12 to 14 range. And there's plenty of cash on the balance sheet, too (thanks, Morgan Stanley) -- almost $8 billion, or about $16.50 a share. Now there is also $5 billion in debt, but in this industry, the use of debt to finance receivables is normal, and the $3 billion left over still amounts to more than $6 a share, strong on a $26 stock.
- Flexibility of independence: For most of its life Discover has been under the thumb of a larger corporate parent -- Morgan Stanley and Sears (SHLD) before that. I anticipate new freedom to implement strategies and allocate capital according to its own instincts will lead to exciting things.
- Improving industry fundamentals: The migration away from cash and checks to debit and credit cards (and Discover provides both) bodes well, especially in this wealthier customer segment likely to spend more.