Capital One: A Bank That Actually Gets It

Story updated with additional analysis.

NEW YORK ( TheStreet) -- Capital One's ( COF) deal to acquire HSBC's ( HBC) U.S. credit card business shows that the company knows where the action is.

And investors get it.

The shares are up slightly to $41, even as the market rout of the financial sector has resumed.

Capital One's deal to pay a premium of $2.6 billion for HSBC's $30 billion U.S. credit card portfolio fits in perfectly with the company's agreement to purchase ING Direct from ING Groep ( ING), as the cheap core deposits from ING Direct will be more than adequate to fund the acquired card portfolio, thus increasing Capital One's interest rate spread, and its earnings power.

Capital One said the card portfolio acquisition would be accretive to 2013 earnings, with a "return on invested capital expected to be greater than 25 percent."

The deal is expected to close in the second quarter of 2012, and follows Capital One's agreement which included a $2 billion capital raise that was completed in July.

Capital One said that it planned to raise an additional $1.25 billion in capital to partially fund the HSBC card acquisition. Assuming a $40 price for a common equity offering -- and factoring in the coming issuance of 55.9 million shares to ING Groep when that deal is completed in late 2011 or early 2012 -- the coming capital raise for the HSBC deal represents a further 6% increase to Capital One's common share count.

That dilution is mitigated by the shares' 10% pullback over the past week, to Tuesday's closing price of $40.82.

One analyst estimated that the deal would add $1.25 a share to the company's 2013 earnings. The current consensus EPS estimate for Capital One in 2013 is $6.01 a share, among analysts polled by FactSet.

Despite the U.S. housing market still going through a multi-year shakeout, credit card quality has improved dramatically and Capital One has posted strong earnings over the past year. It makes sense for the company to stay focused on its core competency and grow its amazingly profitable card business.

Looking at the numbers, Capital One's shares are so cheaply valued, that concerns over the latest dilution to the shares seems overblown.

In addition to the 10% pullback for the shares over the past week -- factoring-in Tuesday's 8% rise in the share price -- the shares were valued at a low 1.3 times a tangible book value of $31.41 a share, according to SNL Financial.

The shares were trading for just six times the consensus 2012 earnings estimate of $6.08. That's an amazingly cheap valuation to forward earnings.

The largest U.S. banks are also trading at low forward price multiples, but none are as profitable as Capital One.

Shares of Bank of America ( BAC) closed at $7.60 Tuesday, and were trading for just four times the consensus 2012 earnings estimate of $1.51 a share. The company booked an $8.8 billion second-quarter loss, and its operating return on average assets (ROAA) for the 12-month period ended June 30, was a negative 0.65%, according to SNL.

JPMorgan ( JPM) closed at $36.40 Tuesday, or six times the consensus 2012 EPS estimate of $5.68. The company's 12-month ROA was 0.96%, according to SNL.

Wells Fargo ( WFC) closed at $24.78, for a forward P/E of 6.5, based on the consensus 2012 EPS estimate of $3.51. The company's 12-month ROA was 1.20%.

Citigroup ( C) closed at $31.82 Tuesday, or five times the consensus 2012 earnings estimate of $5.13, with a 12-month ROA of 0.52%.

Meanwhile, Capital One's 12-month return on average assets was 1.77%, according to SNL.

Even with the further dilution from the HSBC card deal, Capital One looks like a winner for long-term investors with any confidence in the U.S. economy. The card business is far more profitable than the more diversified but slow-growing -- or shrinking -- loan businesses of the largest U.S. banks. The deal also fits in quite well with the ING Direct deal, and dilution concerns are mitigated by the stock's historically low valuation.

-- Written by Philip van Doorn in Jupiter, Fla.

To contact the writer, click here: Philip van Doorn.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.