Breaking Down the Proposed Capital One-Discover Financial Services Deal

In this podcast, Motley Fool host Ricky Mulvey and analyst Jim Gillies discuss:

• How a merged Capital One and Discover Financial Services would compare to the big banks.
• The investor reaction to the proposed merger.
• Home Depot's earnings.
• The end of an activist story at a company that makes garden rakes.

Motley Fool personal finance expert Robert Brokamp and host Alison Southwick continue their conversation with Motley Fool analysts Jason Moser and Bill Mann. They cover the stocks that got away and the ones that broke their hearts.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Feb. 20, 2024.

Ricky Mulvey: Let's ask the Canadian about regulations in the US. You're listening to Motley Fool Money. I'm Ricky Mulvey joined today by the aforementioned Jim Gillies. Jim, thanks for being here.

Jim Gillies: Thanks, Ricky for that intro. Let's indeed ask me those questions.

Ricky Mulvey: The story this morning that is unavoidable is the Capital One wants Discover. There will be questions among US regulators because headlines are acting like this is a done deal. Let's set the terms out first though. It's a $35 billion all-stock deal. The combo would surpass JPMorgan Chase and Citigroup by credit card volume according to Bloomberg. First and foremost, why does Capital One want this business?

Jim Gillies: Well, they want it. The famous or infamous word, I guess would be scale. Discover is the smallest of the four US major global payment networks, so they're about to get bigger. They want to leverage the investments, they being Capital One, leverages the investments and their network they've put down for the last decades, and they can do that by getting larger very quickly with as you say an all-stock deal. They are claiming and you should always look at these claims with a very healthy shaker of salt, let's put it that way. They're claiming there will be strong returns on invested capital, post-deal synergies totaling about $2.7 billion, I think, through 2027, or it'll take until 2027 to fully realize that. But I think the Empire building is a thing, Ricky, and this is Capital One taking the next step on building their position to challenge the folks, as you mentioned, like JPMorgan and Citigroup.

Ricky Mulvey: But the shareholders of Capital One aren't too happy about it, even with these advertised synergies and scale building, they're going to get access to essentially a payment network that they didn't have before, where they had to go out to Visa and MasterCard to get their credit cards out there, and yet they don't seem too happy about it.

Jim Gillies: Well, last I saw it was down what one or 2%, Capital One. They're reacting a little bit, or some people are reacting and say, we want to get out of the way of this. I think that's a little silly. Capital One is not richly valued right now. Frankly, I think let's put, it looks pretty decent. I think Discovery is also similarly reasonably valued. Stock Advisor Canada has a recommendation on Discover Financial, for example, and the analyst covering that, Buck Hartzell, is very enthused about the company. I don't think he's terribly thrilled about it going away. It's a scale building, these types of acquisitions do happen all the time, which I suppose is a nice little softball to you to ask about regulatory issues.

Ricky Mulvey: Let's do it.

Jim Gillies: There you go.

Ricky Mulvey: Usually you do a softball question, not a softball answer for a softball question. But all the headlines are making this sound like it's a done deal from what I've read this morning, and then there's a little bottom paragraph where it's like it still has some regulatory hurdles to clear. There's a lot of big mergers that have been falling apart lately, and it seems like those watching this story, those invested in Discover, like Buck Hartzell, maybe he still has some hope that this could be a stand-alone company.

Jim Gillies: On the subject of regulatory approvals or not, look in a world where Amazon buying iRobot can fall apart because of regulatory concerns, admittedly, that was the European Union who were saying, Amazon's going to delist all their rival vacuum folks on their platform and that will hurt iRobot, which is a little silly. But whatever. I have to think that Capital One and Discover who jointly released the press release today, the CEO of Discover is widely quoted in the press release. Three members of the Discover Financial board are going to be joining Capital One board. I would like to think basic due diligence has had both parties run this up the flagpole in terms of legal and probably regulatory expert folks. Now, my take on this is look, again, Discover is the smallest of the big four. Visa, MasterCard, Amex, all much larger than Discover. On the banking side, which is more where Capital One is held.

Capital One is like number 10 in the US in terms of total deposits, Discover is at 26. The deal will move them to about number six in the US after of course, the big four, JPMorgan, Bank of America, Wells Fargo, Citigroup, and I think US Bank is number five. This would move them up to number six, but they'd still be one-third in terms of deposit base. They'd be one-third the size of Citigroup and Wells Fargo, less than one-third, actually. If you prevent this on an anti-competitive basis, you're sending a second message.

The second message is the big four are all that matter, and we will block anyone coming to any semblance of scale with the big four. I think that actually would send a worst method. Now it doesn't mean that it won't get regulatory scrutiny, and they might have to hive off one or two things to make it sure. But I think it's not the same, obviously, but Microsoft buying Activision Blizzard, where there was some concerns about that going on there. I think this will take longer than is expected, but I think it will ultimately get done. But that two bucks buys you coffee down the street. What do I know?

Ricky Mulvey: Two bucks at the Capital One cafe.

Jim Gillies: There you go.

Ricky Mulvey: You get a coffee and do your banking. Let's go to Home Depot earnings. On Friday, JMo made Home Depot radar stock. He said he was going to be curious about the inflationary story, not much of an inflationary story on the call. In fact we have disinflation, which was interestingly brought up. I think it has to do with lumber, but why is disinflation a problem for Home Depot right now?

Jim Gillies: I don't think it is. Disinflation is just a slowing of the rate of inflation. It's not deflation. Disinflation is arguably what we've been doing for the past two years, trying to slow the rate of inflation. That's why we've hiked, we being the federal banks of both of our countries, hiking rates. I don't think it's that much of a problem. I think these companies like Home Depot have seen all manner of economic environments before. I think the long-term investor just looks at this and doesn't particularly care. Investing is an expectations game, and expectations, they were already set, they were going to be light. They've been light for the last year. They'd be light again this year. But you knew they were going to be light. I think I am going to go in a bit of a sermon here. I know, act shocked. Home Depot is probably one of my favorite, if not my favorite case study for a company that transitions from growth mode to cash-cow. No one noticed.

They noticed, but 16 years ago now. In fiscal 2008, which their fiscal year is ending in February, it's always weird. This is a company that had been in major growth mode. They've been growing their store base by somewhat like 8% a year or somewhat like that before that and 2008, they only did about two-and-a-half billion, $2.2 billion in free cash flow in that last year of growth mode, and their store count was like just over $2,200, and their capex was $3.6 billion, which is actually higher than what the most recent is. Today, the store count has gone nowhere. I think they've grown at 0.3% annually for the last 16 years, but cash flow has exploded. Home Depot is a story of a dominant company in, effectively, an oligopoly. Lowes, you can argue it's an oligopoly. Yes, there's mom-and-pop hardware stores everywhere, but whatever.

They've turned into cash flow mode, and the cash flow exploded. The last 16 years since they went from rapid store growth, plow all their cash flow into growing the store count to, we're just going to do maintenance, very slow growth that they're calling for 12 stores this year. They're probably going to close a couple as well, so net store growth probably won't be 12. They have produced $143 billion in free cash flow for the past 16 years. They have thrown all of it at share buybacks, which has reduced the share count by 41%, and ever-rising dividends, they've just jacked their dividend to nine dollars a share for this coming year. When they stopped their major growth trajectory, like I said in 2008, they were at $0.90 a share. They've 10-folded their dividend.

On a dividend-adjusted basis over the past 16 years, Home Depot, mature giant cash-cow company, has given investors 20% annualized returns. Please tell me again, though, I know there's a bunch of growth-focused investors who like to say, when this happens, it's a sign of a company maturing and all the good stuff has gone. It's been about 16 years, 20% annualized. I'm picking a straw man, obviously. But please tell me how much better the new growth changing the world has done over the 20% annualized put up for the past 16 years at poky no-growth Home Depot, who still has their competitive position unchanged by the way. I go on, I'll wait.

Ricky Mulvey: They offered. I want to meet this straw man who's ready to go to town on Home Depot.

Jim Gillies: I can give you a name or two, but we'll talk after the show.

Ricky Mulvey: What you just described is why Home Depot is able to essentially offer a soft forecast and the stock does not flinch. That's always the story. Earnings beat expectations, stock forecast is down and then the stock gets pummeled. Let's go to Griffon Corp, which is a story you haven't heard. It's not going to be in the headline of today's show. But we're Slacking this morning, and I offer up some stories, you give some takes on it. You wanted to talk about, and I'm quoting now, a maker of fine residential and commercial garage roll-up doors in garden rakes run by a well-comped, in-depth artistic management team.

Jim Gillies: Guilty as charged.

Ricky Mulvey: I was like, we can talk about some other things, but I feel like Jim wants to talk about this story. This is an activist story, seems like the activist plays worked out. Give us the story with Griffon Corp here.

Jim Gillies: Sure. Yes, Griffon Corp is that very thing. They are well-comped. One of the reasons why the activist Voss Capital showed up a couple of years ago is, do you see what these guys are getting paid basically? They pointed to a myriad of compensation plans that seem to basically need a pulse, and they'd be met in full. In fact, the pulse might be optional on a couple of them. They pointed out Voss Capital, that is pointed out that the CEO, who is a gentleman, Rob Kramer. I believe his name is the CEO and Chairman that he made more for this tiny little company. I think today it's barely a four billion dollar company. Again, they make roll-up doors, garage doors, garden rakes, garden hose. They own the Hunter Douglas fan, the old ceiling fan brand. That guy made more than the CEOs of some other companies you've heard of one, we've already talked about Home Depot, Starbucks, and Disney.

Ricky Mulvey: Old Bobby? Your favorite entertainment CEO, Bob Iger?

Jim Gillies: I was going to say, I'm going to hold off on the Bob Iger love [laughs] right now. They said the board was compromised, was full of cronies. I came to the story about a year into the activist fight. They already had one fight and they were calling for a division to be sold off. I recommended it in Hidden Gems Canada in January of 2023, and I think one market day later, they announced the deal with the activist because I was gearing up for another fight and I love a lot of good activist fight. They announced that the head of Voss Capital, who'd already got one of their directors onto the board anyway, in the previous fight, they were announcing that the the lead for Voss Capital was himself joining the board, and they announced the standstill agreement.

We're all going to work together and kumbaya, and we're going to bring it everything together. We're going to create shareholder value for people. They sold off the previous division, but they were in the middle of a strategic review. That strategic review disappointed everyone except apparently me when it came out a couple of months later because everyone is expecting a sale of the company. Instead, it came out that, we're going to give you two dollars a share, special dividend, and we're going to up our buyback program. Stock promptly fell from the mid 30s to the mid 20s, very nice time to add by the way. But since then they've paid that special dividend, they've hiked the regular dividend twice. They have indeed been very aggressive in operational improvements that has led to more cash flow and that cash flow is lead to better buybacks, a little bit of debt repayment.

They got serious about board refreshment, so they actually got rid of a couple of the directors who had been there for forever and ever. The reason I call them nepotistic as the CEO is the son-in-law of the former CEO who himself was the son of the former CEO before him. I'm not scared by that kind of stuff because frankly, I think when you have people so nakedly looking out for their own self-interest, maybe who view to align yourself with their self-interest. But the thing that came out this morning that I think is kind of the end of the activist story. So why Griffon is going forward, is going to have to earn its place in your portfolio based on performance alone, is the word came out that Voss Capital is selling 1.5 million shares to Griffon themselves at a 3% discount to the market. So that's nice, I like that. But this will take their holdings from about 2.8-2.9 million shares down by 1.5 million.

It'll take them below the 5% threshold where you have to report, and the lead of Voss Capital is leaving the board. Now, they gave all the right words and said we're going to keep on owning shares. However, they can now sell without needing to file a form for the rest of their holdings, so it'll be interesting. But this is a stock again, Griffon Corp, maker of garage doors and yard implements. The stock is up. Basically, it's a double over the past year. It's up about 120%, if you did take the conclusion of the strategic review as a buy signal, that's about nine months ago. If I can be said to try anything, it's, I like to preach that you can make market beating returns in odd and weird places. You don't have to go for whatever is super-hyped in in the media at this time. You can find it in Home Depot as we talked about. You can find it in people who sell stuff to Home Depot, like Griffon Corp. So I thought it was an interesting story that most Motley Fool Money listeners probably haven't heard of.

Ricky Mulvey: Well. I think we just hit the SMCI story with that as well, so we're about out of time, Jim Gillies. As always, appreciate your time and your insights.

Jim Gillies: Thank you. 

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Ricky Mulvey: Last week my colleagues, Alison Southwick and Robert Brokamp caught up with Motley Fool Senior Analysts, Bill Mann and Jason Moser for some Valentine's themed stock stories. The Valentine's day is over and it's time for a little heartbreak. This time, Jason and Bill shared the ones that got away.

Alison Southwick: Last week, Jason Moser and Bill Mann joined us in a studio to talk about the great loves of their life, by which we mean, of course, investing in stocks. But you know what, that was last week. This week, it's time to talk about the heartbreak of investing. You guys ready, I've tissues nearby if you need them.

Bill Mann: Valentines is over, back to cynicism. Here we go.

Jason Moser: We're going to power through.

Alison Southwick: Here we go. So our first question today is to talk about the one that got away, by which we mean a stock that you never got around to buying and wish you had.

Jason Moser: Yeah, there are a lot. There a lot that I can put on this list. My recency bias is going to bring Nvidia here front and center. I'll go with Nvidia because it's funny. One of my roles here, I'm the advisor for Augmented Reality and Beyond service, and when i started that service almost five years ago, Nvidia was one of the stocks I recommended. They made a lot of sense at the time and I remember digging into the company thinking, these guys are coming around and doing a lot of cool stuff. This is a stock I really probably want to own. As I mentioned before on the previous episode, we have internal trading guidelines that make it a little bit tricky sometimes for us, just people transact whenever we want.

So it was just never a stock that was open. It was never available for me to actually go in there and purchase, so I didn't at the time it sort of left my mind and never thought about it. Five years later, it's up like 2,000%. Now, I'm thrilled that I've got it on the card for our members because our members have clearly one big from Nvidia. That's one where I looked back and I think, man, I should've just kept that on my radar and I just didn't catch it. I wish, I did because I feel like they still got a lot to do.

Robert Brokamp: I'll just add a little bit about the training guidelines for people who are curious. That is, once The Motley Fool has recommended or discuss the stock, we are as employees prevented from buying it for I don't know what it is 10 days or something like that. Then also if you own it and you want to sell it, you have to check and see if we've mentioned it, recommend you can't sell it. It does limit a little bit of the investment flexibility of working here.

Alison Southwick: Bill, how about for you? What's the one that got away?

Bill Mann: I read this assignment as something that I had recommended for members and had never gotten around to buying myself, and the answer was a company that I loved the moment that I recommended it and never went back and bought it. It was a company called TransDigm, which since that point in time, and I looked this up and it was painful to do so it's up 4,500%.

Robert Brokamp: Oh, goodness gracious.

Bill Mann: TransDigm, what they do is they make basically all of the parts inside of an airplane tube. The tube itself is Boeing or Airbus, but all of the components inside are built by other companies. By other companies, I basically mean TransDigm. They did almost everything else inside Boeing planes. It turns out when you sell those sorts of things that works out really well, and I thought it was going to work out really, really well, and it has worked out really really well for a lot of people who are not me because I didn't buy it.

Alison Southwick: Do you feel it's too late to ask them out?

Bill Mann: It's water under the bridge at this point. It's felt expensive for the entire time and for the entire time that's been wrong. Maybe.

Alison Southwick: It's not in your league now maybe. What about NVIDIA? Is it too late? Can you call out to Nvidia and be like

Jason Moser: Not too late as far as the business goes now. The valuation is one where I feel like, I'm going to be patient here. I'm going to be patient and let it come back to me. If she comes back to me. [laughs]

Bill Mann: You're talking about the Taylor Swift of stocks, right now my friend

Alison Southwick: She's moving on.

Bill Mann: She's on TV and you're not.

Alison Southwick: Next question. Tom, we actually covered this a bit last week, but tell us about the one that broke your heart by which I mean, a stock that you bought and it just went nowhere.

Jason Moser: This one's funny for me because it's one that really did well for a while until it just didn't. That's Under Armour. Under Armour is one that had?

Bill Mann: I dated Under Armour too.

Jason Moser: So much potential. We saw that stretch of time where Kevin Plank really seemed to have the answer for everything and then they just hit a wall and it was self-inflicted errors. I mean, he just made some strategic blunders. I think that really sent the company into a not a death spiral, but certainly something that's been very difficult for them to recover from. Thankfully it was a smaller position. It's not something that was naturally material to my portfolio. It was one where I was considering, maybe this is one we need to keep building this out. This could be the next Nike-like story until it became apparent that it probably wasn't going to be so. To be clear, I still own those shares today. It's a small, meaningless position, but I was telling you before about I default and not selling. The funny thing is, I think Under Armour makes great stuff, I'm wearing Under Armour pants. I mean, I love them. They just can't get that business in order. It's really interesting to watch. I remember before Bill, how we would talk about Lululemon versus Under Armour. I mean, all of these.

Bill Mann: Nobody's talking about that anymore.

Jason Moser: Yeah. It's just, it's fascinating to see how well Lululemon's performed while watching Under Armour just completely flounder. It's been a real lesson.

Alison Southwick: What's been a difference you think?

Jason Moser: Well, I think certainly just vision and leadership. Leadership with Under Armour, they've just never had any kind of consistent vision as to what they wanted to do with the business and recovering from those strategic blunders that Plank made long ago and most of that was in regards to supply chain management. It's just been a difficult road for him.

Bill Mann: I'm still completely distracted by the fact that you used the word brodie. [laughs]

Robert Brokamp: To the max even, to the max. [laughs]

Bill Mann: Yeah. I think it's meaningful that off the top of your head know exactly the name of the founder of Under Armour and don't know the founder of Lululemon. They have a much more professional management.

Jason Moser: Was that Chip Wilson?

Bill Mann: Yeah.

Jason Moser: Now Wilson is out of the picture.

Alison Southwick: Wilson was a bit problematic.

Robert Brokamp: Arguably controversial.

Jason Moser: I'll argue a little bit out there. I don't know that much about him, but it was very clear that there were like, look we got to part ways and get this thing back on track. Under Armour has not had that luxury because Plank is still the majority owner of that business. Split those shares out. He's controlling the whole thing. I mean, I think we could argue that's a bad move and clearly investors have loss from that.

Bill Mann: I'm not suggesting that Wilson was the one that got away by the way. [laughs] I am simply saying that they had a professional management team and structure in place whereas with Under Armour, Kevin Plank's basically up their Napoleon style pointing here, we go there. If you're going to be a Napoleon, you'd better bring it and he hasn't.

Alison Southwick: What's the stock that broke your heart, Bill?

Bill Mann: Mine's Kahoot.

Alison Southwick: Kahoot?

Bill Mann: You know Kahoot. The little Kahoots, the quizzes that basically?

Alison Southwick: Yeah, I know Kahoot.

Bill Mann: Got your kids 80% of the learning they did during the pandemic.

Alison Southwick: Yeah, the little quizzes.

Bill Mann: It was a great little company and we recommended it almost when it was pre-revenue. They were building up their business, didn't even have a marketing team. It was all word of mouth and just exploding. It was one of those companies that simply and I wouldn't take the other side of this, I wouldn't want the other experience, but it was one of those companies that really took hold during the pandemic and then lost its grip on the other side. Again, I don't wish we were still in the pandemic so that Kahoot would be doing well, but it's such a company with a purpose that I really wanted it to financially succeed more than it has.

Alison Southwick: Our last question is for you all. Now, this was the one that got Jason squirming in his seats, so we'll see if if it's true. The one time you cheated, by which we mean an investment that generally goes against your principles or what you've recommended to readers and listeners here.

Jason Moser: Yeah, I think the reason why I squirm is because I look at these tickers and I'm like, yeah, they're not working out and yet I still own them and I don't know why. Oftentimes, I own them because, I either I'm holding out hope that things will turn around, or they serve as living lessons and reminders. I think in this case these are reminders. One of the rules I tend to espouse, and I follow it for the most part but every once in a while I stray, is to just not buy into IPOs, give it some time. I like to see four quarters of reporting. I want to understand how this management team works. What they're focused on, how they report, metrics.

Every once in a while I do stray and two that standout, I'll give you two here, Eventbrite and Unity Software, a couple of companies that I bought into early on in their public lives. They just struck me as interesting businesses with a lot of potential. I didn't worry so much about the valuations and the enthusiasm behind this stuff. Because with IPOs, that can often be a drawback as the enthusiasm that's there pushes those valuations up a little bit irrationally. Especially so in the case of Unity Software, given the time that it went public, but Eventbrite and Unity stand out to me as two where I should've listened to myself. I didn't. Maybe things will get better for them, but I'm not terribly optimistic at this point.

Alison Southwick: Bill, how about you?

Bill Mann: I have a basic rule and it is this, don't leave your money at risk of dictators.

Alison Southwick: We're getting back to Napoleon again.

Bill Mann: We are getting back to Napoleon again. I have a second rule and it is if the person who is running a company seems like a bad person, they are probably a bad person. I had recommended a company called JD.com, which is a Chinese company. It's a very interesting company, a clone of Amazon. Their CEO got in trouble with the law in a very bad way in Minnesota in I think 2019.

Alison Southwick: What was he doing in Minnesota?

Bill Mann: Getting in trouble.

Alison Southwick: You can get in that much trouble in Minnesota?

Robert Brokamp: Yeah. I went to a seminary in Minnesota and I had to storage.

Bill Mann: I don't know how to respond to that. But go on.

Alison Southwick: We will save that for another episode.

Jason Moser: You've left him speechless. 

Bill Mann: Was arrested for messing around with a woman who was not his wife. You know what I mean? I found myself a little bit frozen by what do I do because we as analysts are supposed to focus on a business and you don't want to overreact to things, but you don't want to under-react to them either. In this case, given everything else about what was happening in China, the fact that it's not a particularly friendly environment to foreign capital, I should have just pulled the plug and just got out and said, listen, this is not a place where we need to risk our money. We have thousands of companies that we can invest in. Why would we remain exposed to this one?

Alison Southwick: Let's close on a more optimistic note.

Bill Mann: Thank you. I really didn't want that to be the end.

Alison Southwick: No, we are going to close on an optimistic note here. Moser and Bill, is there any stock right now that you're maybe slipping notes to in-class and do you like me? Yes, no, maybe? Maybe a stock on your radar?

Robert Brokamp: Of course, if you talk about it, then you can't buy it.

Bill Mann: What have I already mentioned?

Jason Moser: Well, I so yes, there is one that, I've recommended it in my Next-Gen Supercycle service and it's performed very well in a very short period of time. It's a company called Samsara and ultimately in connected Cloud operation, helping businesses connect all of their devices and vehicles and buildings and stuff like that. Samsara builds that technology, runs all the software behind it. The ticker is IOT, which is clever because of Internet of Things and all of that stuff, so it's an Internet of things kind of play. Speaking evaluation, the stock has taken off. The valuation is one where I'm like, it needs to come back to me before I can really start getting serious about those love letters. We're going from the notes to love letters. That's what I'm hoping. But that's one that I continue to really be be interested in.

Alison Southwick: IOT. Bill, how about you?

Bill Mann: Jason talks about all this technology. I'd like to talk shoes for a minute.

Jason Moser: We all got to wear shoes, I guess we don't all have to. We're all doing.

Bill Mann: We're all requested to wear shoes lots of times. Not that long ago, I was in Japan and was walking in a very fashionable part of Tokyo. There were all these little boutiques and one had a line going around the block. As an investor, that's the thing that makes me go, huh. The company was On Holdings, the running shoe company. No, they call themselves a movement company.

Alison Southwick: How do you spell that, O-N?

Bill Mann: Yeah, ON. The people will have heard of this even if you have not. It is a Swiss company co-invested by Roger Federer. The guy who founded it was a former triathlete who noticed that other triathletes were suffering from the same exact injuries and decided to try and develop a shoe that would be safer for people. They're fantastically comfortable. They very fetchingly called their technology Cloud technology, which is a great sounding thing for your feet. They're selling off like wildfire. A little bit of a challenging valuation, but in the very same way that Lululemon has always had a challenging valuation. This is a company that I am making goo-goo faces and the like just to see.

Alison Southwick: Eyebrows, eyebrows.

Bill Mann: Exactly.

Ricky Mulvey: As always, people on the program may have interest in the stocks they talk about, so don't buy or sell anything based solely on what you hear. I'm Ricky Mulvey. Thanks for listening. We'll be back tomorrow.