Looks like Discover's (NYSE: DFS) Goldfish has gone belly-up.
The Inside Value recommendation finally decided to throw in the towel on its ailing Goldfish unit, which issues credit cards on the MasterCard (NYSE: MA) and Visa network in the United Kingdom. I don't blame management for wanting to rid itself of this albatross. But let's take a look at what happened.
Eurotrip
The original premise for acquiring the Goldfish unit made sense. In late 2005, Morgan Stanley (NYSE: MS), which was then Discover's parent, agreed to acquire Goldfish from Lloyd's for $1.68 billion. In doing so, it got a very important and strategic footprint in the U.K. credit card market.
However, sometimes "it" happens. Discover's management noted that new legislation has made it more difficult to discharge credit card debt, which isn't helping many debt-ridden U.K. consumers. This, likewise, has led to high credit losses for Goldfish and other credit card issuers such as American Express (NYSE: AXP) and Capital One (NYSE: COF).
In fact, the net percentage of Discover's international credit card loans (on a managed basis) that were charged off as uncollectible losses was 6.54% in 2007, up from 5.45% in 2006. In comparison, the U.S. units' net charge-off rate was 3.84% in 2007, which was actually down from 3.96% in 2006.
Addition by subtraction
Discover did mind that gap, and decided the U.K. business wasn't their thing. After all, the Goldfish unit issues cards over the MasterCard/Visa network, and in the U.S., Discover issues cards over its own internal network.
The unit has also been bleeding red ink from the credit losses. In 2007, the international card unit had a pretax loss of $596 million, or $205 million, excluding a $391 million impairment charge. In 2006, the international unit lost $87 million before taxes.
Getting rid of this money-losing unit was the primary motive behind selling Goldfish. Barclays (NYSE: BCS), which has a much larger U.K. credit card business, most likely agreed to the acquisition because basically it was getting the business for free. Barclay's is paying about $70 million for a business that Morgan Stanley bought for $1.68 billion three years ago. It's getting 1.7 million credit card accounts and $4 billion in credit card receivables. The deal is expected to close in May.
20/20
In my Foolish opinion, it's probably best for Discover to put this episode behind it. When Morgan Stanley acquired Goldfish, it paid about a 17.5% premium to receivables -- a reasonable price to pay for a credit card business. Subsequently, the environment changed; the economic and credit environment worsened significantly, and the Goldfish unit started piling up losses.
Profitability's the name of the game, so it's reasonable for Discover's management to get rid of the Goldfish unit that was subtracting shareholder value and not adding to it.
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