Discover Improves Rewards, Goes B2B With AribaPay And Takes Aim At Visa — At A Cost

Even though Discover’s payments volume rose and its loan portfolio grew by 6.4 percent, the card issuer’s net income plummeted 33 percent for the last three months of 2014. The biggest contributor to the plunge: a change to Discover’s rewards program that makes it easier for cardholders to redeem points for cash.

Discover is also in court with Visa, accusing the larger card brand of anticompetitive tactics, and it’s trying to market a signature debit card to banks. The success of its Discover It card means the company is spending more to build on the card’s existing momentum, and the company is also spending more on its web and mobile efforts.

Even the lower price of gas has hit Discover’s payments growth. During a Jan. 21 conference call with analysts, Discover CFO Mark Graf said that, with stable gas prices, Discover’s annual sales growth would have been about 1 percent faster. “Historically, [gasoline] has been about 10 percent of our sales,” Graf said. “Right now it’s something less than 10 percent.”

The result is that fourth-quarter revenue, net of interest expense, declined 4 percent to $2.04 billion from $2.13 billion a year earlier. Analysts had expected $2.2 billion, about the same as the prior quarter.

The $178 million charge for the rewards-program changes was not a surprise. Discover said in a November regulatory filing that it was removing thresholds for allowing customers to redeem points, and would no longer strip cardholders of rewards if they’re delinquent in paying or their account is closed or inactive. CEO David Nelms said during the third-quarter earnings call that the changes would raise the cost of rewards to about 1.17 percent, up from just under 1 percent of sales volume.

“Customers have told us that, in some ways, not losing their rewards was even more important than the headline rate,” Nelms said this week. “And it was a way for us to meet the competition, have advantages in ways that were greater value to consumers at lower cost to us, and therefore is beneficial to us long term.”

While payments volume overall was up 2 percent to $51 billion, that too was a mixed bag. Pulse EFT network volume increased 4 percent from the prior year, but network partners volume declined 13 percent because of the previously announced loss of a third-party issuer. That, in turn, was partially offset by the $1.5 billion in AribaPay transactions that the Discover Network carried.

Nelms cautioned that, while that number is big for a service that only launched in 2014, AribaPay is B2B. “Even one customer can be very, very sizable,” he said. “You look at the size of that market — in total, it’s a larger market than consumer credit cards and it’s a new market for us. But to some degree we’re substituting for checks and other lower-cost methods of payment than traditional credit cards. It’s a business that we think can produce, over time, very significant volumes, but at much lower than the typical network fees that we might expect on the consumer side.”

Nelms added, “It’s also a little bit hard for us to predict because the product just hasn’t existed in the marketplace. It’s unique. Competitors haven’t offered it. We have got a great partner, and it’s off to a good start in the early days, but it is still very early days in a very new business.”

Another new business is Discover’s signature debit card, which received a boost in September when it got an endorsement from the American Bankers Association. “We are the only ones in the world who have it besides Visa and MasterCard, and I certainly think we look forward to providing better economics and flexibility than the only two options that have been out there up until this point,” Nelms said. “We have a dozen or so very small signature debit issuers and we’re now starting to get to try to really go after some larger players to grow that volume.”

The Discover executives wouldn’t comment on Discover’s lawsuit against Visa except to say that there would be “some expense” related to the lawsuit. In November, Discover sued Visa for anticompetitive practices, challenging a Visa rule that requires Visa signature debit card issuers to also include Visa’s PIN services instead of allowing other PIN networks, such as Discover’s Pulse, to compete for that business.

Nelms also wouldn’t discuss a new card product that Discover will launch in early 2015. “The one thing I would say is that we do think our Discover It platform is something that can be leveraged into other products that have some of the advantages that Discover It offers, including free FICOs and pricing features,” he said, “but maybe something a little different than our traditional cash-back bonus program.”

Along with the $178 million charge from the rewards program changes, the company took a $21 million markdown for Diners Club Italy, which Discover acquired to support local acceptance of the card in June 2013 but intends to sell, and $27 million related to Discover’s home loans business, which isn’t originating mortgages at the levels expected.

As a result, net income for the three months ended Dec. 31, after paying preferred dividends, fell to $392 million, or 87 cents per share. That compares with net income of $588 million, or $1.23 per share, a year earlier.

Excluding the impact of the one-time charges, Discover’s earnings were $1.19 per share. Analysts expected earnings of $1.30 per share, the Associated Press reported, and Discover stock fell $1.99 to $58.85 in after-hours trading on Wednesday. The stock is down 7 percent in 2015 but has gained 14 percent over the past 12 months.


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