Discover stock is getting bought out, bullish consumer trends?

In an unexpected turn of events, Capital One Financial (NYSE: COF) has decided to consolidate its market share further in the consumer discretionary and financing space. Markets had disregarded all M&A (mergers and acquisitions) activity for this year, considering that high-interest rates made financing these deals an obstacle to profitable dealings.

After announcing an all-stock deal to purchase its smaller competitor Discover Financial Services (NYSE: DFS) for $35 billion, the stock is up by S12.0% on Tuesday’s trading session. The genius of the deal comes from its structure; an all-stock deal requires zero financing, which saves Capital One a lot of money in the deal and immediately adds all of the benefits that come from acquiring Discover.

While you could start to dissect Capital One stock's benefits in the near future, there are better ways to play the spillover effect that this deal could have on the rest of the market. At face value, this deal is a vote of confidence on the Consumer Discretionary Select Sector SPDR Fund (NYSEARCA: XLY) and names like Target (NYSE: TGT) and Starbucks (NASDAQ: SBUX).

What happens now?

To get things straight, there is still an opportunity to be had by considering Capital One stock. One of the main drivers of the upside comes from the consolidation of market share and customers, which would make Capital One a respectable competitor to the bigger names in the space.

With an average net income margin of over 20.0% and ROE (return on equity) rates of 24.5%, Discover is an excellent business in the portfolio that enables the American consumer to finance immediate purchases. As it turns out, a 10.0x price-to-earnings multiple made Discover stock a massively attractive deal to buy.

Before the 12.0% pop on the announcement, Discover stock had fallen behind the Financial Select Sector SPDR Fund (NYSEARCA: XLF) by as much as 18.0% over the past twelve months, which also made it a prime buy target for Capital One to look over.

Of course, there are no free lunches on Wall Street, which means that the market is not 100% certain that this deal will go through. Because consolidating so much power into one name could cause regulators to look the other way on this acquisition, markets have left a $5 billion gap to reflect their concerns.

Discover’s market capitalization currently stands at $30 to $31 billion, falling under the acquisition price of $35 billion set by Discover. The actual market cap won’t reach the intended value of the buyout terms until the market is more than sure that this acquisition is precise of any risks.

So, if you want to get behind this buyout in your bet for the future of the consumer credit space, know that the risk of the deal not going through still stands.

But at least now, one thing is clear: Capital One is the big player in the industry, and the current consumer trends are bullish enough to double down on the space.

Alternative plays

If the guys behind the curtain are bullish on the consumer. In that case, you, too, can assume that tailwinds are building on more momentum to push other stocks in the sector higher. Some of these names already mentioned, the Targets and Starbucks of the world, could be in for a significant bump.

After a swift rise of 41.5% over the past quarter, Target stock is a perfect example of the market placing its bets on what could come from the consumer end, particularly on a mix of defensive and discretionary items such as Target's.

Analysts at Morgan Stanley (NYSE: MS) still think the stock could go higher, up to $165.0 a share in their latest rounds of price targets. Of course, these beliefs are built on the expectation that the FED will now cut interest rates in the United States.

According to the FedWatch tool at the CME Group (NASDAQ: CME), traders bet these cuts could come as soon as May. The way Target stock has risen is the market’s authentic ‘forward-looking’ fashion shifting its focus ahead of the curb.

A distant cousin to Target in the American consumer’s arsenal is Starbucks. This stock has underperformed the broader consumer sector by as much as 32.0% over the past twelve months, creating an opportunity for you to ride the catch-up to close the gap.

Considering that the stock is expected to grow its earnings per share by 16.2% in the next twelve months, analysts feel comfortable assigning a price target of $111.4 a share, calling directly for a 19.3% upside from where it trades today.

It looks like Wall Street is now on the same page regarding the same tailwinds Capital One sees in the industry.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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