Can Capital One Get Real Value From ING Direct?

By Stephen D. Simpson, CFA | June 22, 2011 AAA

Capital One (NYSE:COF) has seemingly always been on the hunt for more loanable funds, and the company has taken a big swing with its acquisition of ING Groep's (NYSE:ING) ING Direct. While there is no question that this acquisition will give Capital One a much larger deposit base, it is not so obvious that the company will turn this into a value-additive deal. (For more on how this deal and others are valued, check out Analyzing An Acquisition Announcement.)

TUTORIAL: Mergers and Acquisitions

Terms of the Deal
Capital One agreed to pay $9 billion for ING's U.S. online banking operations, with $6.2 billion of that coming in the form of cash. With the remainder in stock, ING will be a major shareholder of Capital One. At close to 1 times tangible book value, it may not seem like Capital One is paying all that much, but investors should remember that ING was a highly motivated seller - divesting ING Direct was a requirement as part of the company's bailout.

What Capital One Is Getting
With this deal, Capital One adds about $80 billion in deposits to its franchise and returns to the mortgage business. While Capital One already had its own online bank, ING Direct is arguably the best-known operator of online savings accounts and may enjoy some brand value and distinction. Unfortunately for Capital One, the branch-free model at ING Direct is not quite as profitable as some might imagine and pre-provision earnings of $630 million is not a compelling return on capital. (To help you determine if this acquisition is going to be a success, read What Makes An M&A Deal Work?)

Can Capital One Leverage This Deal?
The real question is not about what ING Direct is today, but what Capital One can do with it in the future. Simply combining the acquisition with Capital One's existing online operations should lead to tens of millions of dollars of cost savings. On top of that, there may be some cross-selling opportunities that will allow Capital One to grow its core consumer lending (credit cards) business on ING Direct's back. While online savings accounts are not exactly cheap money (compared to what banks presently pay for demand deposits or CDs), they are cheaper than equity, trust preferreds, and other sources of funds and the customers are reasonably loyal so long as rates stay competitive.

Capital One has a lot of challenges, though. ING Direct may have pioneered the online savings account and convinced people that it is safe and worthwhile, but the moat is not that wide. Banks like HSBC (NYSE:HBC) and Zions Bancorp (Nasdaq:ZION) have their own offerings. Moreover, the idea of using online savings accounts to fund credit card lending is not exactly new - American Express (NYSE:AXP) and Discover Financial Services (NYSE:DFS) are both in the game as well.

At this point, then, it is fair to wonder whether online savings has become commoditized. Does ING Direct have enough of a reputation advantage to attract customers and enough ease-of-use advantages to keep them when customers can easily choose Ally, HSBC Direct, or other competing products? Likewise, can Capital One cut costs enough to make the returns attractive without compromising its competitiveness?

And don't forget too that Capital One has been trying to compete in traditional branch banking with the likes of PNC (NYSE:PNC), Bank Of America (NYSE:BAC), and Regions (NYSE:RF) in the New York, Washington, DC metro areas, and Louisiana. It's hard enough to do one thing well, let alone trying to operate two very different business models simultaneously. Not only that, but this deal likely minimizes the odds that Capital One will be a player in further branch banking deals. (To learn more on how banking has grown and changed, read The Evolution Of Banking.)

The Bottom Line
Adding $80 billion in deposits at tangible book value is not an opportunity that comes every day. If Capital One works hard and is very careful not to alienate its ING Direct customers, this deal could ultimately be a real winner for the company. Not only is the company going to need to cut expenses on the back end (which should be an attainable goal), but also exploit the deposit base with mortgage and credit lending. But given how many banks have devastated their balance sheets with bad mortgage and credit card lending, that is not a risk-free proposition for shareholders. (For more on online banks, check out Online Banks: Lower Costs And Little Sacrifice.)

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