Discover Financial Services, a major credit card brand that had pretax domestic profits of $1.5 billion in 2007, has agreed to purchase Diners Club International Ltd. from Citigroup Inc. for $165 million in cash.

Under terms of the agreement disclosed on April 7, 2008, Discover will acquire the Diners Club network outside of North America, its brand and trademarks, employees, and agreements with 44 network licensees (franchises) who issue Diners Club cards.

Citi will continue to own a number of franchises. All franchises will be licensed under the Diner's Club brand and will continue to be independently owned and operated.

Although Discover will become the franchisor and Citi will become the largest franchisee, Citi is committed to remaining a significant long-term issuer of Diners Club cards as part of the proposed transaction. Discover will not issue cards or extend consumer credit in international markets.

However, Discover will control the Diners Club brand, set the operating guidelines for the network and receive royalty fee income from the licensees.

Once the networks are fully integrated, Discover anticipates both increased transaction volume and wider acceptance of the Discover Network brand.

Expanding consumer reach

Network integration, which Discover said should take two to three years, will enable Discover cardholders to use their cards around the world. Additionally, Diners Club cardholders will be able to use their cards on the Discover Network in North America.

"The impact of the acquisition on our profits will be modest at first as we invest to strengthen the Diners Club brand and work to achieve interoperability," said David Nelms, Chief Executive Officer of Discover, in a conference call to shareholders. 

"We expect this acquisition to significantly improve our competitive position by giving us global reach and accelerating growth in our payments network revenues.

"We also expect to see a higher transaction level and expanded profitability as non-U.S. volume contributes to overall spending, particularly in the higher margin travel and entertainment segments.

"In the next two years, we will reinvest to build network operability for Discover and the licensees and provide enhanced marketing support."

Hindsight is 20/20

Even with the incremental investments, Discover expects Diners Club to make a modest positive contribution of about $10 to $15 million per year to pretax profits in its payments segment. In his statement, Nelms added that Diners Club would have generated over $75 million in incremental revenue for Discover had it owned the company in 2007.

Nelms expects the addition of Diners Club to increase third party (independent franchise) payments volume by approximately 30 percent and its third party payments revenues by roughly 60 percent. The Diners Club network operates in 185 countries and territories worldwide, with more than eight million merchant and cash access locations, processing $30 billion in network volume in 2007.

Nelms said the purchase provides Discover "a path to achieve global acceptance, establish new international partnerships, generate higher payments volumes and increased fee revenues, all at a very attractive level of investment. The acquisition gives us a unique opportunity to advance our market share and positioning in a cost effective manner. We could not be more excited about this opportunity."