Just the facts, finances and finale. Discover spinoff part 3 of 3
We’re just a few days out from the last day possible where an investor can buy Morgan Stanley and receive a share of Discover for every two shares of Morgan Stanley owned. I wanted to finish up my series by posting some final thoughts on Discover, and a brief discussion of a few facts related to Discover’s financial position.
I want to start off by saying, I’m not an equity analyst, I do this for fun. So any prices or attempts at valuation are based on simple factors such as P/E instead of some sort of black box Wall Street formula.
Discover financial position
I struggled with the best way to present this information, while reading the balance sheet I took some notes, so I’m going to make bullet points of my notes and give a small discussion for each.
- Discover has 5.119 billion dollars in cash, and will have 527 million shares outstanding which is $9.71 cash per share.
- They also have $41.40/share in credit card loans. The interest spread on this is between 5-6%. The interest income is earnings for Discover.
- $4.62/share in short term debt.
- $6.48/share in long term debt.
- Interest coverage ratio is 1.8
- $5.85 billion in debt
- $5.426 billion in equity giving Discover a debt to equity ratio of: 1.078
- 2006 earnings of $1.98/share
- 2007 earnings of $.44/share YTD
So doing a back of the napkin estimation valuing Discover at P/E 15x 2006 earnings we get a value of $29.70. I believe this is pretty accurate, trading began today for DFSWI and it traded between $28-30.
Backing this out of Morgan Stanley we get $14.85 is the value of each Discover share. So for today’s MS closing price of $89.30 the new price would be $74.45.
Final Thoughts
I think many people are looking at this spin off through the lens of MasterCard. I doubt Discover’s newly issued stock will do as well as MasterCard. MasterCard is a much different business model, and in general is a much stronger business. Discover is more similar to American Express in the sense that it backs the credit card loans it distributes.
I believe the value in this spinoff is in Morgan Stanley. Currently Morgan Stanley is trading pretty cheap due to some past failures. I believe by shedding Discover they will be able to refocus their business on investment banking and generate excellent returns for their shareholders.
Last thoughts:
For the short term trader: I think there is some potential for a nice move upwards with both Discover and Morgan Stanley. Especially with the rallies these past few days, I would expect 10-15% gain in a matter of weeks on Discover.
For the long term holder: I think the value in this play is Morgan Stanley. Discover seems to be doing well in a good economy, but I’m not sure how well they’ll do in a recession or downturn. I say this because with their debt there isn’t a lot of wiggle room. They do have the credit card loans which generate interest, but if a downturn hits hard many of their cardholders could stop paying their bills which would dry up that interest income stream. I would be cautious about buying Morgan Stanley for the Discover stock alone. If you want in on Discover I would purchase it on the open market starting July 2nd, or currently with the trading symbol DFSWI.
If anyone has any comments or feedback I would appreciate it. I hope to continue this type of coverage across many different companies and industries. If any readers have suggestions of stocks to look at please let me know. Thanks!
June 15th, 2007 at 1:29 pm
Thanks very much for putting your thoughts together in such a easy-to-read manner. I just inherited some MS stock and am not familiar with this industry at all. I was going to sell it but may hold onto it for awhile until the Discover thing plays out.
I am also an investor in the generic drug industry. I have owned Mylan for many years and it did amazingly well when it was small. Over the past few years, it has not done well even though it is the best in the industry (my opinion). They are very high quality producers of generics (never had a recall) and have the largest line of products in the industry. They are in the process of trying to buy Merck (Germany)’s generic business and I cannot figure out if this is a good deal or not. How about looking at this company and industry? The industry will do well as the government starts to pay for more medicine (Medicare Part D) and pushing generics is very cost effective. Many Indian companies coming in but they have had a history of poor quality production.
Thanks again for the very good article on Morgan Stanley and Discover.
Mike
June 18th, 2007 at 3:00 am
Great read - I saw your post on the message board. Can you help me with these question? Could I buy MS on Monday, sell it on Friday and still have DFS shares distributed to me? What is the earliest date I could sell MS and still get the DFS stocks? Is there money to be made that way?
Thanks,
Roger
June 19th, 2007 at 4:25 pm
Nice article. I enjoyed reading it. Might I suggest looking at NYX or ELN?