1. Discover Financial Services
Zhifeng (Jack) Chen
Gloria Ho
Jonathan Li
Swechha Salgia
Jeremy Smith
Zheng(Andrea) Zhang
RCMP presentation

2. Agenda Company Overview - Jack Business Model - Jonathan
Industry Overview - Jeremey
SWOT - Andrea
Stock Performance – Swechha
RCMP Position - Swechha
Valuation: Multiplies - Gloria
Recommendation - Gloria

3. Company Overview

4. Company Overview
A leading credit card issuer and electronic payment service company in US and UK
Three major business segments:
U.S. card  50m card members, $47.4b receivable
Third party payment  PULSE, 2.8b transactions
International card  Goldfish Bank, 2m card members, $4.4b receivable
Primary revenue source:
Interest income
Securitization income
Fees from card members, merchants
Operating capital source:
Asset securitization
Consumer deposits
In a credit card securitization, loan receivables are first transferred to securitization trusts, from which beneficial interests are issued to investors. We continue to own and service the accounts that generate the securitized loans. The trusts utilized by us to facilitate asset securitization transactions are not our subsidiaries and are independent from us. 4

5. Recent Key News June 2007 officially spun off from Morgan Stanley
July 1, 2007 DFS Added To S&P 500
July 2, 2007 DFS Debuts On NYSE
Sept DFS Profit Falls in the 3rd quarter ER due to higher marketing and interest expenses
Dec DFS to take big charge for UK card business in its 4th quarter ER (about $422M, equal to its half-year earning)
Dec Discovery's Consumer Spending Index Down 96.593.4 from Oct. to Nov.

6. Key Businesses Discover Bank Discover Card Payment Networks
Offers housing and student loans to customers
Offers CD’s and money market deposits
Issuer of credit, debit, and stored charge (gift cards)
First to provide incentivized rewards programs
Discover Network supports Discover Card transactions
Pulse Network supports Visa, MasterCard ATM users

7. Key Businesses Discover Bank Discover Card Payment Networks
Offers housing and student loans to customers
Offers CD’s and money market deposits
Issuer of credit, debit, and stored charge (gift cards)
First to provide incentivized rewards programs
Discover Network supports Discover Card transactions
Pulse Network supports Visa, MasterCard ATM users

8. Business Model Credit Card Company Credit Card Issuer Consumer
Merchant
Payment Network
$100
$98
$.25
$1.75
Monthly Fee
Discover owns all aspects of Credit card payment operations, and thus captures all revenue points in this model
Transaction Fee
Visa/MasterCard:
Discover:

9. Revenue Breakdown 2006 Revenue *Consumer Loans Asset Securitizations
Payment Networks
5.2 B
2.1B
2.3B
.8B
*Mostly Credit Card revenue

10. Future Strategies Focus on credit quality
Delinquency and charge-off rates significantly less than competition.
Average credit score 734.
Increase third-party revenues
Pulse network, debit cards.
International Partnerships
Reciprocal acceptance agreements with Asian credit card companies.
Challenge Visa/MasterCard dominance in this space.

11. Industry Overview

12. Industry History
Diner Club Program, first general-purpose charge card established in 1949
Bilateral Model
In late 1950s, Bank of America started to issue first credit card nationally, evolved to Visa network later on
Multiple Card Issuer Model
In 1966, MasterCard network was established
American Express (1958) and Discover Card (1986)
single-issuer model

13. Credit Card Industry Highly competitive among concentrated market
American Express, Visa, Mastercard, Discover
Declining credit quality
Mortgage Crisis (for some)
Failure of loan payments
Increase in Charge-offs
DFS susceptible to loss rates
Heavily influenced from consumer spending
Threatened by tightening of lending practices

14. Credit Market Home mortgage defaults biggest factor
Increase in bad loans expense (3rd quarter)
Loan-loss expense $16.6BN v. $7.5BN in 3rd quarter 06
Net charge-offs up 200% last year
$10.7BN total (3rd quarter 07’) vs. $3.6BN(06’)
Significant decline in stock values of all the biggest US banks
DFS hurt from sale of asset backed loans to big investors
Further loss expected in near future
"FDIC Quarterly Banking Profile ." Third Quarter December 2007 <

15. Current Market Is a mature market
Estimated 76% of American families had credit card in 2001
Average card number for all households: 6.3
Nearly all retail establishments can process credit card

16. SWOT Analysis

17. Strengths “One-of-a-kind company”:
4th-largest network, 6th-largest credit card issuer, owns the nation’s 3rd-largest debit network.
Potential as a top-tier issuer and processor in a secularly growing market.
Good credit quality: 3.12% delinquency rate 2Q07
Focus on lending to the prime credit segment and strengthening its portfolio: no direct exposure to housing or housing credit market
Attractive and stable card member base
Higher income, better educated, higher percentage of home ownership
Highest percentage that cardmembers stay longer than 5 years
Possibility of a future acquisition
Discover has an attractive and stable cardmember base relative to its peers. These strong demographics include: Higher income Better educated Higher percentage of home ownership. ‘

18. Weaknesses
Continued losses in DFS's U.K. business due to UK’s weak economy.
Lack of global diversification:
Recently inaugurated joint programs with China UnionPay and JCB in Japan.
Has no plans to expand in Europe or Latin America, where the usage of card is growing at double digit rate in selecting countries.
The core Discover Network business, experienced transaction growth of just 4.8% in 3Q07 comparing to MasterCard’s 15.3% in 2Q07
Lower spending per card than peers: the active account rate is only 44%. Marketing the brand to a desirable product is a primary issue.
0% introductory interest rate: 16 out of 17, or 94% of its lending card by discovery carries a 6 or 12 months APR, the highest percentage among peers, where industry average is 73%
Economy of scale: much smaller than Visa and MasterCard
We expect continued losses in DFS's U.K. business due to UK’s weak economy. Lack of global diversification (but able to be turned into opportunities-growth potential)
ThecoreDiscover network
business, whichisthemainsourceof thecompany'sprofitability, experiencedtransactiongrowthof just 4.8%in3Q07.
Thisveryweakgrowthinaseasonallystrongquarter (whichincludesbacktoschool spending), representingjust
one-thirdthegrowthrateof MasterCard, whichturnedintransactiongrowthof 15.3%inwhat isaseasonallyweaker
secondquarter.
Low customer acceptance: although Discover presently has 77% coverage in small and mid-size merchant markets, and been trying to increase its presence in the market. However, the active account rate is only 44%. Marketing the brand to a desirable product is a primary issue.
0% interest rate: 6 out of 7 lending card by discovery carries a 6 or 12 months APR, which potentially might be a problem. After those 0% introductory rates reset and card members are left with significantly higher monthly payments.

19. Opportunities
Continued migration from cash spend to plastic and other electronic forms of payment within the U.S. and continued card penetration internationally
U.S. charge-offs were a solid 3.7% in Aug-Q
Possible take over target
Debit cards usage is growing much faster than the consumer spending and the card usage.

20. Threats On housing and credit related issues,
Possible deterioration of US consumer confidence that would have an impact on consumer spending
A rise in unemployment that would pressure credit quality.
The competition of the industry is very intense: competitors offer identical or similar products

21. Stock Performance

22. DFS Stock Performance Closed at $ 16.45 on 5th Dec 2007
52 Week high low : $ $ 15.72
Source: Wall Street Journal :

23. DFS Stock Performance
International losses have contributed to 39% decline since its spin-off especially Europe
International card business suffered $ 67 million pretax loss in the third quarter
Source: Wall Street Journal :

24. RCMP Position DFS Position
201 shares by virtue of spin off on 2nd July per share
.87 % of RCMP Value
Total RCMP value as of 12/03/07 $
Source: Yahoo Finance:

25. RCMP Profit/Loss Net Profit as of 12/03/07 $ 92173 DFS Loss $ 617
Source: Yahoo Finance:

26. RCMP LOSS Total Loss as of 12/03/07 $ 4499 DFS Loss $ 617.07
Source: Yahoo Finance:

27. Valuation

28. Valuation Difficulties in valuing DFS by cash flow and DCF
Profitability depend on
Interest spread on loans
Investment income
incl. profit / loss from sales of securities
Changes in market value
Loan quality
Young as a stand-alone company

29. Multiple Valuation IMPLIED PRICE: $25.5- $55.96 Company *P/E
Price/Sales
Price/Book
Price to OCF
Discover
17.43
2.40
1.49
8.38
Mastercard
528.65
7.98
11.23
40.86
American Express
19.2
2.56
6.62
7.73
AIG
10.77
1.34
22.17
Industry
11.55
1.95
N/A
Multiple Used
14.98
4.05
14.95
* Figures represent trailing PE multiple. Forward earnings are applied to this multiple to arrive at valuation.
IMPLIED PRICE: $25.5- $55.96

30. Hold! Recommendation Thank you!
Short history as a standing along company
It’s hard to forecast whether the management is able to bring the company out of current trouble
Although multiple valuation gives a high target price, we are hesitant to recommend a buy at this juncture in the company’s young history
Hold!
Thank you!