Discover Financial Services RCMP presentation 12 06 2007

Discover Financial Services RCMP presentation 12. 06. 2007 Zhifeng (Jack) Chen Gloria Ho Jonathan Li Swechha Salgia Jeremy Smith Zheng(Andrea) Zhang

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

Company Overview

Company Overview • • A leading credit card issuer and electronic payment service company in US and UK Three major business segments: ü U. S. card 50 m card members, $47. 4 b receivable ü Third party payment PULSE, 2. 8 b transactions ü International card Goldfish Bank, 2 m card members, $4. 4 b receivable Primary revenue source: ü Interest income ü Securitization income ü Fees from card members, merchants Operating capital source: ü Asset securitization ü Consumer deposits

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. 25 2007 DFS Profit Falls in the 3 rd quarter ER due to higher marketing and interest expenses • Dec. 3 2007 DFS to take big charge for UK card business in its 4 th quarter ER (about $422 M, equal to its half-year earning) • Dec. 5 2007 Discovery's Consumer Spending Index Down 96. 5 93. 4 from Oct. to Nov. • •

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

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

Business Model Visa/Master. Card: Credit Card Company Credit Card Issuer Credit Card Company $. 25 Consumer $100 Merchant $98 Payment Network Credit Card Issuer Monthly Fee $1. 75 Discover: • Discover owns all aspects of Credit card payment operations, and thus captures all revenue points in this model Monthly Fee Consumer Merchant Transaction Fee

Revenue Breakdown 2006 Revenue *Consumer Loans Asset Securitizations Payment Networks 5. 2 B 2. 1 B 2. 3 B . 8 B *Mostly Credit Card revenue

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

Industry Overview

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

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

Credit Market • Home mortgage defaults biggest factor • Increase in bad loans expense (3 rd quarter) ü Loan-loss expense $16. 6 BN v. $7. 5 BN in 3 rd quarter 06 • Net charge-offs up 200% last year ü $10. 7 BN total (3 rd quarter 07’) vs. $3. 6 BN(06’) • Significant decline in stock values of all the biggest US banks ü DFS hurt from sale of asset backed loans to big investors • Further loss expected in near future "FDIC Quarterly Banking Profile. " Third Quarter 20072 December 2007 .

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

SWOT Analysis

Strengths • • • “One-of-a-kind company”: ü 4 th-largest network, 6 th-largest credit card issuer, owns the nation’s 3 rdlargest debit network. ü Potential as a top-tier issuer and processor in a secularly growing market. Good credit quality: 3. 12% delinquency rate 2 Q 07 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 ü Higher income, better educated, higher percentage of home ownership ü Highest percentage that cardmembers stay longer than 5 years Possibility of a future acquisition

Weaknesses • • • Continued losses in DFS's U. K. business due to UK’s weak economy. Lack of global diversification: ü Recently inaugurated joint programs with China Union. Pay and JCB in Japan. ü 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 3 Q 07 comparing to Master. Card’s 15. 3% in 2 Q 07 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 Master. Card

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.

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

Stock Performance

DFS Stock Performance • Closed at $ 16. 45 on 5 th Dec 2007 • 52 Week high low : $ 32. 17 - $ 15. 72 Source: Wall Street Journal : http: //online. wsj. com/quotes/stock_charting. html? symbol

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 : http: //online. wsj. com/quotes/stock_charting. html? symbol

RCMP Position • DFS Position • 201 shares by virtue of spin off on 2 nd July 2007 @ 19. 52 per share • . 87 % of RCMP Value • Total RCMP value as of 12/03/07 • $ 379895 Source: Yahoo Finance: http: //finance. yahoo. com/p? k=pf_1

RCMP Profit/Loss • Net Profit as of 12/03/07 • $ 92173 • DFS Loss • $ 617 Source: Yahoo Finance: http: //finance. yahoo. com/p? k=pf_1

RCMP LOSS • Total Loss as of 12/03/07 • $ 4499 • DFS Loss • $ 617. 07 Source: Yahoo Finance: http: //finance. yahoo. com/p? k=pf_1

Valuation

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

Multiple Valuation 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 1. 49 22. 17 Industry 11. 55 1. 95 N/A Multiple Used 14. 98 1. 95 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

Recommendation • 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!