ere's a potential scenario that's sure to create angst among card issuers and acquirers, alike: First Data Corp. buys Discover Financial Services and diverts huge volumes of transactions to its already large processing systems.An analyst recently broached the possibility of such an outcome at a TowerGroup conference on technology and financial services. TowerGroup is a research house owned by MasterCard International.

Morgan Stanley's pending spin-off of Discover was the focus of some discussion, as well as recent court rulings that have taken to task Visa U.S.A. and MasterCard International. The competitive implications of certain corporate combinations (e.g., Discover and First Data) were also a hot topic.

"I don't see American Express [Co.] as a main competitor for bankcards," said John Gould, Director of Bankcard Research Service at TowerGroup. "What I see is Discover making a move." He then asked rhetorically: "Could First Data buy Discover?"

It's possible, I suppose, but I can't imagine something like that occurring without the Department of Justice, and maybe even the Federal Trade Commission, having a say. Today, First Data's card acquiring arm, First Data Resources (FDR), acquires about 21% of all U.S. credit card volume, Gould said. First Data also owns STAR, the largest ATM/POS card network, and Western Union. "Add a credit card [brand] to the mix, and they become an 800-pound gorilla," he said.

First Data was all but accused of being a monopoly during its acquisition of Concord EFS Inc. in 2003. Concord owned STAR, and First Data owned NYCE. At the time, NYCE was the third-largest debit network, supporting PIN-based debit throughout the Northeast. Justice Department protests (filed in federal court) stalled the deal for several months. Only after First Data agreed to sell NYCE did the Justice Department allow its acquisition of Concord. So you see, Visa and MasterCard aren't the only payments companies to pique the interest of federal antitrust cops.

Discovering a Way Around Visa

First Data has made no secret of its desire to grow revenues produced by its transaction processing platform. In 2002, Visa sued to block the acquiring giant from diverting card transactions directly acquired by First Data and its acquiring bank partners from the VisaNet processing system. That litigation, and a counter-suit accusing Visa of "anticompetitive and monopolistic practices," are still in the courts.

Discover is a two-party credit card system launched nearly two decades ago by Sears, Roebuck and Co. Sears eventually spun it off along with the rest of its financial services business under the Morgan Stanley corporate moniker. At last count, Discover had nearly 20 million active card accounts.

Last year, the U.S. Supreme Court affirmed lower court rulings that Visa and MasterCard rules, which precluded member banks from issuing competing cards (like American Express or Discover), violated federal antitrust law. That ruling has spurred several new alliances. The most notable of these has Wal-Mart Stores Inc. issuing a new Wal-Mart card processed through the Discover network.

Earlier this year, Discover acquired PULSE EFT Association, the largest bank-owned ATM/POS network. At that time, an estimated 90 million cards bearing the PULSE logo were being accepted at 4 million merchant and ATM locations, according to PULSE.

Shortly after the acquisition of PULSE, Morgan Stanley announced it would spin-off Discover. This latter move has prompted speculation about who might purchase the company's card issuing and acquiring portfolios.

Analysts have named Wal-Mart as a possible buyer, but the retailer has hit legal brick walls in the past in its attempts to own a bank (a legal prerequisite for issuing bankcards). But say they get past the legal barriers. Now imagine that Wal-Mart has the kind of success selling credit cards as it does bargain household items. Then imagine all those transactions flowing across Discover's network. Now imagine First Data owning Discover.

What if Visa loses its argument against First Data withholding transactions from VisaNet? Nothing could stop First Data from combining the volumes generated by PULSE, Discover and the new Wal-Mart card, with its existing on-us workload. That makes it easy to see how First Data poses a real competitive threat, especially for Visa.

Of course, all this is idle speculation and conjecture. But, stranger things have happened in the payments space.

Patti Murphy is Contributing Editor of The Green Sheet and President of The Takoma Group. E-mail her at patti@greensheet.com .