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Morningstar | Capital One's Tech Investment Is Leading to Customer Wins and Higher Growth

We maintain that technology investment and related capital spending is of growing importance to banks, specifically Best Idea Capital One, and investors should be paying better attention to banks' technological capabilities. Early adopters such as Capital One stand to benefit from higher growth, while laggards like Synchrony will see an eroding competitive advantage, which is why we are lowering Synchrony's moat rating and trend to none and negative, respectively. Investors don't seem to appreciate how important a role technology plays in a bank winning new business and defending its competitive position. We believe Capital One's impressive technology capabilities will benefit its growth in the coming years and increase the likelihood of winning new card partnerships without having to pay a premium. This is why we continue to believe that Capital One is materially undervalued by the market.

In addition, we believe lower tech investment will catch some banks flat-footed, which is why we've lowered Synchrony's moat rating and trend to none and negative. Though we anticipate Synchrony will continue to generate returns well in excess of its 11% cost of equity, we believe there are question marks around Synchrony's capabilities in data and technology. Until these questions are answered, we will not be awarding a moat. Should Synchrony's current issues prove to be benign, we think the company can regain a narrow moat rating. For that to happen, we would need to see Synchrony's technology improve or have the company's remaining partners consider technology less of an issue than other retailers.

In a new Select piece, "Capital One: A Moat in Tech That Vikings Can't Surmount," we take a look at the role technology investment is playing in narrow-moat Capital One's efforts to maintain its positioning in an industry known for intense competition. Capital One's leadership in technology may be most observable in the bank's retail card partnership operations. In July, Capital One caught many investors by surprise when it deftly stole Walmart's retail credit card portfolio from rival Synchrony. Some will suggest that Capital One likely just offered Walmart better economics. We think it's more likely a result of Capital One's superior tech offering built on its decision to provide its internally generated intellectual property as open-source software available to anyone. In addition, Capital One’s technology greatly benefits from the company’s decision to migrate its operations from local hosted data centers to Amazon Web Services. We believe Capital One’s embrace of the public cloud should significantly accelerate development speed, which was likely a key competency that enabled it to win Walmart’s credit card business.

We suspect Capital One's focus on DevOps, a concept likely new to many investors, played a significant part in winning Walmart. Simply put, DevOps is a culture that aims to unify software development and operations, resulting in faster deployments and greater efficiencies. We believe the DevOps movement is analogous to manufacturers' focus on lean production techniques, and investors will be hearing much more about this concept in the coming years. We view technology investment and technology culture as critical areas for all banks as they seek to win customers not on Main Street but through digital channels. In our opinion, retail credit card portfolios are just the latest example of how critical it is for banks to develop state-of-the-art technology infrastructure in order to maintain economic moats.