Sept. 25 (Bloomberg) -- Discover Financial Services, the fourth-biggest U.S. credit-card company, may settle for up to $4 billion with Visa Inc. and MasterCard Inc. in a lawsuit over their efforts to keep banks from working with rivals, according to three industry analysts.

Visa and MasterCard may have to pay as much as $18 billion if the suit fails to settle. U.S. courts earlier determined that restrictions placed on banks by the world's two largest card companies stifled competition and violated federal antitrust law.

Lawyers for Discover will argue that Visa and MasterCard shut it out as the industry grew fivefold in 15 years. The Riverwoods, Illinois-based company claims damages of $6 billion, 10 times its 2007 net income. Under U.S. antitrust law, any award would be tripled automatically.

``It's going to be a payday for Discover,'' said David Robertson, 53, president of the Nilson Report, which tracks the card industry from Carpinteria, California. ``It's just a question of what Discover can do with the money.''

Pretrial rulings in Discover's favor and the potential size of the final award will prod Visa and MasterCard into settling, Robertson predicted. The larger card companies could end up paying a total of $2 billion to $4 billion, he said.

Sanjay Sakhrani, a KBW Inc. analyst in New York, and analyst Scott Valentin of Friedman, Billings, Ramsey Group Inc. in Arlington, Virginia, also forecast a settlement.

Morgan Stanley

Discover wouldn't be the sole beneficiary of a settlement or victory. As part of a spinoff from Morgan Stanley in June 2007, the card company agreed to pay the former parent the first $700 million recovered in the suit, or 22 percent of the bank's net income of $3.2 billion last year.

Morgan Stanley would also receive half of any proceeds above $1.5 billion, up to a maximum of $1.5 billion, according to regulatory filings.

U.S. District Judge Barbara Jones, 60, who's presiding over the Discover case in New York, ordered settlement talks in April after requests from Visa and MasterCard for mediation, according to court papers. She asked for resolution of the case by June 30.

``The mediation scheduled by the judge was unsuccessful in reaching a settlement, but we're stopping short of saying it is officially concluded,'' Discover spokesman Jon Drummond said yesterday by e-mail. ``We continue to prepare for trial.''

MasterCard General Counsel Noah Hanft and spokeswomen Denise Dunckel of Visa declined to comment on settlement talks.

Rule Canceled

Jones ordered Visa and MasterCard in 2001 to stop forcing banks to choose between their cards and ones from Discover and American Express Co.

Visa and MasterCard withdrew the rule in 2004. The Justice Department sued the companies in 1998 over anti-competitive practices.

The judge will instruct the jury in the Discover case that Visa's and MasterCard's rules were illegal restraints on trade, she said last month. Jurors will then decide whether Discover was harmed by the practices and by how much. The trial is scheduled to start Oct. 14.

Visa, based in San Francisco, had 51 percent of the U.S. credit- and debit-card market last year, according to the Nilson Report. MasterCard, based in Purchase, New York, accounted for 28 percent, the report said.

Discover's share was 3.8 percent, and New York-based American Express had 17 percent, the newsletter said. The value of U.S. credit card purchases was $2.17 trillion in 2007, up from $426 billion in 1993.

Discover Earnings

Third-quarter net income fell 11 percent to $180 million, or 37 cents a share, excluding the disposal of its U.K. credit-card business, Discover said today. The per-share earnings were 2 cents more than an estimate by 12 analysts.

Discover fell 40 cents, or 2.6 percent, to $14.82 in New York Stock Exchange composite trading. Of 13 analysts surveyed by Bloomberg, two recommend buying, four say to sell, and seven advise holding.

Morgan Stanley rose $2.31, or 9.3 percent, to $27.10.

Visa and MasterCard say Discover's setbacks stem from its business model. They'll argue the company hasn't entered significant partnerships with banks since 2004, partly because financial institutions earn less from their smaller competitor than from other major networks, according to court papers.

Discover's policy of charging merchants less for using its card produces lower revenue for bank partners, Visa and MasterCard said in court papers. It was ``this business decision,'' MasterCard's Hanft said in a statement, that hampered the smaller card company's growth.

Low Fees

The Nilson Report said Discover merchant fees are the lowest among the four card companies. Discover's Drummond declined to comment on the company's fees.

``Discover has been free to engage in bank-issuing partnerships since 2004, but has yet to demonstrate that it can do so in a meaningful way,'' Visa's Dunckel said.

That's inaccurate and misleading, Discover spokeswoman Leslie Sutton said. The company has more than doubled network transactions over the last four years, signed on private-label card issuers and increased international acceptance, she said. It bought Citigroup Inc.'s Diner's Club International for $165 million in April to add overseas revenue.

``Visa and MasterCard have been consistently over-optimistic about their prospects'' in the cases, Sutton said.

Discover lost almost half its market value since the spinoff. The company may use any proceeds from the suit to increase growth by investing in marketing, Sakhrani of KBW said.

Negative Perception

``There is a perception among consumers that Discover isn't accepted everywhere. The company has said that that's the No. 1 complaint'' among customers, said Sakhrani, who rates the shares ``market perform.'' Discover won't recover until the economy rebounds, the analyst said.

Any settlement will top $1 billion, Sakhrani predicted. American Express, which sued separately, settled for $1.8 billion from MasterCard in June and $2.25 billion from Visa and its bank partners last year.

Discover's settlement is likely to be smaller than American Express's because of the relative size of the two businesses, Nilson's Robertson said. Revenue of the U.S.'s third-largest credit-card issuer is five times Discover's.

A settlement of about $1 billion wouldn't enable Discover to surpass American Express's market share, said Valentin of Friedman, Billings, Ramsey. He rates American Express ``underperform'' and doesn't follow Discover.

Not `Game-Changing'

``I don't think it will be a game-changing event for any of the companies,'' he said.

Visa set aside $3 billion from an initial public offering in March for several cases. Of that, $650 million was earmarked for the Discover suit. About $2 billion is left.

The company will sell additional shares if it needs more than the remaining reserve to resolve the Discover case, diluting stakes held by about 1,800 banks, Visa said in 2007 filings.

Visa has agreed to pay the bigger share of any verdict of settlement, primarily based on relevant business volumes, MasterCard and Visa said in second-quarter filings.

The Discover case is Discover Financial Services Inc. v. Visa USA Inc., 04-cv-7844; the Justice Department case, U.S. v. Visa USA Inc., 98-cv-07076, both U.S. District Court, Southern District of New York (Manhattan).

To contact the reporter on this story: David Glovin at the federal court in New York at dglovin@bloomberg.net.

Last Updated: September 25, 2008 16:51 EDT