BUSINESSWEEK ONLINE : APRIL 3, 2000 ISSUE
COVER STORY

Why E*Trade Isn't Just Another Online Hawker of Stocks
Its own stock is in the dumps, but investors who hang on now may be happy later

Whether you find E*Trade's get-rich-quick advertisements appalling or amusing, one thing is for sure: They're working. The company is growing faster than any other online brokerage and is poised to overtake Charles Schwab (SCH) as the Net firm with the most accounts. If you're an investor in E*Trade, though, you may qualify as a victim of Wall Street hype. For while E*Trade may be one of the hottest Net companies around, its stock is in the cellar.

In one sense, that's understandable: E*Trade isn't one of those B2B darlings the market has come to love. And profitless Net stocks in general have lost a lot of allure. Moreover, E*Trade is in a crowded field: Today, more than two dozen independent Internet brokerages -- each using roughly the same technology and the same pricing structure -- are jousting for survival. All of which helps explain why E*Trade closed at 27 7/8 on Mar. 23, well off its 52-week high of 72 1/4.

What investors may be overlooking, however, is that E*Trade isn't just another online hawker of stocks. It was one of the first Net brokerages, and thanks to that early lead, it has been able to expand beyond the brokerage business by buying an online bank and offering insurance and mortgage products. It fact, it may be the first dot-com financial superstore -- and it well could be the last.

"ASLEEP." "E*Trade should never have happened," says analyst William Wong of Josephthal & Co. "It was extremely easy to set up an online brokerage, but all the traditional financial institutions were asleep. E*Trade got enough of a jump start that it could spread out to other areas. Now, every financial firm is doing that, and a startup won't be able to replicate the feat."

E*Trade's breadth has caught the attention of entrenched banks and brokerages: The Wall Street Journal reported in mid-March that both American Express (AXP) and Goldman Sachs (GS) had been in takeover talks with the company. The apparent failure of both those deals knocked E*Trade's stock down 3% on Mar. 21. But E*Trade shareholders should smile, not frown: An independent E*Trade has a lot more appeal and room to maneuver than if it were a subsidiary of a larger corporation. "They have a model that works," says Bryan Keane, an analyst with Prudential Volpe who rates the stock a strong buy. "Why should some other company take advantage of the platform that E*Trade has already built?"

At the end of 1999, that platform was being used by 1.9 million brokerage customers and 130,000 banking customers. E*Trade traditionally has experienced 30% to 50% annual growth in accounts, and this year should be no different, says Josephthal's Wong. He expects that when the company reports its fiscal second-quarter results, in mid-April, it will have added about 354,000 new accounts.

STOCK MACHINE. That's impressive for the first quarter of the calendar year, which is traditionally a slow period for brokerages. Wong thinks E*Trade's average daily transaction volume will increase 43% in the second quarter. He also expects the company's online bank, currently called Telebank (it will probably change its name to E*Bank sometime in the next month) to add an additional 33,000 customers.

To grow faster, E*Trade has just bought the nation's largest independent ATM network, Card Capture Services. That makes it the first online bank to have a nationwide point-of-presence network. Now customers can deposit money in either a banking or brokerage account, withdraw money without paying the $1.50 fee, and even buy and sell stocks -- all at an ATM. E*Trade hasn't announced how much it paid for the network, which has 8,500 individual ATM's in the top 80 metropolitan areas of the country. But "this is a hugely important acquisition," says Scott Appleby of Robertson Stephens. "It gives them a space to interact with customers that they didn't have before."

It also makes the concept of an online bank much more practical. Previously, customers had to mail in deposits and withdrawal requests, both of which can now be done at an ATM. And ATMs are an effective marketing tool. "There aren't many other places where you're forced to stand in front of a computer screen and give your whole attention to a corporation. In some ways, it's better advertising space than the Internet," says Matthew Vetto, an analyst with Salomon Smith Barney.

PROFITS, SOMEDAY. E*Trade isn't without problems. The biggest drawback analysts see is the size of its average account. While Charles Schwab averages more than $90,000 per account and Ameritrade (AMTD) averages about $43,000, E*Trade boasts only $23,000. "Part of the problem is the [large] number of new customers, which tend to start as small accounts," says Prudential Volpe's Keane. "But I would definitely be happy to see [the average account size] going higher."

Another trend analysts would like to see would be more cross-selling of the banking service to brokerage customers. As of the end of January, only 15% of Telebank's customers were also E*Trade brokerage customers. But the company will try to change that with marketing. "The cheapest customer to acquire is someone who already is affiliated with you," says Salomon Smith Barney's Vetto.

Of course, the key event analysts are waiting for is profitability. E*Trade was briefly profitable last year, then decided to take losses in order to invest more in its business. Most analysts expect it to show earnings again in the second half of 2001. The current consensus of analysts is that the company will lose $55 million, equal to 19 cents a share, in the just-concluded second quarter, vs. a per-share profit of 30 cents in the year-ago period.

But Josephthal's Wong recently lowered his estimated loss from 19 cents to 16 cents: "This is going to be a good quarter," he concludes. "They have a lot of things going for them right now." Apparently, something more than hype.

By Sam Jaffe in New York

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