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There's mounting evidence that smaller online brokers should start thinking seriously about their options. The Nasdaq's slide this year is putting the squeeze on trading commissions industrywide. More importantly, the ranks of online brokers have swelled to more than 150 players. This has put a lid on price increases, while forcing firms to maintain high marketing expenses so they can build their brands and stand out from the crowd. E*Trade (EGRP) spent $500 million on marketing in the 12 months ending in June. Few competitors have the resources to compete with that kind of spending. The bulge in the number of online brokers will only put increasing pressure on smaller players. In the second quarter, 93% of the 1.8 million new accounts that constituted 90% of the trading volume at online brokers went to the 10 largest firms, according to Chase H&Q analyst Greg Smith. The trend continued in the third quarter, and there's no reason to think it will change. BIG LEAGUES. For big financial-services firms that don't provide online brokerage, now is the time to consider a deal. On Oct. 12, Germany's Deutsche Bank paid $840 million to buy the 84% of National Discount Brokers (NDB) that it didn't already own. The price represented a 100% premium over NDB's share price at the time. That's a steep price. But with brokerage stocks at sustained low levels, there's a good chance some of the world's giant financial-services firms that are weak in retail brokerage could pull off similar deals that would instantly catapult them into the big leagues of the retail investment world. One potential deal: General Electric Corp. (GE) could buy E*Trade Inc. to create GE*Trade. GE needs an online broker, and it needs one fast. The company recently launched a national ad campaign to promote GEFN.com (www.gefn.com), which is billed a broad-based financial-services site but looks more like a sales vehicle for GE's insurance business. Despite the company's claims that GEFN.com will simplify people's financial lives, the site has a gaping hole: It does not offer online trading. EASY SELL. GE could easily afford E*Trade -- though it wouldn't be cheap. Its recent market capitalization has hovered around $3.5 billion. If GE paid twice that amount, matching Deutsche Bank's premium for NDB, it would instantly become a major competitor to Fidelity, Schwab (SCH), and Merrill Lynch (MER). And with some GE magic applied to E*Trade's bloated cost structure, E*Trade could potentially meet GE's strict standards for profitability. It wouldn't be a tough sell to persuade E*Trade shareholders to trade in their stock for GE shares, one of the best-performing stocks of the decade. GE might even be able to do it for less than a 100% premium over today's prices. Any one of the top independent brokers would benefit from such a deal. Charles Schwab & Co. (SCH) has long been rumored to be a takeover target for Goldman Sachs (GS). While that's possible, Schwab's top rivals are also highly desirable. Ameritrade (AMTD), TD Waterhouse, and E*Trade are all high on analysts' lists of potential acquirees. The potential buyers are numerous. American Express, Citibank, Goldman Sachs, American International Group, or some of the large European banks could all do deals for online brokers. Many of these buyers won't want to bother with many small online brokers. For the small fry, the best option may be to find a big company that needs brokerage services and wants to form a partnership. If they can't do that, they'll need to merge with other small brokers. Smith covers a wide variety of topics, including personal finance issues, from Business Week's Boston bureau. Have a question or a comment? Let him know at geoff_smith@ebiz.businessweek.com. |
