E*Trade Is No One-Trick Dot-Com


By Eric Wahlgren The glass-sheathed E*Trade Center on Madison Avenue, perhaps New York City's most upscale thoroughfare, gives a sense of the change afoot at the online brokerage. The dot-com dynamo helped pioneer do-it-yourself investing, which it hyped with trendy TV ads featuring dancing monkeys and the like. Today, investors can stroll into E*Trade's decidedly bricks-and-mortar superstore in New York -- and others like them across the country -- to place trades, take part in investing seminars, or meet with financial advisers, face to face.

If E*Trade (ET), which logged about $1.3 billion revenues in 2001, is beginning to walk and talk like a traditional financial-services company, that's because it's trying to survive and prosper beyond the online trading boom of the late '90s. Largely through a string of acquisitions, the Menlo Park (Calif.) company now provides banking, insurance, mortgage lending, and other services in addition to its core brokerage business.

Thanks in part to this diversification, E*Trade in mid-January posted a big jump in fourth-quarter profits, to seven cents a share. That trounced the consensus estimate of four cents a share on net revenues of $345 million. The company also lifted its fiscal 2002 earnings guidance from five cents to a range of 45 cents to 55 cents a share.

DISTINGUISHING FEATURES. The company's performance has not gone unnoticed by investors. Afte hitting a post-September 11 low of $4.83, E*Trade shares soared 154%, to a closing high this year of $12.29 on Jan. 4, before settling back to close at $10.62 on Jan. 25.

The stock's takeoff prompted several analysts to cut investment ratings -- mainly on valuation concerns, which helps explain the recent price dip. But many still rate the stock a buy, based on E*Trade's moves to diversify -- and the fact that its brokerage business shows signs of picking up as the market stabilizes.

"One of the things that E*Trade has done to distinguish itself is its attempt to become a one-stop financial supermarket," says Tim Butler at Pacific Crest Securities in Portland, Ore., who is keeping his buy rating. "Although I don't think we will return to the buoyant conditions of the late '90s, we have seen some stabilization in the stock market. This should start to attract individual investors back [to E*Trade]."

SCHWAB'S LEAD. E*Trade isn't the only online brokerage -- nor is it the only one expanding into other markets. Charles Schwab (SCH), the No. 1 discount brokerage, with $846 billion in client assets, vs. E*Trade's $53 billion, is fabled for its customer service and investment research. Schwab tops the list on research outfit Gomez Advisors' most recent quarterly rankings of online brokerages -- judged by criteria such as ease of use and on-site resources. E*Trade was No. 3. Ameritrade (AMTD), No. 6, also posted expectation-topping quarterly profits in mid-January. Ameritrade, too, is expanding its personal-finance offerings but not as vigorously as E*Trade, analysts say.

E*Trade stands out for at least one reason, says Butler, who also has a buy rating on Schwab and Ameritrade. Despite tough competition, E*Trade is the winner when judged by its price-to-earnings ratio. Based on Butler's 2002 profit estimates for the companies, E*Trade's p-e is 25, vs. 30 for Ameritrade and 32 for Schwab. Butler adds in a research note: "This will serve as a catalyst for E*Trade shares."

Balanced against that are the entire industry's sluggish prospects for trading activity in 2002. Justin Hughes, senior equity analyst San Francisco-based Robertson Stephens, estimates that trading will increase a modest 6%. But although he recently lowered his rating on E*Trade to buy from strong buy, Hughes still sees signs that it's doing better than the rest of the pack.

"NATURAL HEDGE." E*Trade said it handled a daily average of 110,000 trades a day in the fourth quarter, down 27% from 150,000 in the year-ago quarter -- but up 21% over the previous quarter. These numbers are important, since the bulk of brokerage revenues come from trading commissions. By comparison, Hughes estimates that E*Trade's rivals will report a 15% fourth-quarter increase in average daily trades.

"E*Trade has the best chance of making its earnings numbers in a bad market," says Hughes, who has made it his top pick in the sector. He also recently increased his 12-month stock-price target to $15 from $13.

"There are other ways to boost revenues if [trading] transactions remain light," notes Dan Burke, director of brokerage services at Gomez Advisors, based in Waltham, Mass. One reason for Hughes's upbeat outlook is E*Trade's success in decreasing its reliance on its brokerage business. In 2002, Burke projects that trading commissions will account for about 26% of revenues, vs. about 30% in 2001 and 45% in 2000.

"I think we have been pretty clear with the Street that we don't see a significant catalyst from trading volumes," says Mitchell Caplan, chief financial products officer and managing director at E*Trade. "About a third of our revenues will come from transactions, a third will come from interest-rate spreads, and a third from [lending] fees. Each [category] is a natural hedge against volatility in the others."

EXPANSION PLANS. E*Trade is a much leaner company than it was a year ago, analysts say. Although it's again sponsoring the Super Bowl's big-ticket half-time show, it had slashed overall marketing expenditures -- to about $54 million in the fourth quarter of 2001, from about $98 million in the year-ago quarter. Butler estimates that it cut total operating expenses by $250 million last year.

Although E*Trade has a "no-furlough" policy, Butler says the company has become more rigorous about weeding out underperforming employees. "Management has really been managing costs," says Butler. As it continues to watch expenses, E*Trade has accumulated about $400 million in cash for acquisitions and other strategic purposes, adds Hughes. Caplan says the company is looking to expand into other areas and that a credit-card operation may be on the horizon.

E*Trade does have its skeptics. Raymond James & Associates' Michael Vinciquerra concedes that it has "been pretty successful at expanding." But Vinciquerra, who decreased his rating on the stock recently to market perform from buy, adds that the diversification "complicates the business and makes it more difficult to manage."

THE MORTGAGE FACTOR. E*Trade's mortgage business, which Hughes says added about $64 million in revenues in the fourth quarter, could slow somewhat next year if the flurry of refinancings that occurred in 2001 due to rock-bottom interest rates dries up and long-term rates rise. Says Vinciquerra: "If you have the brokerage business and mortgages weak, that tells us the stock may be a bit ahead of itself."

Another question that gives some experts pause is whether E*Trade can pull off its transformation into a diversified financial-services company. "Financial issues can get complicated, and the lack of dedicated advisers can be a weakness," says Burke. "Are people going to look to E*Trade for a one-stop shop for financial needs?"

Burke says many investors like the ease of working with one company that can handle a variety of accounts, including investment, insurance, and banking. Providing that breadth demands resources, however. If E*Trade wants to go after the high rollers who generate more fee revenue, it has some work to do. According to Butler, current assets-per-account at E*Trade are about $12,700, vs. about $110,000 at Schwab.

COMING SOON. To keep adding heft to its offerings, E*Trade is partnering with Ernst & Young to allow investors with $100,000 or more in their accounts to consult with advisers at that firm. In addition to its stand-alone centers, E*Trade will be opening up 43 E*Trade "Zones" in Target stores, where customers can open accounts, do research, and meet with a service associate. Still, cautions Burke, "that's going to take a lot of resources going forward."

How well E*Trade can pull off its transformation will depend to a large extent on market conditions in 2002, analysts say. But even if the market only putters along, many analysts are confident that the company is firing on enough cylinders to see some decent gains this year. Wahlgren writes about financial markets for BusinessWeek Online in New York


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