Can E*Trade Net Its Rival?


By Joseph Weber If E*Trade Financial (ET) succeeds in taking over its slightly larger rival, Ameritrade Holding (AMTD), the merged company would become the force to beat in online brokerage and banking. Together, the outfits would control an industry-leading 36% of online trading volume. And with E*Trade's moneymaking and growing banking operation, the combined entity would set the pace for rivals such as Charles Schwab (SCH), TD Waterhouse Investors Services, and the giant Fidelity Investments (see BW Online, 5/11/05, "Schwab: Staying Single").

"There are tremendous synergies," says Friedman, Billings, Ramsey & Co. (FBR) analyst Matt J. Snowling. "It would put the combined company in a dominant position."

But whether the deal will get done is far from clear. Ameritrade's major owner, founder J. Joe Ricketts, has cherished his company's independence. He and hard-charging CEO Joseph H. Moglia, a former Merrill Lynch (MER) executive, have built it into the No. 2 online brokerage firm, behind Schwab, by buying smaller rivals, such as Datek Online Holdings and National Discount Brokers. Selling out now could prove to be a tough move for them. The company's board is expected to meet May 11 to consider E*Trade's overture, and neither company is commenting at this point.

FORCING ITS HAND? While Moglia has never hidden his interest in making deals, he has always wanted to be the acquirer. In meetings with BusinessWeek editors on May 4, the Ameritrade chief was talking about being in business for the long haul, pursuing more long-term investors by using new software products, and preaching smart asset allocation.

He also praised the firm's internal reorganization, which created an office of the chairman to spread responsibility among several executives. Moglia was saying his strategies wouldn't take hold for up to two years.

E*Trade CEO Mitchell H. Caplan, for his part, has been broadcasting his interest in a deal with other players for months. In January, he told BusinessWeek that he expected consolidation in the industry and noted that he'd prefer to be an acquirer -- particularly of Ameritrade.

Now that E*Trade has put its rival into play with its estimated $5.5 billion offer, Ameritrade may be forced into a deal. Otherwise, disappointed investors could clobber Ameritrade's stock. Since news of E*Trade's interest, Ameritrade's shares have climbed 24.5% to $13.42, at the market close on May 10. E*Trade's stock has risen 10.3% to $12.31, since speculation arose on May 6 of its plans to acquire Ameritrade.

DISTANT THREAT. Analyst Snowling thinks Ameritrade will be able to demand that E*Trade up its bid -- perhaps by $1 billion or so. Otherwise, Ameritrade could scurry off into an alliance with another rival, perhaps TD Waterhouse. E*Trade itself had considered pairing with TD Waterhouse last year but backed off when it decided it didn't want to cede control to the outfit's parent, the Toronto-Dominion Bank (TD), which would have had a dominant stake after such a merger. A similar deal was rumored between Ameritrade and TD Waterhouse but didn't happen.

Lackluster trading volumes in the online brokerage world are driving the industry's consolidation. The clutch of firms that the Internet boom spawned are battling over a so-so market, which is why they've slashed trading fees so aggressively. Heavy traders can now pay as little as $6.99 per trade on E*Trade.

A merger among online traders likely would not have an immediate impact on the big retail investment houses on Wall Street, since most firms adjusted long ago to discount pricing on stock trading for small investors. But if increased heft helps an online giant draw in institutional customers, along with the small fry, the Web outfits could make a dent. For now, such a threat seems remote.

BRICK-AND-MORTAR POWER. It has also become painfully clear that trading alone may not be enough to sustain an online financial-services firm. E*Trade CEO Caplan, a lawyer-entrepreneur who got his start in the business by founding the online bank that E*Trade acquired, has been beefing up the company's online banking products -- including credit cards, mortgages, and deposit accounts -- on the belief that customers will gravitate to Web firms that can do more than help trade stocks. He argues that his online bank can offer services cheaper than giant well-established banks still fairly new to doing business on the Net.

Still, Caplan's big wager is hardly a sure one. Pure-play online banking has largely been a dud, as established bricks-and-mortar banks, with their powerful brand names and huge customer bases, have moved aggressively to build their Net presence. Even E*Trade has been slow to turn stock traders into banking customers, with just 642,000 bank-account holders and 3 million brokerage-account customers.

Yet the bank is a key reason that E*Trade's profits are growing: Its net income rose 4%, to $92 million in the first quarter, compared with last year. This occurred on a nearly 5% rise in net revenues to $420 million, even as brokerage-driven Ameritrade saw a 12% slide in its net income, to $71 million, as revenues slipped 5.6%, to $247 million.

OTHER SUITORS? Acquiring Ameritrade wouldn't dramatically beef up Caplan's banking business at E*Trade. But it would help. He would more than double his client base of traders to about 7 million accounts and boost his customer-asset base to $200 billion, swelling the group to whom he could pitch banking services. And analyst Snowling figures that E*Trade would initially sweep about $7 billion in cash, from customer assets, into its bank.

Will Caplan get the chance? If he doesn't and his bid for Ameritrade fails, he could wind up butting heads even more with other powerhouses in the business. Virtually any one of the rivals might like to snap up Ameritrade's customer base. Schwab, with about 21% of the trading volume in the online brokerage business now, could secure its leadership with a deal. And both Fidelity, with its 11% of volume, and TD Waterhouse with its 14%, could similarly stand to gain.

As the online trading consolidation gain momentum, the key players are paying close attention to how E*Trade's overture fares. With Adrienne Carter in Chicago and Tim Mullaney in New York

Weber is the manager of BusinessWeek's Chicago bureau


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