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MAY 10, 2002 STREET WISE By Olga Kharif How Valuable Is E*Trade's Crown? The No. 1 online broker has cut costs to combat slowing trading volume. And despite its diversified business, trading is what it's really about
Now, with the tech-laden Nasdaq having dropped 24% in the past 12 months, E*Trade's fortunes have taken a turn for the worse. Yes, the Menlo Park (Calif.) company has managed to keep revenues steady despite a 30% decline in online trading volume. And E*Trade's online banking business (it owns the nation's second-largest ATM network) has helped keep its head above water. Still, at $5.70, E*Trade's shares are a far cry from prior heights -- and they continue to fall. Most analysts maintain a rather bearish stance on the company's outlook. What's going on? E*Trade reported $331 million in revenues in the first quarter, vs. $330 million in the year-ago period. Its net loss totaled $276 million, or 80 cents a share, vs. a loss of $9.2 million (3 cents) in the 2001 quarter. E*Trade blames a required accounting change on goodwill, along with merger-related expenses, losses on investment, and nonrecurring charges. It should turn cash-flow positive in the second half of 2002, says Connie Dotson, chief communications and knowledge officer. Financial researcher First Call says operating earnings, excluding charges, should grow 40% this year, to $223 million (63 cents per share), from $159 million (45 cents) in 2001. SLIMMER PAYCHECK. Part of E*Trade's problem, however, is that this impressive growth is expected to come mostly from cost cuts, rather than revenue increases, says Bob McMillan, an analyst with Standard & Poor's. Among those cuts is a downwardly revised compensation package for CEO and Chairman Christos Cotsakos. On May 10, E*Trade announced that Cotsakos is getting a new two-year contract that stipulates no salary and a bonus based on performance objectives (which aren't specified). If those are met, he'll get a $4 million bonus. Cotsakos also forfeited some of his other perks. He returned 2 million of 4 million restricted shares in E*Trade that he received in 2001 as a one-time grant. The remaining 2 million shares are valued at $14.5 million. And he gave back $6 million of $9.6 million in last year's contributions to his retirement. The biggest cut, however, came from the changes he agreed to in his severance package: Cotsakos would get a lump sum of $4 million instead of $44 million. Cotsakos accepted the cuts because "his goal with his new compensation package was to ensure that it was completely aligned with shareholder interests," according to a company spokesperson. GRIM PROJECTIONS. He faces a struggle there: E*Trades sales likely will increase 10% in 2002, to $1.4 billion from $1.27 billion, estimates S&P's McMillan. That's respectable growth in a sluggish economic environment -- but certainly not what investors have come to expect from an online giant with an appetite for gobbling up half a dozen companies a year. Furthermore, these results are predicated on the stock market at least remaining stable, which is hardly a certainty. Analysts are concerned because online trading, which accounted for 68% of E*Trade's revenues in the most recent quarter, keeps suffering as the stock market continues to wobble. Trading revenue fell 13.2% in the quarter ended Mar. 31, to $223.8 million from $258 million in the 2001 period. The April acquisition of closely held broker Tradescape, whose users are professional traders, should help stabilize revenues somewhat, since professional trading hasn't fallen as much as that of other investors, says Dotson. In the near term, however, online trading is unlikely to reemerge as a lucrative business. By 2006, the number of trades made online should increase by 62%, to 389 million from 240 million in 2000, according to researcher Jupiter Media Metrix. But much of that volume will come as new users -- who usually make fewer than 20 trades a year -- get online. GOLF WITH A PRO. Online brokers make most of their money from heavy traders, who make at least 51 transactions a year. And while that group recorded 92 million trades in 2000, it will likely do fewer than that in 2006, estimates JMM's Robert Sterling. Thus, revenues per trading account would continue to decline, and overall trading revenues might not show much growth even when the market regains its footing, he says. To counter these possibilities, E*Trade is doing all it can to attract new customers and increase the number of transactions they execute. One of the most well-known Web and TV marketers, it recently ran ads offering golf lessons with the pros and race-car driving lessons as a bonus to investors who sign up for E*Trade's services. Another ad targets customers of online broker Datek Online Holdings, which was recently acquired by rival Ameritrade (AMTD ). However, "a client doesn't leave because of an ad in the paper," counters Ameritrade CEO Joe Moglia, who says he expects negligible attrition (see BW Online, 5/10/02, "Why Ameritrade 'Is Very Comfortable'"). Meanwhile, E*Trade recently announced that it would increase fees by $3 per transaction for investors making fewer than 75 trades a quarter. At a time when competitors are cutting prices, that could potentially turn some customers away. BACK TO THE BANK? E*Trade's banking business, which accounts for 32% of sales, also could have a bumpy ride in the next few quarters. Most of the growth in banking deposits -- now at $9 billion -- has come from acquiring accounts from other banks, rather than from increasing deposits by existing customers, says David Marsh, an analyst with Friedman, Billings, Ramsey & Co. About 80% of its certificates of deposit, offering high rates of return that were used to lure new account holders, should mature by the end of the third quarter, he estimates. At that point, many customers may choose to move to traditional local banks offering comparable rates, Marsh believes. Dotson disagrees, saying: "We have not seen a huge attrition." E*Trade's mortgage business, accounting for 7.5% of revenues in the past quarter, would likely slow if interest rates rose, McMillan says. Already, mortgage revenues have declined by 26% in the first quarter, to $24.7 million, down from $33.3 million in the fourth quarter, when the refinancing boom peaked. And Marsh says E*Trade must still contend with a shareholder lawsuit alleging "a breach of fiduciary duty and a waste of corporate assets" over $15 million in loans, among other payments, it gave CEO and Chairman Cotsakos. E*Trade declined to comment on the lawsuit. TOO MANY IRONS? Still, E*Trade is probably in a better position than many other online brokerages, says Todd Halky, an analyst with Putnam Lovell Securities, who has a buy rating on the stock based on what he considers an attractive valuation. He rates competitors Charles Schwab and Ameritrade as holds. With its bank operations and the nation's second-largest ATM network, E*Trade is more diversified, he says. "It becomes a model that really works in the best of times and in the worst of times," says Dotson. However, going after many different businesses -- most recently, E*Trade made plans to offer analyst research -- could strain its resources, says Michael Vinciquerra, an analyst with Raymond James & Associates. The financial markets reward companies for being diversified, but E*Trade may be too spread out. E*Trade has many good points. Its debt-to-equity ratio of 2.6 is "very low" relative to the rest of the industry, says Marsh. It also has significantly cut its costs: by 22% in the past year, and they should fall by an additional 7% by yearend, calculates Halkey. But that, in the eyes of investors, might not enough to fuel another rocket ride to the moon.  Kharif covers technology for BusinessWeek Online in Portland, Ore. Edited by Beth Belton Get BusinessWeek directly on your desktop with our RSS feeds.  Add BusinessWeek news to your Web site with our headline feed. Click to buy an e-print or reprint of a BusinessWeek or BusinessWeek Online story or video. To subscribe online to BusinessWeek magazine, please click here. Learn more, go to the BusinessWeekOnline home page  | | MAY |
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