E*Trade Eyes Strength in Size with Ameritrade Bid

The trend for industries to consolidate through major mergers and acquisitions has made its way back to the e-commerce space, with No. 2 online brokerage E*Trade Financial reportedly posed to make a surprise US$5.5 billion bid to buy smaller rival Ameritrade.

Neither company has formally acknowledged the offer has been made and it’s not clear whether Ameritrade would be open to the bid, or whether it could, in fact, spark a bidding war.

Some reports suggest that TD Waterhouse also has been talking to Ameritrade about a merger. Published reports suggest that E*Trade also held extensive merger talks with TD Waterhouse without coming to a successful conclusion.

Future Growth

Whatever the outcome, consolidation would come as no shock to observers of the industry, who have been predicting such moves for more than a year, as companies seek efficiencies to help them become more profitable in the face of slower stock trading levels and sharp drops in the commission fees such brokers charge.

Ameritrade ranks fourth among online brokers, a field currently led by Charles Schwab. Analysts say a merger would be key for helping E*Trade compete effectively with Schwab and positioning itself for future growth in the industry, which could come the next time markets put together a long enough run of gains to win back reluctant individual investors.

Analysts said the fact that the deal has not been publicly acknowledged is an interesting wrinkle, since doing so could cause shareholders eager to capture a significant premium to put pressure on a company to take a deal quickly.

Fox-Pitt Kelton analyst David Trone said in a research note that a $15 per share offer for Ameritrade would be a reasonable price for E*Trade to pay and would provide Ameritrade shareholders a 30 percent premium over recent trading levels.

Trone said he would view “this type of consolidation quite favorably” and said that as individual stocks, the companies aren’t as strong as they could be together, given the climate of lower prices and less trading. “As independents, we are cautious on both,” he added.

Larger Trend

E*Trade has had a decent past year, posting a first-quarter profit that was 4 percent ahead of last year. Ameritrade, however, said in April that second-quarter net income was down 12 percent over last year.

With the potential merger, the online brokerage world is echoing a larger trend that began with the New York Stock Exchange announcing it would buy Archipelago Holdings, an all-electronic securities market that offers after-hours trading and other derivatives trading. In response to that move, Nasdaq Stock Market agreed to buy Instinet Group, another provider of all-computerized trading.

That in turn reflects a larger M&A upswell that has reached virtually ever industry, from telecom to the Internet, energy firms to retail.

However, the urgency might be especially great among the online brokerages. The need to merge is well documented by analysts and, according to published reports, has led to various discussions about merging both E*Trade and Ameritrade with TD Waterhouse in the past year and now to the apparent E*Trade move on Ameritrade.

Neither of the companies involved responded to requests for comment. Speculation about a major deal ramped up when E*Trade canceled a planned European “road show” for investors. That drove up E*Trade shares Friday. The stocks continued to move north today, with E*Trade shares up 6 percent to $12.64 and Ameritrade shooting up 21 percent to $13.71.

Shrinking Margins

The online brokerage world, like many e-commerce sectors, has seen huge changes of fortune since the beginning of the dot-com era. Companies like E*Trade and its rivals saw huge growth in the late 1990s as stock trading boomed in popularity, only to then scramble to cut costs and diversify their businesses after the markets plunged in 2000.

Since many individual stock investors were burned badly by that plunge, many have tiptoed back to the markets, with the strong gains of late 2004 helping to boost trading volumes. E*Trade addressed the drop in trading by diversifying into bank services; it was one of the first online financial firms to begin opening storefront offices around the country.

The uneven market performance of early 2005 has only underscored the urgency of mergers, said Banc of America securities analyst Michael Hecht. “The discount brokerage industry is ripe for consolidation and hopes to participate,” he wrote in a recent report. “To the extent weak equity markets put pressure on the group’s economics, consolidation becomes more likely.”

Forrester Research analyst Tom Watson said the underlying trends — including wider e-commerce adoption, demographics shifts and rising personal incomes — favor online trading in the long run. At the same time, however, some brokerages are cutting fees so deeply as to all but erase profit margins on some trades.

“Brokerages are aggressively courting the active trader, but as firms cut prices and bulk up on functionality, they erode profitability,” he said.

That favors diversified firms, such as E*Trade, while pure-plays — which includes Ameritrade — will see shrinking profit margins on certain trades. The combination could help revive those profit margins by enabling costs to be squeezed further while offering E*Trade’s range of value-added services to a suddenly larger customer base.