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Snubbed E*Trade rebounds nicely with acquisitions
Even if Brown & Co. and HarrisDirect weren't first on E*Trade's wish list, acquiring the two also-rans should be enough to give the online broker's own shares a boost.
By Robert Walberg
Spurned at the altar a few months back by Ameritrade, E*Trade has wasted little time lining up new partners. Last week, the online brokerage company agreed to pay $1.6 billion to acquire Brown & Co -- the online brokerage arm of JP Morgan Chase. That deal came just weeks after E*Trade said it would buy HarrisDirect for $700 million.
Were these just hasty moves by a desperate company? Or has E*Trade (ET, news, msgs) landed a couple of small but valuable assets at a fraction what it was willing to pay for Ameritrade (AMTD, news, msgs)?
With the online brokerage industry in the midst of rapid consolidation, there werent that many jewels left to be had. E*Trade didn't have a lot of time to waste. Unfortunately, businesses, like people, often make bad investment decisions when they make them quickly and out of a sense of panic.
Knocking on Ameritrade's door
It could be that the management over at E*Trade was looking at HarrisDirect and Brown & Co. as alternatives all along. Both might have been on E*Trade's original short list -- and for good reason.
In adding HarrisDirect and Brown & Co, E*Trade gains about $60 billion in assets and more than 600,000 new accounts. When the deals are done, E*Trade will have about 4.3 million accounts and nearly $160 billion under management. Well behind industry leader Charles Schwab (SCH, news, msgs), certainly, but knocking on the door of Ameritrade.
In fact, with the recent spate of deals, industry experts now say these three firms control a 75% share of online trading, up from about 55% when the summer began. As you can see, the leverage from future deals in the space will start to diminish as added companies get smaller and smaller. This is why E*Trade felt compelled to act, and act fast.
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Though the company paid a hefty premium for Brown & Co (about $8,000 per client versus, a little more than $1,625 HarrisDirect client), there was good reason. The account size of Brown & Co. clients was significantly larger, the average trade size was much greater and its customers traded much more frequently.
So while the price E*Trade paid for Brown & Co raised some eyebrows, the numbers do add up -- especially when you consider that Brown & Co.s sophisticated, relatively wealthy clients will make ideal targets for E*Trades banking services. Most adjusted earnings estimates after the deal excluded the potential benefits from cross-selling products and services.
A sound rebound
Left with few good alternatives after being spurned by Ameritrade, E*Trades management deserves credit for acting quickly and decisively to add a couple of quality firms that when combined will provide E*Trade with the heft and product breadth it needs to compete in the industry.
The wave of consolidation was triggered by declining investment activity and pricing pressures -- factors that persist today. Consequently, the failure to act would have been a bigger risk to E*Trade than acting too quickly. Though most of the big names in the online industry have now been acquired, dont be surprised to see E*Trade add one or two more specialized names in the months and quarters to come, as it continues its attempts to add wealthier, more active accounts. One such possibility would be optionsXpress Holdings (OXPS, news, msgs).
E*Trades acquisition binge is weighing on its valuations a bit, as investors wait to see how effectively the company integrates its new partners. Assuming all goes well, and theres little reason to expect much attrition, E*Trade looks like a relative bargain at about 13.9 times estimated 2006 earnings of $1.24. If the company merely meets its earnings targets, there should be upside to the $20 to $21 area over the next 12-months. Thats a gain of 16% to 21.8%.
For a company that was all dressed up with no place to go just a few months ago, that's not bad.
At the time of publication, Robert Walberg did not own or control shares of companies mentioned in this column.
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