TD Ameritrade In Merger Talks With E*Trade By SUSANNE CRAIG and DENNIS K. BERMAN August 22, 2007; Page A1
The online brokerage industry, which underwent a wave of consolidation after the bursting of the dot-com bubble, may be headed for another shakeout, with giants TD Ameritrade Holding Corp. and E*Trade Financial Corp. holding merger discussions.
A merger of the two online brokers would create a dominant player in what has been a highly fragmented industry, with dozens of smaller companies battling for market share. As a result, it could reduce some of the fierce competition that has benefited consumers by driving down the cost of online trading but has squeezed the industry by chipping away at its profit margins.
As of the end of June, E*Trade had 4.7 million brokerage and banking accounts, TD Ameritrade had 6.3 million such accounts, and Charles Schwab Corp., now the largest online broker, had about 6.9 million. Merrill Lynch & Co., in contrast, has more than 7 million customer accounts.
A spokeswoman for E*Trade said the firm's management team has consistently stated it believes there is "tremendous value in consolidation that aligns business strategy and operational synergies and will do what is in the best interest of its customers." A TD Ameritrade spokeswoman said, "We have talked and continue to talk to peers in the industry."
E*Trade and TD Ameritrade have been in serious discussions for weeks but aren't yet close to a deal, according to people familiar with the matter. They have discussed an alliance several times in previous years but have never managed to make it to the altar. This time, however, they may feel more pressure to reach a deal. Two hedge funds with big stakes in TD Ameritrade have publicly urged the two companies to talk.
The two funds -- Jana Partners LLC and S.A.C. Capital -- have argued that Toronto-Dominion Bank, which owns 39% of TD Ameritrade, opposes a merger of the company because its interests aren't fully aligned with other shareholders. The funds, which own a combined 8.4% of TD Ameritrade, contend that the Canadian bank wants to use the online broker, which is based in Omaha, Neb., to grow in the U.S. and isn't necessarily focused solely on maximizing shareholder value. TD Bank has publicly disagreed with that characterization of its position.
Even so, Jana and S.A.C. successfully pressured TD Ameritrade to remove TD Bank's chief executive from the online broker's mergers and acquisitions committee in early July.
It isn't clear what a merger deal between E*Trade and TD Ameritrade would be worth or how it might be structured. One person familiar with the talks estimated a deal could create a company valued at as much as $20 billion, given the cost saving that could result from uniting both company's accounts on a single computer system. The consolidation would make the cost of adding new clients minimal.
Yesterday, E*Trade shares rose 93 cents to close at $15.57 in 4 p.m. composite trading on the Nasdaq Stock Market. TD Ameritrade, which also trades on Nasdaq, closed at $16.35, up 17 cents. TD Ameritrade currently carries a market capitalization of $9.74 billion while E*Trade's stock value is $6.6 billion.
A person familiar with the merger talks said the discussions currently are focused on making sure both online brokers agree on strategy. Ameritrade historically has been known as king of the low-cost trade while E*Trade has pursued a more diversified strategy and even owns a bank. In recent years, though, both firms have become more focused on offering customers an array of products.
"Both companies are looking to add client assets and diversify their operations away from trading commissions, so on many levels a merger makes sense," says Rich Repetto, an analyst at boutique brokerage firm Sandler O'Neill + Partners LP.
Since the Internet bubble burst, the sector has been beset by falling commissions. New York-based E*Trade, for instance, now charges between $6.99 and $9.99 a trade. In 1997, by contrast, Schwab Corp. made headlines by offering the then-bargain price of $29.95 for online trades of up to 1,000 shares. At the time, Schwab insiders worried that such a price cut -- trades had cost roughly three times that amount before -- would eat up profits.
Today, the competition for low-cost trades is even fiercer. Some banks, including Bank of America Corp. now offer free online trades for customers who meet certain minimum-balance requirements. In Bank of America's case, customers must have at least $25,000 in deposits to qualify.
With private-equity firms shrinking from the acquisition scene amid the current credit crunch, traditional mergers among industry rivals like TD Ameritrade and E*Trade may be the surest path for such companies to reach a deal. Such a deal might also be subjected to less antitrust scrutiny now under the business-friendly Bush administration than if it came up for review under President Bush's eventual successor.
In recent years, a number of deals between major competitors have passed antitrust muster, including appliance maker Whirlpool Corp.'s acquisition of Maytag Corp. and the merger of the nation's largest and second-largest hog producers, Smithfield Foods Inc. and Premium Standard Farms Inc.
The credit crunch, however, has added a new wrinkle to the TD Ameritrade-E*Trade talks: Last week E*Trade was hit with rumors that the quality of its mortgage portfolio, a growth engine for the company in recent years, was weak. The company's stock's dropped 28% last Thursday before rebounding the same day after E*Trade assured the market that despite some volatility, "the financial health of the company is sound."
Still, sources close to the negotiations say the quality of E*Trade's mortgage portfolio is an issue TD Ameritrade is watching closely.
Eventually, those involved in the talks say they expect the sticking points to be familiar ones: The two sides will need to agree on a management team to run the combined company and, on a related note, what degree of control Ameritrade shareholder TD Bank would have once the two brokerage firms were combined.
Picking a management team won't be easy. Both companies are run by forceful chief executives: Mitch Caplan at E*Trade and Joe Moglia at TD Ameritrade. Control was a point of contention during Ameritrade's 2005 talks with TD Bank. Eventually Mr. Moglia got the CEO post and TD Bank acquired five of the company's 12 board seats.
A person familiar with the matter said the two companies were talking before hedge funds Jana and S.A.C. went public with their call for talks between the pair. This person said the move actually slowed down negotiations because TD Ameritrade has been working to address some of the concerns raised by the funds, such as removing the TD Bank CEO from its merger and acquisition committee.
A deal between E*Trade and TD Bank would put added competitive pressure on Schwab. During a conference call with analysts in July, Schwab Chief Executive Charles Schwab threw cold water on speculation his firm might merge, suggesting that its internal growth opportunities were superior to acquisition-related ones. Yesterday, a Schwab spokeswoman declined to comment.
Schwab, long criticized by analysts for its high expenses, has sought in recent years to cut costs. It also recently named Walt Bettinger as president and chief operating officer to help assuage some concerns that had been brewing on Wall Street about the depth of Schwab's management bench. In another move aimed at getting its house in order, Schwab last year sold U.S. Trust to Bank of America. Schwab initially bought U.S. Trust in hopes of retaining more wealthy clients, but the marriage never worked, in part because of culture clashes between the two companies.
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