Why Is E*Trade's CEO Giving the Company to Citadel?

Yesterday was supposed to be a great day for E*Trade's (ETFC) stock price.

Most retail longs were waiting anxiously for the Loan performance data release as promised. It was widely expected that E*Trade will continue to see improvement in loan performance which should once and for all put an end to speculation that E*Trade's loans will destroy the company. And indeed, the loan performance metrics released at 6.49am (link) showed that the delinquencies decreased further which would have meant that provisions would have been reduced in coming quarter and hence we could have seen a relief rally in the stock price today.

However, within minutes of excellent loan performance data, at 6.52am to be exact, E*Trade announced that it is giving away a majority of the company to Citadel for approximately $1 to $1.20 per share (link).

This is a massive take-under of the company with full co-operation (indeed active assistance) of the current management. The key point here is the timing of the two announcements. Clearly, if the Citadel announcement was done even a few hours after the metrics release - it would have looked VERY embarassing (or suspect), for the CEO to suggest a price of $1 to $1.20 since the stock price could have easily risen from closing price of $1.65 after the loan performance details.

Indeed, ever since it has been clear that E*Trade was putting its trouble behind, every attempt has made to push the stock price down so that such a "take-under" can be completed. Note that at last quarter's earnings report, earnings were missed by 1 cents to suppress the stock price (which at that point had risen to $2.90s). See my previous article about that release.

Subsequently price has been suppresed by continued short-selling.

All this was in preparation of the take-under of a great American company - the only company that managed to survive after the same players who shorted Bear Stearns, Lehman Brothers, Merrill Lynch, WaMu and Wachovia out of existence also attacked E*Trade. Yesterday the final plan was executed - in a terrible haste - because otherwise the $1-$1.20 conversion price on debt-swap would have never been acceptable. By manipulations, they have diluted current E*Trade shareholders 2x to 3x more than what was necessary.

Note the extreme haste with which this deal is being consummated and the events that led to this deal. It started with surprisingly good loan performance numbers in March 2009. To avoid the stock from rising up too fast, my belief is that earnings were missed by 1 cent in Q1 by over-provisioning and OTS's requirements were suddenly brought forward with a threat of major dilution. When Schwab indicated that it may be interested in E*Trade, I suspect that take-under plan had to be put in high-gear. The Citadel CEO joined E*Trade's board suddenly probably to make sure nothing goes wrong. The stock price was kept in control with heavy shorting, and then the deal had to be announced within 3 minutes of the loan performance data.

My question to E*Trade management is, did OTS require you to do this deal within 3 minutes of loan performance data being released? Or would they have been OK if the deal was done 1 week later or even 1 day later? Do you believe that good loan performance data and metrics would have helped current share-holders more and hence would have garnered us better conversion price on those debt swaps? And if so -- why not wait for 1 day -- or even few hours before the deal? Further - what is the hurry in closing this deal by June 18th (i.e., 1 day after the announcement) as indicated in filings yesterday? It is all geared towards making sure that no-one has a chance to challenge "the deal".

The saga that started with Citadel approaching E*Trade in the summer of 2007 for something (not realized), Stock Analyst Prashant Bhatia causing a run on the bank in Nov. 2007, which caused $3B in deposits leave the bank, which caused a shot-gun wedding to Citadel - has now come full circle.

It is clear that only thing killing E*Trade is the debt it was forced to take on due to a manipulative report by an analyst. E*Trade would have survived its loan portfolio fine (as it is clear now).

I am only a small investor writing from my bedroom - I have no power to stop anything. The last few years have taught me that as a retail investor, you are up against an entire system that is working against you (Wall Street professionals, analysts, reporters, politicians, regulators and maybe even the management).

I just hope that a large investor steps up to question this deal and that much better alternatives to this deal exist in an open and "free" market.

Disclosure: Author is long in E*Trade (sadly).

Comments

[Axolotl Folly:]

The deal is not necessarily a bad one for ETFC holders. The interest expense at the parent will be reduced significantly, and the price of $1-1.20 puts a floor under the stock (which has traded as low as 59c earlier in the year). I think Citadel will ultimately aim to sell out a very large profit in a few years when the E-Trade loan portfolio is in much better shape.

Note that Ken Griffin is now on the board of directors, and as such he would have a fiduciary duty to act in the interests of all shareholders. The deal still needs to be approved at a special shareholder's meeting under NASDAQ listing rules.

Happy investing.

Jun 18 08:28 AM

[Al the pal:]

You must be on drugs. The only way Citadel was going to be able to bail out the company was going to be to clobber the shareholders. The writing was all over the wall. plain as day for anyone who wasn't a damn fool permabulltard to see.

This is still far from over, ETFC may not be able to raise 400 million, roughly half its market cap in a secondary offering. Failure to do so would lead to a rapid meltdown and complete failure of the company. The OTS is considering public supervision of the company and its failure to add new capital fast would force their hand.

If they do raise the money that just gives them about 4 months worth of additional HELOC losses before they need to raise funds again. The Heloc losses are ongoing, they haven't stopped.

The ongoing dilution to this stock should keep it in penny stock territory for years to come.

Jun 18 09:41 AM

[gwinner:]

The magnitude of the problem exposed in the fall of 2007, a $3 billion dollar CDO and $42 billion mortgage/HELOC portfolio, is the Augean Stables for the mighty E*Trade brokerage. As a loyal and long-time E*Trade customer, it is easy to fall in love with this stock. However, previous management made terrible decisions the weight of which has been and will continue to be staggering.

Citadel knows E*Trade better than anyone. It would not be in their best interest to overpay or underpay for E*Trade stock. E*Trade management telegraphed that current shareholders would be diluted and the market discounted the statement. In fact, the market reacted insanely last week upon learning that Ken Griffin had joined the board and a deal was forthcoming.

Wouldn't common sense suggest that meant current shareholders were about to be significantly diluted, as promised?

Wouldn't E*Trade management wait until it had announced good May results before dropping the dilution bomb?

Wouldn't waiting to make the dilution announcement a day later have been more manipulative of the stock price than timing it the way they did?

Citadel also has, from the initial deal, a competency in disposing bad loans (on which I'm guessing it has mined a significant profit). It is uncertain what that may mean for the future of E*Trade, but they are going to be inseparable from Citadel for the near future and that business knowledge in a close partner could be invaluable for survival.

That E*Trade no longer offers industry leading rates on savings accounts has got to be hurting deposits. Perhaps by easing the debt burden payed on notes they will resume paying high-interest rates to attract new customers and retain current customer deposits. I hope so. If new account growth slows or deposits move elsewhere, they may be toast.

Most emphatically, it may not matter that the mortgage loan portfolio performance is improving right now. The Option ARM/ALT-A reset/recast disaster begins this fall and will last 3 years. That "may" strike at the core of the E*Trade portfolio. Couple that with the ongoing HELOC bleeding and one would have to believe that management at E*Trade is very concerned.

Jun 18 01:44 PM

[Jim Rich:]

I am long and think this is about the best thing that could have happened. There are multiple positives from this deal that I commented on elsewhere. I'm going to have to disagree with you on this one. Don't be sad and keep accumulating while it's cheap; I think we'll be happy later this year.

Jun 18 05:54 PM

[AYL:]

I thought most of their portfolio was mainly first lien and HELOC. Where do you get the option ARM/ALT-A stuff from?

Jun 18 09:39 PM

[Hirendu Vai...:]

E*Trade has no Option ARMs or Alt-A. In addition, they have no exposure to commercial real-estate and negligible consumer debt. In my opinion, E*Trade would be completely unaffected by future waves of troubles.

Again -- today they slammed current shareholders with $1.034 conversion rate on the swap (not even $1.20). In addition, the secondary offering was priced at $1.10 -- substantially below yesterday's closing price and way below $1.97 closing price on Friday. Further $400M raise was inexplicably raised to $478 (even at the punitive $1.10 price) AND ON TOP OF THAT, they said it was oversubscribed and are authorizing 65M more shares.

If it was oversubscribed; wouldn't you think the prices could have been better as a result.

This has been ramrodded from the inside.

On Jun 18 01:44 PM gwinner wrote:

> Most emphatically, it may not matter that the mortgage loan portfolio
> performance is improving right now. The Option ARM/ALT-A reset/recast
> disaster begins this fall and will last 3 years. That "may" strike
> at the core of the E*Trade portfolio. Couple that with the ongoing
> HELOC bleeding and one would have to believe that management at E*Trade
> is very concerned.

Jun 19 11:43 AM

[Al the pal:]

About time from you to retire from the ETFC blog business and go back to business school to learn about offerings and stocks, the 478 million included Citadels required 100 million. As to the oversubscription, who do you think will be buying those shares? The underwriters themselves and flipping them to make a little bit more money for themselves.

The money raied by this offering only offsets their ongoing loans losses by 4 or 5 months, with a little debt interest relief of the debt swap that gives them about 6 more months before the OTS is breathing down their necks again for additional capital.

ETFC is far from being out of the woods, they need a capital infusion of about 2 billion dollars to be financially sound long term. Who do you think is going to bear the brunt of that? That's right the shareholders are going to get hammered even more down the road, on top of the massive dilution they will face with the convertible debt that is over twice the size of this secondary offering.

Jun 19 02:38 PM

[Hirendu Vai...:]

Al the pal -- look carefully at their leading edge of loan portfolio performance. As of May 2009, as per my calculation, they are at about $75M per month negative after everything (without the current debt swap and PIK). And this is hugely decreasing. Indeed in a few months, over-provisions so far would have covered everything. Mark my words and come back and look at what happened here about 3-6 months from now. However, I strongly feel that Citadel and CEO will not allow that to happen. They might move quickly to take E*Trade private to sell it off to hide the true strength of E*Trade's balance sheet.

Because if they don't, there are going to be some serious questions as to what happened here. Indeed, they may move sooner.

If they take this private, not only they would have taken over the company through manipulation, they would then exclude current shareholders from any future gains.

I am not sure what is your motivation in defending Citadel so heavily. But I thank you for your feedback.

Jun 19 05:41 PM

[roman1:]

so the deal is done wouldnt citadel start making etrade pump the stock up in price since they have what they wanted?

can etrade use m2m in this earning comming up? i was told they where not alowed to use m2m in there last earnings because u had to either say u wanted to use m2m or if not u could not use it? ir told me this but i never asked if it could be used in future earnings

Jun 20 10:32 AM

[Al the pal:]

There are a host of problems with your privatization theory. First off Citadel won't take ETFC private because they do not want to let the OTS take over supervision of their company which is what would happen if they took them private.

Second off, Citadel would need to either buy out the existing shareholders in order to go private which it would be stupid to do, especially with all the dilution they just forced on the company or it would have to have the company go through bankruptcy court in order to take it private as ETFC's still largest creditor but in the bankruptcy scenario they would be better off lobbying for a sell of the good assets of the company to pay themselves and the other creditors off. Unless they want their hedge fund supervised by the OTS they will avoid taking over total control of the company.

They have maybe six months or so left given the current loan loss rate before they are back trying to find a way to raise more money.

Also, they will be reinstituting the remaining 87 million dilution out of the previous 150 million dilution. ETFC shareholders % of ownership just keeps getting smaller and smaller. They will have so many shares outstanding in the float that it will be impossible for them to ever have any significant EPS growth even if they are eventually able to turn profitable. When they were profitable remember that those numbers were driven by the bank and all the loans they were issueing, the very things that led to their collapse when they went bad. The brokerage firms profit numbers were always small in comparison to the banking numbers and since they aren't creating any new loans those bank numbers will never return to the levels they once were. So now you are left with a small part of the company trying to make enough money to cover all the additional loan losses that the entire company has.

In case you didn't know it, EPS does matter and the more shares you have the harder it is to increase them. If the stock did somehow manage to climb in price, Citadel will sell off the convertible bonds to people for a profit, those people can then dilute the stock to a ridiculous level.

I really doubt the company survives the next year, but if it does the stock wont do anything for a long long time.

Jun 21 04:21 PM

[sdv30:]

Hirendu, I am a regular stockholder like you, and I have the same questions regarding stock manipulation of ETFC like you. Please keep writing about these issues. Regards.

Jun 21 11:01 PM

[roman1:]

is etrade alowed t ouse m2m in the 2nd quarter or can they not use it since they didnt before?

Jun 22 07:12 AM

[Al the pal:]

"We continue to firmly believe that E-Trade will likely be bankrupt or sold by mid-year 2010, with the latter now looking more likely," Trone wrote in a note to investors. He thinks the brokerage could be sold for $3.51 a share, with the bulk of proceeds used to repay debt and $1.68 in cash left for shareholders -- a 33 percent gain from the current price.

He gives the firm about the same amount of time I give them although I think the OTS will move in for bankruptcy sooner rather than later.

Jun 22 09:53 AM