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A Hard Sell in the Discount Brokerage Space

|Includes:AMTD, BAC, E*TRADE Financial Corporation (ETFC), OXPS, RF, SCHW, WFC

Over the past decade investors have watched as the online brokerage industry has steadily consolidated and a few large players were left standing.  One of those players, E-Trade, was severely hobbled by the financial collapse a few years ago due to exposure the company had to subprime mortgages. Now, Citadel, the E-Trade’s largest shareholder with a 9.8% stake in the company, has recently urged the company to maximize value for shareholders (via a letter to the E-Trade's Board of Directors which you can read here).  Any transaction would be transformational in regards to the industry as a whole and create a windfall of cost synergies for any other discount broker.

The two most logical candidates to purchase E-Trade would be Charles Schwab and TD Ameritrade (please see article cited in next paragraph for Barron's take).  Both are already large players in the sector and would realize cost savings through the merging of the trading platforms and advertising budgets and various back-office functions.  Both companies also have a long history of successful acquisitions, with Ameritrade recently completing its acquisition of thinkorswim and Schwab in the midst of closing on its acquisition of optionsexpress. 

It is hard to see Schwab getting involved in an attempt to take over E-Trade at this point unless it was a strategic play to keep the company out of the hands of a competitor it felt it could not lose out to.  We have read from other sources that Schwab is still busy getting ready to close on its acquisition of optionsexpress, which Barron’s ran an article on recently with the CEO of Schwab (see here).

TD Ameritrade is also expanding and still digesting thinkorswim.  Their platform has incorporated the best of thinkorswim, however they are still educating their customers as to what this is.  Case in point, I personally received a call from my account representative not long ago to explain the various ways the new tools could help me trade.  More importantly, TD Ameritrade is undergoing a major rollout in the southeastern United States as TD Bank converts The South Financial Group’s branch network into its own.  The signs are already changed and commercials on radio, TV, news print, billboards and the internet.  It is a full out blitz and TD Ameritrade will be placing representatives in branches.  Like Schwab, they too have a lot on their plate at the moment and it is hard to see them getting side tracked paying a high premium for a company with a sub-par balance sheet.

Although both Ameritrade and Schwab have been rumored suitors for years, nothing has ever materialized and it must be noted that TD Ameritrade has expressed concerns in the past regarding E-Trade’s toxic balance sheet (see 7th and 8th paragraphs here).  E-Trade’s follies in the past continue to haunt it in that their non-core holdings are seriously damaging the value of the operating business.

In years past we would have also included Bank of America, Regions Financial and what is now Wells Fargo as potential suitors for the reason of filling out their brokerage offerings.  B of A is, in our opinion, too focused on their mortgage crisis and hobbled by their own follies to make a deal, and there is no guarantee the government would let them get sidetracked in a bid for E-Trade.  Regions too is hobbled from their free lending days, and still is on life support.  A purchase by them no longer makes sense. 

Wells Fargo, who purchased Wachovia in the dark days of the financial crisis took over a great brokerage franchise, however they have more of a full-line brokerage and not a discount version available.  Of the potential banks out there who could make a bid, Wells seems the only one with the capacity to do so yet with little incentive. 

Although it is apparent to most the value of the core business that E-Trade has, one has to wonder how much of a premium, if any, the company could actually realize via a sale.  Anyone who seriously wanted E-Trade and all of its baggage could have made an offer before and had Citadel to broker a deal with the company’s Board.  As far as takeover plays go, there has been a lot of smoke around E-Trade for years, and with Citadel’s recent letter it appears there may be fire however we see very little upside for the company’s shares at this point.