trending Market Intelligence /marketintelligence/en/news-insights/trending/Sjnlzi2JjIg86U_wo808jg2 content esgSubNav
In This List

Talk of E*TRADE sale returns as online brokers confront free trading

Podcast

Street Talk Episode 87

Blog

A New Dawn for European Bank M&A Top 5 Trends

Blog

Insight Weekly: US banks' loan growth; record share buybacks; utility M&A outlook

Blog

Banking Essentials Newsletter 2021: December Edition


Talk of E*TRADE sale returns as online brokers confront free trading

The era of free trading at the largest online brokerages has brought new questions about how their business models will cope — and for one company, whether a sale is back on the table.

Charles Schwab Corp. sparked the industry's latest price war Oct. 1 when it said users would soon be able to trade U.S. stocks, options and exchange-traded funds for effectively nothing. The decision was quickly followed by rivals TD Ameritrade Holding Corp. and E*TRADE Financial Corp., which announced similar offerings of their own.

The companies have disclosed that the move to fee-free trading will hurt their revenues to varying degrees. The new wave of price competition arrives just as other challenges, from falling interest rates to macroeconomic challenges and fears of a recession, are not likely to ease up.

"The race to zero commissions came fast and furious in an environment of already significant environmental headwinds," said UBS analyst Brennan Hawken in an Oct. 6 note. "We expected pricing to be more rational. We were wrong."

E*TRADE may hit the block

The free-trading wave is widely expected to cut into revenues for the brokers. That, along with a management shake-up and a tough rate environment, could create the perfect storm for E*TRADE to come back up for sale.

The price war uncertainty was always an overhang on a possible buyout of E*TRADE, the smallest of the publicly traded brokers. Potential buyers were likely hesitant to make an offer because they were waiting for the zero commissions shoe to drop, according to Michael Wong, an analyst at Morningstar.

"Now that has already reared its head, and the valuations of these companies have rebased," Wong said in an interview. "Expectations across the board might be more aligned now."

SNL Image

Three years ago, E*TRADE's board ousted the company's CEO to add urgency to the company's attempts to catch up with its higher-growth competitors. The board then set a series of growth targets that, if not met in a two-year window, could lead the directors to pursue a sale. The company opted to remain independent in late 2018, saying it believed it could strengthen earnings per share to $7 or more.

Analysts say that with commission prices at zero, E*TRADE is unlikely to hit that target. And Executive Chairman Rodger Lawson previously hinted that a sale was never really off the table. Now, with another new chief executive at the helm, the broker might choose another strategic direction.

TD Ameritrade's capacity

An E*TRADE sale is far from certain. Merger rumors have swirled around the company for a decade, only to have them fizzle out with no final word.

SNL Image

Still, analysts see TD Ameritrade as the suitor in a potential deal. The two companies have "large expense redundancies," and TD Ameritrade is racing to match the scale of Schwab and Fidelity, Credit Suisse analyst Craig Siegenthaler wrote in an Oct. 1 note.

Reports that the two brokerages might combine date back to the mid-2000s. More recently, TD Ameritrade consolidated another major brokerage player: It completed a deal for rival trading brokerage Scottrade Financial Services Inc. for $4.33 billion in September 2017.

Now, two years after that deal, TD Ameritrade could be in a strong position to act on E*TRADE. The broker had $2.95 billion in cash and cash equivalents as of June 30, according to its latest quarterly filing. The company has a debt-to-EBITDA ratio of 1.04x as of the end of the third quarter, which could leave room to finance M&A with debt.

"If this had happened a year ago, TD Ameritrade's management would've been too busy," Morningstar's Wong said. "But now they may have some capacity."

A TD Ameritrade spokesperson declined to comment on a potential merger. E*TRADE did not respond to requests for comment.

Schwab solidifies push beyond trading

Free trading has been on the horizon for retail brokers for years now.

Silicon Valley-based trading start-up Robinhood Markets Inc. first introduced the concept to the masses to draw in users and then sell that order flow to Wall Street's biggest and fastest traders for execution. JPMorgan Chase & Co. and Bank of America Corp.'s Merrill Edge are among the growing cohort of well-known financial institutions that have started offering various versions of free trading to their clients since Robinhood broke onto the scene in 2013.

Traditional online brokers initially balked at the prospect of free trading, but some of those companies began to build out other revenue streams as zero commission fees proved popular with investors.

"It's the nature of financial services right now," said Steve Biggar, director of financial institutions research at Argus Research, in an interview. "The strong will tend to survive because they can spread their costs out across a much larger base of assets."

Schwab has been slowly diversifying its business mix away from trading commissions for years.

SNL Image

The San Francisco-based company's exposure to commission fees is a fraction of what it once was, although it does expect to see a quarterly revenue hit of $100 million from introducing free trading. Schwab generated less than 6% of its total net revenue in the second quarter from commission fees, versus 21% in 2009.

After starting out exclusively as a discount retail brokerage, Schwab today offers a mix of services such as wealth management and banking. Net interest revenue, which measures revenue on interest-earning assets, has become an increasingly central part of the company's operation as it has diversified. That revenue made up 60% of the whole for Schwab in the second quarter.

Schwab's move away from trading makes it one of the better-positioned online brokers today, analysts have said. E*TRADE and TD Ameritrade are still more tied to trading, as commissions accounted for about 17% and 21% of their second-quarter total net revenues, respectively. E*TRADE disclosed that its second-quarter results would have suffered a $75 million blow with $0 commission fees, while TD Ameritrade said it is expecting a $220 million to $240 million decline in quarterly revenue as a result of the decision.

Questions linger about timing

Questions remain for analysts about what prompted Schwab to launch this latest price war now, with interest rates on the decline and a foreboding economic outlook.

The move came days after Interactive Brokers Group Inc. unveiled a new platform that allows users to trade for free. But Interactive Brokers' clientele tend to be somewhat more sophisticated investors and traders, making it less of a direct competitor to Schwab and the others. And Interactive Brokers is not eliminating commissions entirely. Its free product will coexist with the current commission-based offering.

But once Schwab made its move, TD Ameritrade and E*TRADE were forced to follow suit, analysts said. Fidelity Investments, the only private online broker in the mix, has not yet eliminated its commission fees.

"Schwab clearly has some explaining to do," UBS' Hawken said in an interview. "It's one thing to start up a price war when interest rates are higher, but it's another when you've got all these environmental headwinds."