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Barclays downgrades 3 brokers amid fee-free trading announcements

Barclays analyst Jeremy Campbell lowered Charles Schwab Corp., TD Ameritrade Holding Corp. and E*TRADE Financial Corp. to "underweight" from "overweight" amid the sector's latest commission price war target: fee-free trading.

All three companies have announced that they will eliminate their commission fees for clients trading U.S. stocks, options and exchange-traded funds online. Schwab previously charged a fee of $4.95, while both TD Ameritrade and E*TRADE charged $6.95 per online equity trade. Clients at all three companies will still have to pay 65 cents per contract when trading options.

The announcements came days after Interactive Brokers Group Inc. detailed plans to launch a new free-trading platform called IBKR Lite in October. The traditional online brokers have faced continued pricing pressures from Robinhood Markets Inc., a Silicon Valley-based startup that was an early champion of free trading, and from big banks like JPMorgan Chase & Co.

The analyst expects the moves will cut commissions revenue by about 60% for the group. Schwab indicated that it expects a $100 million per quarter revenue hit, while TD Ameritrade anticipates a $220 million to $240 million hit per quarter. E*TRADE estimated that the revenue impact from $0 trading on its second-quarter results would have been about $75 million.

Earnings pressure from the fee cuts could be an M&A catalyst, Campbell said in his Oct. 2 note. Merger rhetoric has cooled since E*TRADE's board said in October 2018 that it did not plan to immediately sell the company after conducting a two-year review, but Campbell noted that the commission cuts "could resurface conversations" as the brokers look for combination synergies.

"There could be a near-term pop in a deal announcement scenario, but the bigger problem we see is that the market hasn't penalized the eBroker [price-to-earnings ratios]," Campbell said. "Ultimately, M&A could make these stocks look more 'fairly valued' than under- or over-valued."

The analyst anticipates a cut to the online brokers' earnings per share by 12% to 30% when factoring in the commission cuts and two more cuts to the Federal Reserve's benchmark federal funds rate. There are no direct cuts to operating expenses that these brokers could make to offset the loss of revenue, Campbell said. The analyst has cut his expectations for Schwab 12% to $2.44 per share. He now expects TD Ameritrade earnings to come in 31% lower at $2.74 per share and E*TRADE earnings to post 29% lower at $3.33 per share.

Campbell also reduced target multiples on each of the companies, citing "very poor sentiment and more 'bank-like' earnings."

The analyst updated his price target for Schwab to $34, down 29% from $48. He amended his price target for TD Ameritrade to $31, down 46% from $57. Campbell also lowered his price target for E*TRADE to $31, down 45% from $56. These price targets represent a 10% to 15% drop below the companies' current market levels.