|
Online brokerages at risk?
|
 |
August 25, 2000: 2:54 p.m. ET
Investors are logging on, so why are online brokerage stocks declining?
By Lisa Myer
|
SAN FRANCISCO (www.redherring.com) - Never before have individual investors had more control over their money.
Individual investors are now equipped more like brokers, with increased accessibility to financial data to faster transactions. The recent fair-disclosure regulations proposed by the Securities and Exchange Commission will give even more power to individuals.
The digitization of the financial industry has led to a boom in online brokerage firms. Not only have traditional financial players such as Charles Schwab established profitable online divisions, but ETrade and Ameritrade have kick-started the trading game. But, since March, the stocks of these two virtual brokers have plummeted.
 On Wednesday, ETrade closed at $16.94, 58 percent below its 52-week high of $40. Ameritrade also closed at $16.94, 45 percent under its 52-week high of $31. Now, some analysts speculate that the time is ripe for these companies to sell out to larger competitors. In fact, Ameritrade's stock spiked up as much as 21 percent on Tuesday on speculation that the company would sell out to American Express. Both companies declined to comment on the rumors, which have since died down.
One wonders why these stocks are down so much in the first place. The fundamentals for the industry appear solid. Deutsche Bank Alex. Brown estimates that online accounts should top 20 million by the end of this year, and will grow to almost 35 million by 2003. Nor do analysts expect a decrease in the combined volume on the New York Stock Exchange and the Nasdaq, which has risen 23 percent annually since 1990.
So, if an increasing number of investors are logging on to perform an increasing number of trades, why are online brokerage stocks declining?
Land grab is over
Some analysts attribute the stocks' drop to the Nasdaq's April downfall. Others say security issues and possible outages are scaring online investors away. But the most likely reason is that a decrease in customer account growth and trading volumes, coupled with increased advertising spending, has narrowed profit margins for these pure-plays.
 The land grab for Ameritrade and ETrade is over. They spent their early careers channeling a significant portion of their revenue back into customer acquisition strategies in order to build market share. But trading volume per account has reached critical mass, and some analysts say that online brokerage shares may never reach their highs again. Now, just to survive, the pure-plays must prove that they can be consistently profitable. Both companies are expected to lose money this year but be in the black in 2001, according to institutional research firm First Call.
"In theory, we think that the ultimate model in retail financial services is very simple and centers around the accumulation of investable customer assets," Deutsche Banc Alex. Brown analyst Glenn Schorr wrote in a recent study, Online Brokerage Industry.
"While assets may come and go in good and bad markets, assets make for a more sustainable and less volatile franchise," Schoor said. Studies have shown that a small number of accounts represent a large percentage of total trades at online brokers. Some in the industry say that less than 1 percent of total accounts are active, yet these comprise 75 percent of total trades.
"You don't make money on trades," said Richard Bove, analyst at Raymond James & Associates. "You make money on the bucks." The challenge for online brokers is to operate efficiently enough so that each new customer is a profitable undertaking.
ETrade goes up against Goliath
Competing in a market that's about 150 companies strong, ETrade and Ameritrade have very different strategies.
ETrade is trying to become a global supermarket of financial services. The company is the second-largest online broker in terms of average daily trades, third in number of accounts and fourth in client assets.
But average daily trades at ETrade were down 26 percent in the June quarter. As of June 2000, the company had only 15.7 percent market share and $20,866 assets per online account, compared to brick-and-clicks brokerage Schwab, which had 23.6 percent of the market share and $100,854 assets per Net account.
In an effort to diversify revenue away from volatile transaction-related business, the company is expanding its offerings into a variety of financial products and geographies. A year ago, ETrade bought Telebanc to provide online banking. On Wednesday, ETrade purchased PrivateAccounts.com, a privately held firm that gives users direct access to money mangers and portfolio information.
With such an aggressive diversification strategy, ETrade may not see returns on its heavy investments. "The company is currently spending about $100-150 million in cash per quarter and, at this rate, ETrade will burn through most of its cash and investments by early 2002," Mr. Schorr wrote in a recent research report.
Ameritrade tempts buyers
Ameritrade, on the other hand, is gunning for a niche market. Despite the declining average online account size and volume traded per account, Ameritrade hasn't budged from its transaction-based business model, building a name for itself by providing fast and inexpensive execution.
Indeed, the average Ameritrade account traded seven times during the company's most recent quarter, which is almost double the average of its competitors. The company is the fifth-largest online broker in terms of online accounts (1.2 million) and asset size ($35 billion). But its percentage of assets per account is shrinking, according to Mr. Schorr at Deutsche Banc Alex. Brown. In fact, as of June 2000, its operating cost per transaction rose $1.73 from $8.54 in March.
In order to expand its brand name in other markets, the company has forged partnerships, such as its online-banking alliance with NetBank. Such partnerships allow Ameritrade to enter markets without paying.
Possessing a valuable brand, technology infrastructure, and strong customer base, but burdened by concerns of low profitability, analysts think Ameritrade is the more attractive acquisition candidate.
"Because of their focused and deep business strategy, concentrating only on transactions, Ameritrade would make an easier transition into a more diversified financial company," said Mr. Schorr.
Still click and trade to me
So where does this leave the private online investor? Cheaper and faster data and transactions have become not only the norm but also practically a civil right, due largely to the customer-acquisition spending that got these companies in hot water in the first place.
Dueling analysts predict either black ink or total cash loss within the next two years. Whether ETrade and Ameritrade go it alone or get gobbled by larger institutions, the little guy will still be better off, no matter whose button he clicks to make the trade.
Discuss the transformation of traditional industry sectors in the Industry Talk forum, or check out forums, video, and events at the home page. 
|
|
|
|
|
 |
|
