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Online brokers, tool & target
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November 5, 1999: 3:31 p.m. ET
NDB, TD Waterhouse benefit from positive remarks from analyst
By Staff Writer Alex Frew McMillan
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NEW YORK (CNNfn) - Online brokerages became the target of investors' attention Friday rather than just the tool they use, thanks to a report from a prominent e-commerce investment bank.
Several are good values, according to Jim Marks, who today issued a report initiating coverage of six online brokerages for CS First Boston. But these are trickier times for online brokers, and many of their shares are 50 percent and sometimes as much as 60 percent off their highs in April. They face competition from traditional financial-services companies that finally have responded to the threat online brokers pose.
Marks takes over from the prominent online brokerage analyst Bill Burnham, who left CS First Boston this summer to join the venture-capital company Softbank Capital Partners.
Marks stated that in particular, National Discount Brokers and TD Waterhouse are trading at discounts to the other brokers and represent bargains. That might not be true for long. The stock of National Discount Brokers (NDB), which Marks said is small enough to make it a takeover target, leaped as much as 29 percent Friday, reaching a high of 37-1/2. It was trading at 35-7/8 in the early afternoon.
Marks also praised NDB as a pioneer among online brokerages, with consistent top ratings for reliability, ease of use and research.
Frank Lawatsch, NDB's general counsel, didn't rule out the possibility of the brokerage being taken over. "We've openly said that we expect consolidation in this industry. We're not afraid of it. If it happens, it happens."
But the bank-reform bill passed by Congress, removing ownership and cross-selling barriers between banks, brokerages and insurance companies, makes for a rosy picture for brokerages on their own, he said. In the future, middle- and upper-class people will have one strong financial relationship, with their brokerage, using a debit card and virtual links, and paying bills online.
People already have stopped going to the bank other than to use the ATM, Lawatsch said. Financial services companies have to "touch" their customers every day, which means using the Internet if they're not going to branches or responding to bulk mail, he said.
NDB can't outspend its larger rivals in getting new customers, Lawatsch said. "What we hope to do is to be a lot smarter." That means it will concentrate on technology and co-branding products with other companies, trying to acquire customers cheaper than its rivals, he said.
Despite Friday's runup, NDB may still have a long way up to go. Marks set a very bullish 12-month price target of 85 on NDB, which he rates a strong buy. He set the same rating for TD Waterhouse, with a more-modest target of 30.
Marks praised TD Waterhouse for having the lowest acquisition cost per account in the industry. And it has the right mix of online, telephone and branch services that the analyst believes will be "the winning combination" in the future.
TD Waterhouse (TWE) also got a stock-price boost, leaping a little over 20 percent to a high of 15-3/8. The stock still was near its high in early afternoon, well up from its close Thursday of 12-3/4.
Though not as good value as NDB and TD Waterhouse, Marks set a buy rating on DLJ Direct (DIR). Thanks to good management, its ties with the investment bank Donaldson Lufkin & Jenrette and a concentration on higher asset-balance customers, he expects the stock to hit 23 over the next 12 months and rates it a buy.
The stock trades at similar valuations to Ameritrade and E*Trade, he said, but Marks expects DLJ to see greater growth than the industry as a whole and to have more-profitable accounts. He likes its attempts to fashion itself into a financial-services hub, with lots of services.
The news isn't good for online brokers across the board. Marks and CS First Boston weren't bullish on Ameritrade (AMTD), E*Trade (EGRP) and Charles Schwab (SCH), all of which rate only holds.
Ameritrade's financial performance has deteriorated markedly over the last two quarters, for instance, as personnel and technology expenses have taken their toll. The brokerage needs to see results from its $200 million marketing campaign, Marks said.
Schwab is the industry leader and, like TD Waterhouse, has branches and good phone service to go with its online presence. He also called it the "category killer" of online financial services. But it could be hurt by a downturn in the stock market and the stock, at 51.8 times next year's earnings, is too expensive, the analyst thinks.
E*Trade is also a hold for Marks, who believes now is a "time to exercise caution in investing in online brokerage stocks." Established players are showing much more creativity and strategic vision than before, with Merrill Lynch entering the fray and American Express and, through Wingspanbank.com, Banc One offering new products that compete with the online brokers.
But a bigger problem facing the industry is with trading volumes. They have been way above the norm established over the last three years since the fourth quarter of last year, and can't continue at such high rates, Marks wrote in his report.
Still, the market seems infatuated with online brokers as Internet stocks, he said, and the basic truth that these are brokerages operating in a volatile business sometimes gets forgotten.
But online brokers are in the most valuable position, Marks said. And investors still seemed infatuated anyway, despite his words of caution. With news of the banking reform bill's passage, only Schwab's stock, 13/16 off its open in the early afternoon, was trading down after Marks' report came out. 
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