Monday, April 5, 1999

National Discount Brokers Group
Phone: 201-946-2200
Website: http://www.ndb.com
Price (4/1/99): $27 7/16


As the stock market recovered from its late summer collapse, online trading surged, launching leading online brokers into the stratosphere. Generally ranked #10 among online brokers, National Discount Brokers Group (NYSE: NDB) benefited from the attention and its own improving results.

NDB's shares ran from $9 to $33 in late December on the strength of its November Q2 earnings report. Revenues jumped 28% to $54.5 million, pumping up EPS by 163% to $0.42 per share versus $0.16 a year ago. That reversed a dismal first quarter, when lower revenues forced the company into the red.

By early February, National Discount had ridden the next wave of Internet investing euphoria, briefly hitting a high above $44 per share before sinking back to the low $20s.


Known as The Sherwood Group until December 1997, National Discount Brokers Group is the parent of two financial services units: National Discount Brokers/ndb.com and Sherwood Securities.

National Discount Brokers is an online brokerage with roughly 128,000 customer accounts and assets of $6.5 billion. Basic limit orders cost $19.75. Barron's recently rated NDB in a tie for #2 among 21 online brokers. Piper Jaffray figures NDB claimed 1.2% of all online accounts and 1.3% of trading volume as of December, placing it tenth among online brokers.

Sherwood is a wholesale market maker in about 3,600 Nasdaq and small-cap stocks. It executes transactions primarily for institutional investors.

The parent also owns a 47% membership interest in Equitrade Partners, a specialist in 157 New York Stock Exchange stocks. NDB plans to sell Equitrade.

Revenues are derived mostly from the firm's market-making activities (61% of FY98 revenue), retail brokerage commissions (23% of sales), and NYSE specialist activity (10%).

As of September, insiders owned 8.1 million shares, or 56.2% of the company.


Income Statement*
12-month sales: $196.1 million
12-month income: $15.7 million
12-month EPS: $1.11
Profit Margin: 8.0%
Market Cap: $389.6 million
(*From continuing operations.)

Balance Sheet*
Cash: $0.8 million
Total Assets: $195.5 million
Total Liabilities: $69.3 million
Long-term Debt: None
(*As of Nov. 30, 1998)

Price-to-earnings: 24.7
Price-to-sales: 2.0


Given that the parent company is so dependent on market-making activities, NDB might have seemed one of the least-appealing online brokers. That's because changes in Nasdaq's order handling rules and general fallout from the settlement of regulatory charges brought by the SEC and the National Association of Securities Dealers (NASD) means that the spreads between bid and ask prices (a market maker's main source of profit) were narrowing.

For FY98 ended May 31, for example, the company's revenue from securities transactions actually declined 18% despite a 32% jump in trading volume. Trading profit per ticket was falling. The parent launched NDB partly to increase its share of Nasdaq volume and remain a player in an industry undergoing consolidation because of these changing economics.

Then again, speculators discovered smaller online brokers like Siebert Financial (Nasdaq: SIEB) over a year ago. It was only a matter of time before NDB, a top 10 online broker, stirred investors' interest.


As with other online brokers, NDB insiders have taken the recent rally as a chance to sell stock. Perhaps the insiders see that investors seem to be valuing the firm strictly as an online broker when most of its revenues come from market making.

Indeed, National Discount's Q2 numbers really said less about the firm's online brokerage business than about its sensitivity to changes in overall stock-market trading volume.

Market-making revenues soared 37% in the quarter to $9.6 million as rocketing high-tech and Internet stocks attracted frenetic trading. Though per-trade revenues declined in its floor brokerage business, 47% higher trading volume allowed the company to report a 15% gain in revenues from its NYSE specialist business.

However, commission revenues actually dipped 1% as more NDB retail brokerage customers shifted to lower-priced Web trading. Higher assets in customer accounts pushed interest income up 13% in the quarter, but it still accounted for less than 4% of overall revenue.

Clearly, National Discount Brokers offers a quality online service -- including its innovative NDB University, which provides educational materials on personal finance and investing through an arrangement with Time Warner's (NYSE: TWX) Money.com. In addition, Piper Jaffray estimates that NDB's customer accounts grew by 32% in the December quarter -- twice the industry average.

However, its share of online stock trading volume declined to 1.3% from 1.6% in the September period. To compete longer term, NDB must boost its ad spending, which was less than $2.2 million in the December period.

On the other hand, the market is now valuing the company at $3,000 per customer account, or just 30% to 50% of what investors are paying per account for the top online brokers like Charles Schwab (NYSE: SCH) and E*Trade (Nasdaq: EGRP). And that assumes the firm's market-making and specialist businesses are basically worthless. Of course, investors are willing to pay up for firms with the best-known brands and significant market share. Still, that's an enormous price disparity.

Not long ago, a single analyst was estimating the company would earn $0.85 a share in the year ending in May. But Q3 earnings released March 30 suggest that estimate could prove way low. Revenue roared ahead 81% to $68.2 million, pumping EPS from continuing operations up to $0.58 from just $0.14 last year. That brings year-to-date earnings to $0.90 per share.

Frenetic market activity continues to produce outsized profits. Trades per day by individual investors soared 61% from the same period a year ago while trades through its Sherwood Securities unit increased 74%.

As long as market activity stays so strong, National Discount Broker should remain on a roll. Then again, it could get hit much harder than the other online brokers in a market slowdown.

-- Louis Corrigan

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