Dear E*AmeriSchwab client,
It is April 1, 2008, and a lot has happened over the past year. The three-way merger involving TD AMERITRADE (Nasdaq: AMTD ) , Charles Schwab (Nasdaq: SCHW ) , and E*Trade (Nasdaq: ETFC ) that seemed so improbable in the springtime of 2007 is finally complete.
It wasn't easy. It took a pair of hedge funds with significant stakes in AMERITRADE making a public consolidation plea to get this unlikely threesome together. Like watching a pair of drunk uncles at a wedding, shouting to get hitched to the bouquet-grabbing bridesmaid, we were slightly amused at first. Then we realized that the uncles were rich -- and quite sober -- so AMERITRADE went a-courtin'.
The details are a bit hazy after that. No one remembers whether AMERITRADE snapped up E*Trade first or if Schwab consumed AMERITRADE to kick off the festivities. We're just proud as punch to see the three major discounters operating under the same umbrella.
Consolidate, consolidate, consolidate. Henry David Thoreau said that. Well, at least he said something like that. So we did the right thing, after Thoreau-ly thinking through the implications and ramifications.
So welcome to your new broker. The bed is big, but there is always room for you.
Getting through Thoreau
Maybe I am the only one to get that letter in the mail 10 months from now. Then again, after Jana Partners and S.A.C. Capital Advisors made it known that they feel their combined 8.4% stake in AMERITRADE would be worth more if the discount broker would hook up with either Schwab or E*Trade, the constraints of logic and time seem to have flown out the window.
Oh, don't get me wrong here. The hedge funds are right. Consolidation has fueled a lot of the growth in the discount-brokerage space. Between AMERITRADE's deals to acquire Toronto Dominion's (NYSE: TD ) TD Waterhouse, JB Oxford, and Datek, and E*Trade's firm handshakes to consume BrownCo and Harrisdirect, we're not exactly tiptoeing through an organic growth garden.
"I think that there is still potentially more consolidation in the trade," AMERITRADE CEO Joe Moglia told me three years ago. "The market has recovered over the past year, so that will probably slow down the pace of consolidation, but it should continue."
His final point relates to buyout activity picking up in depressed sectors. One shouldn't be surprised to find sluggish steakhouse chains and subprime lenders hooking up these days. If a sector is hot, there is little incentive for lesser players to cash out.
I wouldn't call discount brokerages a dead industry, but the key players have seen headier growth in the past. So the two hedge funds tapping champagne glasses with reception hall flatware aren't exactly original here.
Big steps for big feet
Since the three remaining public players are so huge -- with no offense to smaller standalone discounters like Siebert Financial (Nasdaq: SIEB ) -- it would have to take the consumption of a hefty rival to truly move the needle.
Yes, the benefits would be dramatic. Beyond the obvious economies of scale, we're also talking about shaving costs through closing redundant local offices, trimming support overhead, and maintaining better control over pricing wars.
Notice that I didn't call the truce through nuptials "collusion." The reason that regulatory forces would be hard-pressed not to accept a mega-buyout is that undercutting competition is coming from several unlikely sources these days.
Whether it's big banks like Bank of America (NYSE: BAC ) offering free trading as a way to drum up assets in their non-brokerage banking relationships, to a site like Zecco that aims to subsidize free trades through online advertising, it's not just discount brokers that are discounting brokering these days.
Maybe an AMERITRADE and Schwab pairing would turn heads, though E*Trade and AMERITRADE teaming up at current prices would still combine for a smaller market cap than all of Schwab. Either way, all three would add up to a smaller market cap than behemoth bankers like Bank of America and Wells Fargo (NYSE: WFC ) , which is also offering commission-free trading these days.
The problem at this point is pride. The three remaining heavies don't want to play the submissive role. The hedge funds claim that Toronto Dominion, which owns 40% of TD AMERITRADE, is reluctant to do a big deal that would be dilutive to its significant stake. I'm not sure I buy that. If Toronto Dominion were such a control freak, it would have never handed over TD Waterhouse in the first place.
So let's see how the next few weeks and months play out. The mock April Fool's Day letter I wrote may be completely fake, but E*AmeriSchwab may be closer than you think.
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Longtime Fool contributor Rick Munarriz has been trading through discount brokers since the early 1990s. He does not own shares in any of the stocks in this column. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. Bank of America is a Motley Fool Income Investor recommendation. The Fool has a disclosure policy.