Maybe there's room for even more consolidation in the discount brokerage sector. With E*Trade (NYSE: ETFC ) and TD AMERITRADE (Nasdaq: AMTD ) both posting disappointing quarterly reports earlier this month, a megamerger makes sense.
What will it take to get TD AMERITRADE and E*Trade to the altar? (The question isn't mine. Kopin Tan raised it in his Barron's column last week.)
Keep in mind that both companies have been busy buyers in the past. TD AMERITRADE swallowed down Toronto Dominion's (NYSE: TD ) TD Waterhouse. Before that, it had acquired JB Oxford in 2004 and Datek in 2002. E*Trade has also been busy, completing a $1.6 billion deal for BrownCo. and a $700 million acquisition of Harrisdirect in 2005.
To the victors go the spoiled milk
Fragmented sectors cry out for consolidation. Whether we're talking about video rental chains, hardware stores, or food-service providers, larger companies are prone to snapping up regional leaders.
Rival shopping sprees accomplish several things.
• They eliminate feisty competitors.
• They create cost savings by trimming redundant overhead.
• They beef up the asset bases.
• Economies of scale kick in.
"I think that there is still potentially more consolidation in the trade," TD AMERITRADE CEO Joe Moglia told me three years ago. "Discount brokers have gone from numbering in the hundreds to just 110 over the past few years. I think that number will continue to go down. The market has recovered over the past year, so that will probably slow down the pace of consolidation, but it should continue."
Keep in mind that Moglia mentioned this before TD AMERITRADE and E*Trade would pull off their biggest deals. Consolidation makes sense in most industries, but in the discount brokerage space, it may be more about survival than the opportunistic knocking.
Rival Charles Schwab (Nasdaq: SCHW ) bucked the trend by posting reasonable quarterly results. The company didn't point to market volatility and lackluster trading activity as sources of weakness the way its competitors did.
Come with me if you want to live
A merger between E*Trade and TD AMERITRADE wouldn't be a case of stumbling leaders banding together to commiserate. Both companies are still growing nicely. A market hitting fresh highs is more likely to excite investors than spook them.
However, the deep discounters can't get too complacent at this point. Fees are falling from many unlikely sources.
• Schwab lowered account minimums and axed many minimum balance penalties two weeks ago.
• Last week, it was mutual fund giant Vanguard that made direct mutual fund investing more attractive by doing away with annual account maintenance fees for customers willing to perform transactions online.
• Commission-free trading -- typically with strings attached -- has been rolled out by Bank of America (NYSE: BAC ) , Wells Fargo (NYSE: WFC ) , and Zecco.com.
Cheaper trading is great for investors, though it naturally eats into margins for brokers that now have to remain competitive. This is important, because part of the allure of consolidating an unwieldy sector is that price wars are easier to keep in check when there are fewer players involved. With major banks promising free trading for those with $25,000 in bank account assets, that bonus is out the window.
If nil is the new floor -- and ceiling -- this doesn't mean that the sector is doomed. Brokers make money in several different ways, like collecting the spread on margin interest. Lower commissions and the eradication of penalty fees throughout the industry may encourage investors to trade more frequently, and there's money to be made there even with a big fat zero on the commission schedule.
So don't let the competitive nature of the market get in the way of appreciating the potential combination of two major players. It would make perfect sense. The only thing holding this back may be simply a matter of who is willing to be the one to swallow some pride and agree to be the firm acquired.
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Longtime Fool contributor Rick Munarriz has been trading exclusively through discount brokers since 1990, but he does not own shares in any of the companies in this story. He is also part of the
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