July 22, 1999
Strong Half for Online Brokers and Banks
by Bill Barker (TMFMax)
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The continued success of online brokerages across the board inspired a couple of Initial Public Offerings (IPOs), including the spin-off of TD Waterhouse Group (NYSE: TWE) from Toronto Dominion Bank (NYSE: TD), and DLJdirect (NYSE: DIR) from Donaldson Lufkin & Jenrette Inc. (NYSE: DLJ). Both IPOs occurred well after the April 14 sector high and, as such, did not show the immediate pops that some investors might have expected from "hot Internet IPOs."
While the explosive growth in online trading has translated into higher revenues and stock prices at both Ameritrade and E*Trade, the mainstream full-service brokerages have largely been shut out of the fun. Prior to this year, the party line from Wall Street's most venerable brokerage houses was that online trading was something that their customers did not need or want. With this background, the biggest headline in the first half of the year produced by any of the traditional brokerages was the announcement by Merrill Lynch (NYSE: MER) that it was abandoning its previously stated policy that "The do-it-yourself model of investing, centered on Internet trading, should be regarded as a serious threat to Americans' financial lives." In what at first blush appeared to be a full about-face, Merrill Lynch announced on June 1 that it would expand its online trading business, making online trades available to all clients at a rate of $29.95 per trade. The press release indicated Merrill was attempting to convince potential customers (and perhaps investors) that this would no longer be your father's Merrill Lynch.
The market was having none of that. In response to the news, shares of Merrill Lynch immediately shed 11% of their value, dropping from the mid-$80s to $75 a share. Investors have continued to be wary of the new Merrill Lynch model, as it is unclear whether Merrill will be able to generate enough new revenue from perhaps increased trading to offset the lowered commissions. (Merrill's full-service brokers charge an average commission of $150 per trade.) Merrill's new online trading option is set to roll out in December.
It appears at this point, however, that Merrill is not really going to promote the availability of the reduced online trading commissions, but will continue to advise that its customers use (or at the very least pay for) Merrill's advice. For the moment, Merrill is promoting a new account that carries a minimum of $1500 in annual fees. These accounts will include access to Merrill's research and brokers. The accounts will also include unlimited trading, meaning that anyone who is making more than 50 trades a year might benefit from the new pricing structure, assuming that they're comparing the price of an online trade to Merrill's high end of the market $30 per trade price tag.
Given that Merrill has all but announced that it is going to alter its model as little as possible while still being able to claim that it has an online trading option, it is no wonder that the market today prices Merrill at essentially the level that it did two years ago, and no higher than the price that Merrill shares sported in January. The more things change at Merrill Lynch, the more they stay the same.
Any questions about the viability of full-service brokerages, however, did not necessarily hurt Goldman Sachs Group (NYSE: GS), as it was finally able to get its long-delayed IPO to market. The Goldman IPO, initially scheduled for last summer but delayed because of unfavorable market conditions at that time, was a successful offering, and the market accorded Goldman Sachs a market capitalization of over $32 billion, pushing it past Merrill Lynch in terms of market capitalization.
The continued bull market and generally increased trading helped the earnings results of all the old-line brokerages in the first two quarters. Nearly all brokerages easily beat their earnings estimates, and many reported record net earnings results.
Neatly paralleling the ascension in prices of online brokerages was investors' newfound love of online banks. Entities such as Telebanc Financial Corp. (Nasdaq: TBFC) and especially Net.B@nk (Nasdaq: NTBK) showed the same kind of market appreciation as their online brokerage cousins. While visiting and descending from the same peaks on April 14 that the online brokerages saw, online banks have basically doubled their valuations year-to-date. Net.B@nk in particular showed the same wild swings that the smaller online brokerages saw, starting at about $9 a share as 1999 debuted, and visiting its intraday high of $82 on April 14 before receding back to the $30 per share range as the second quarter closed.
Looming on the horizon for online banks, however, is the increasing number of traditional bricks-and-mortar banks that are expanding their own presence on the Internet. Though strictly online banks may be able to offer substantially better interest rates than their offline counterparts at the moment, it has yet to be seen whether they can do so with a high level of customer satisfaction and retention. For more on this, see the June 14 Boring Portfolio report, and the other articles linked therein.
-- Talk About: E*Trade Ameritrade TD Waterhouse DLJdirect Merrill Lynch Goldman Sachs Telebanc Financial Net.B@nk
-- Interview with Ameritrade's Chair and CEO -- 1/14/99
-- Charles Schwab Stock for Mom -- 4/27/99
-- Online Brokers Take a Breather -- 3/24/99
-- DLJdirect Goes Online -- 5/26/99
-- Learn from Merrill Lynch -- 7/9/99
-- Merrill Lynch Dueling Fools -- 5/5/99
Next -- Internet Stocks Cool Off