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Post of the Day
September 23, 1999

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Subject:

TBFC, NTBK, and EGRP: Merge none, two, or three

Author: shiloh4378

In recent times we have seen the mergers of many innovative consumer driven companies. Some were done to increase the perceived synergies that would come from the merger (Coke and Columbia Pictures, RJR and Nabisco, CNN and Time Warner) while others were done to help the acquiring company move up the value chain or diversify via acquisition (GM and EDS, GE and NBC, Pepsi and Taco Bell/KFC/Pizza Hut.) In time, what established the successes of the mergers is not necessarily the financial or synergistic benefits, but the goals and cultures that would coalesce and coexist during the ensuing years. Today I hope to adequately analyze the potential futures of three players in the online financial industry, Netbank, Telebanc Financial Corp., and E*Trade.

Within the last few months the online/branchless banking world has witnessed a proposed merger between it's most successful upstart, Telebanc Financial Corp., and the second largest discount brokerage, E*Trade. Theoretically this merger and alliance has many strengths and potential synergies that may be capitalized. E*Trade provides more than a million individuals with online branchless services and is growing at a rate of 30,000+ customers a month while Telebanc provides branchless services in the banking sector for more than 80,000 customers. E*Trade has practiced it's quest for cost and differentiation competencies by providing their customers with low commissions, reasonable fees for risky behaviors (margin trading and daytrading), and a well thought out web site that does a commendable job of simplifying the investment experience. Likewise Telebanc offers free checking for most of their clients, an interest rate many times greater than that of a bricks and mortar bank, and most importantly a customer service center that is the standard for the banking industry (calls are usually answered within a minute!). Based on such similar outcomes and methods for customer retention and growth it appears that these two companies have a market perspective and execution that would be an excellent fit.

Let's look at the benefits for the present and future E*Trade customers. Since there satisfaction will be the key to the new companies success. If the merger is approved by the shareholders of Telebanc, E*Trade will have the means to arguably become the first complete online financial services firm in the world. E*Trade will be able to deposit your money into a savings account, transfer it to a brokerage/money market account, and allow you to invest in practically any financial instrument that is commonly available to the general public. All without leaving your home for a fee that will probably be no more than $19.95. If you need money for a house, a business, or even to go to the movies, E*Trade could do it at a cost that would virtually price out most competitors.

You may think that E*Trade's cost competencies would be limited by its small size relative to the Citibank's and Chase's of the world. This would not be true for three reasons. First, every bank from Citibank to your local community bank pays the same amount of interest for the monies that are provided to them by the Federal Reserve. Second, the CEO of Telebanc, Mitchell H. Caplan, was a former investment banker for Goldman Sachs who specialized in the acquisition of mortgages and other related financial instruments. By acquiring Telebanc, E*Trade would be given a mortgage portfolio that currently possesses the second lowest default ratio in the entire banking industry. Third, experienced online investors simply no longer need, nor desire to have a human being transact these things at a higher cost. Why pay a human being to fill out forms and provide hand holding when you already know what you're doing? All the bricks, mortar, salaries, pensions, and chandeliers that affirm and authenticate the loan experience are replaced by a server, a PC, and a click of a button. This can do wonders to E*Trade's profits (which are right now non-existent) and will help the new company provide interests rates and loans that will be among the top in the banking industry.

Speaking of profit, did you know that Telebanc made as much per share in the second quarter as America OnLine (0.12 EPS)? If you did you are probably a current shareholder or analyst who may also know that it took Telebanc approximately 70,000 customers to attain this goal� vs. AOL's 17 MILLION at that time. To put it another way, Telebanc received as much profit from 1 customer as American Online received from 25 customers. That's a fantastic return on eyeballs in an online world where even the best and brightest companies can't make a plug nickel due to the need for differentiation and growth.

Theoretically this seems to be a match made in heaven. Unfortunately, the next few years will not be bright ones for this newfound company; there are certain challenges, obstacles, and needs that will be difficult for the two companies to overcome. The most important of which is profitability.

E*Trade has lost money in every single quarter of it's existence despite having over a million customers in the biggest boom market of the twentieth century. Think about that. E*Trade has not been able to make a penny in profits in a financial world where practically every Tom, Dick, and Jane has seen a positive return on their assets. The Fool within us may cite the billions of dollars that have become the market value of the stock as a source of excellent return for the shareholders. But, three other realities must be considered. First, E*Trade is currently in an industry that is capital intensive and low margin. In the business world these are called "Dogs". In E*Trade's case while customer acquisition and retention costs remain high (>$200 per customer), competitors are offering worthy alternatives at drastically lower costs. Second, the online brokerage industry from all indications is about to end its growth phase and undergo a shakeout. When industry shakeouts occur profits dwindle and thus shareholder value follows suit. If the market slows down from its supernormal growth in volume of the last few years the shareholders of online brokerage companies may be in for a rude awakening. Third, there comes a time when companies simply can't rely on growth and cache to survive. They are asked to produce through growth AND profit. Unfortunately for E*Trade shareholders it seems that this time has now come and stayed for a while. Hence the recent drastic reduction in E*Trade's perceived market value.

So, is this merger a good idea? Better yet, what in the heck does any of this have to do with Netbank's future? Is shiloh4378 going to propose the merger of all three industry players, some combination of the two, or just say "forget mergers� be a pure player and grow your own darn business!" Tune in on Friday and you'll find out.

Best Regards

Shiloh4378

P.S. My apologies to TMF's Netbank visitors (and shareholders). In the second act your company will play a pivotal role in the possible alliances that may come to be.