The brokerage industry has changed a lot in the past 50 years, with deregulation in the 1970s setting the stage for the rise of discount brokerages to challenge Wall Street's giants and appeal to ordinary investors. Lately, though, brokerage companies have been combining forces, especially as well-known full-service financial institutions realize the value of having a large customer base of retail investors.
Morgan Stanley (MS -1.31%) just announced that it would pay $13 billion in an all-stock deal to acquire E*Trade Financial (ETFC). In doing so, Morgan Stanley hopes to give its Wall Street-oriented business a broader scope. For E*Trade, the deal finally answers a tough question that the discount broker had faced for months without resolution.
What brought E*Trade to this point?
Discount brokers have fought each other for a long time, and ever since Charles Schwab (SCHW -0.47%) began operating as the first-mover in discount brokerages back in 1975, players in the discount brokerage industry have sought to distinguish themselves from their full-service counterparts by charging much lower fees. Yet the specific areas in which they've competed against each other have changed a few times along the way:
- In the late 2000s, brokers like Schwab, Vanguard, TD Ameritrade (AMTD), and E*Trade looked at ways to offer their customers commission-free purchases and sales of certain exchange-traded funds, seeking to cash in on the popularity of the ETF revolution.
- A few years ago, brokers turned their attention toward gradually reducing their basic commissions for making stock trades. Facing competition from new online upstarts that offered commission-free trading, Schwab decided in 2019 to slash its commissions to $0. That prompted TD Ameritrade, E*Trade, and others to follow suit.
Yet all this in-fighting among discount brokers also set the stage for would-be purchasers to look closely at acquisition targets. For Schwab, buying TD Ameritrade was an obvious way to grow in scale and to combine forces to reduce inefficiency and cost. It also threatened to leave E*Trade as a much smaller also-ran among discount brokerages.
Finding a partner
In an ironic twist, E*Trade has had experience working with Morgan Stanley before. Back in 2011, the discount broker engaged Morgan Stanley to help it explore strategic options, including a possible sale.
Fast forward to 2020, and Morgan Stanley decided it was in the right place to pull the trigger. The all-stock deal will have E*Trade shareholders trade each share of their stock for 1.0432 shares of Morgan Stanley stock.
The move comes at a time when Morgan Stanley is competing with its own big-bank peers for supremacy in the broader financial services industry. Morgan Stanley is well-known for its wealth management business, which has traditionally catered to higher-end clients with extensive assets. To put the deal in perspective, Morgan Stanley has 3 million clients with $2.7 trillion in client assets, working out to about $900,000 per client. E*Trade's client list has 5.2 million accounts, but at $360 billion in assets, the average account size is much smaller at just under $70,000.
Adding E*Trade will help Morgan Stanley broaden the wealth spectrum of its overall client base, filling in gaps in coverage and creating a smoother pathway for customers as they grow their wealth. It'll also produce big cost savings, as consolidating redundant operations should produce hundreds of millions of dollars in reduced expenses. E*Trade's technology platform should also be helpful for Morgan Stanley as it seeks to offer both advisory and self-directed services to its client base.
The next chapter
With E*Trade leaving the fold, the ranks of discount brokers continue to dwindle. Yet at least for now, it doesn't seem likely that Morgan Stanley and other financial institutions will seek to reverse the fee decreases that brought E*Trade to the point at which it needed to find a strategic partner to compete effectively. If anything, E*Trade's acquisition signals that discount brokers have actually won the broker wars -- and shared the spoils of their victory with ordinary investors in the form of lower costs that will hopefully be here to stay.