A Look at Online Trading -- through the Crystal Ball
STREET WISE By Amey Stone October 7, 1999
Will full-service or discount brokers win online? Will Net trading fees vanish? Those were just two of the hotly debated issues at New York's Internet World trade show
As much as trade show organizers endeavor to pack their events with announcements that will generate buzz, such conferences don't typically produce much real news. But they can be an excellent way to get at the big picture in an industry -- to find out what some of the sharpest minds in a field think about where their business is going and what hurdles it must overcome. In fact, a series of panels on online financial services at Internet World in New York City during the week of Oct. 4-8 prompted a surprisingly lively debate over which strategies are most likely to succeed on the Web. Here are the questions that sparked the most intense debate -- and that are most relevant to investors in Web brokerages and related companies.
Will the fees that online brokerages charge eventually fall to zero?
Merrill Lynch Internet analyst Henry Blodget, who doesn't officially cover brokerage stocks, asked this question of the panelists who do. Blodget seemed to think so, calling trading "a commodity" and pointing to announcements of lower fees, such as E*Trade Group's (EGRP) August revelation that it was cutting prices for active traders to as low as $4.95. In another example, American Express (AXP), announced on Oct. 5 that it would offer free Web trading for customers whose accounts exceed $100,000.
There will be a class of wealthy clients who get to trade free online, and some discount brokers may experiment with free trading, but commissions won't go to zero for everyone, argued Credit Suisse First Boston analyst James Marks. That's because of simple economics. He estimates the cost per online trade at $7 or $8, so brokers would suffer a negative return if they went to zero. "Some companies will come out with zero pricing, but I don't think they are going to have staying power," Marks said.
To deflect pricing pressures, companies such as E*Trade will need to broaden their offerings so they manage more money for customers -- through mutual funds, for example -- and become less dependent on day traders, said Jupiter Communications analyst Rob Sterling. "It's going to be a tough business for the next couple of years," he added.
What will happen to the online brokers in the event of a stock market crash?
Clearly they will suffer, the panelists agreed. "At the bottom of the cycle, everyone is at risk," says Bill Burnham a former e-commerce stock analyst who is now a general partner at Softbank Capital Partners. But as long as the market doesn't implode and the firms monitor risks carefully, "they should be able to survive a market downturn," he says.
In fact, online brokers may be in better shape to weather a downturn than the big investment banks, says Marks. That's because they don't have major costs such as high-paid analysts and bankers, and they don't engage in risky trading of the firm's own capital or make large loans that can get them in deep trouble.
Still, says Marks, it's hard to tell how exposed the discount brokers are to margin risk (basically, the risk that their customers won't be able to cover margin calls if stocks plummet). "I spend a lot of time asking them how they assess risk, and they all say the right things," Marks added. "But until it actually happens, you don't know."
Who will win online -- discount or full-service brokers?
"I think full-service brokerages will get their clocks cleaned online," said Softbank Capital's Burnham. He argued that full-service firms won't be able to offer discounted online trading without angering, and losing, their full-service brokers. Dealing with the inherent conflict in the sales channel will be so daunting, Marks thinks, that an investment bank like Goldman Sachs has a better opportunity to expand into online trading than a Merrill Lynch.
Blodget, sticking up for his firm, disagreed. He argued that trading is a commodity that simply takes time away from the primary job of a stockbroker -- matching investment opportunities with clients and disseminating ideas.
The market has been so strong that it has been a great time to be a broker -- full-service or discount, Marks said. The real battle will come when the market turns south and the amount of money to be made in the brokerage business shrinks.
Can financial Web portals compete with online brokerages?
Burnham doesn't seem to think they can. He argued that brokerages, which generate revenues from trading, can provide richer investing content than sites such as Yahoo! Finance and Microsoft MoneyCentral, which rely on advertising and sponsorships. A key, he said, is that discount brokers can afford to buy Wall Street research from the top brokerage houses and use it as a loss leader to attract more clients. For this reason, he sees a 60%-to-70% chance that TheStreet.com (TSCM) will be acquired by a brokerage house.
Where are the online banks?
They're coming, said Marks. He thinks that WingspanBank.com, a spin-off of Bank One (ONE), is the most exciting player. Sterling argues that while brokerages are popular during a bull market, online banks will have the advantage in a stock market downturn. But Marks doesn't think that online brokerages need to rush to buy up banks to get into the highly regulated industry. For example, he thinks it was unwise for E*Trade to buy Telebank for $1.8 billion in stock when, he calculates, it could have built its own bank for less money.
Is VerticalOne onto something?
The site, which launched on Aug. 2 with a few partners ("In Online Bill Paying, It's BankOne vs. VerticalOne," BW Online, Aug. 26), plans eventually to offer consumers one place where they can pay bills, check bank balances, monitor credit-card accounts, and review their frequent-flier miles. Security First Corp. (SONE) announced in late September that it was buying the company for $166 million in stock. Burnham called VerticalOne "the biggest thing to hit financial services." Panelists from Microsoft MoneyCentral and Quicken.com agreed that they were keeping an eye on it.
Still, Jupiter Communications analyst Rob Sterling thinks financial-services companies can easily keep customer data from being distributed to VerticalOne, as well as to other sites that try to do the same thing. "It's going to be a battle," said Sterling. Burnham didn't believe financial companies could legally block customer data when the customer had requested that it be passed along. But Marks said that doesn't matter since anyone who legally or technically blocked the flow of data would alienate customers.
What will be the next big thing to hit online financial services?
Bill payment and presentment (allowing consumers to review bills online), is coming, although it has been slow out of the gate, panelists said. Financial Web sites are eager to offer the service since it is "sticky," meaning that it will keep customers coming back.
Also on the way are online insurers. Most insurance sites today, including InsWeb (INSW) and Quotesmith.com (QUOT), compile information from multiple carriers and refer customers to the insurance company with the best price. But a new site called E*Coverage is the first true online underwriter and worth watching, said Marks.
How do the three key online financial services stack up when it comes to taking advantage of the power of the Internet? Marks rated discount brokers way out in front of the trends, followed by mortgage lenders, and then insurers.
Amey Stone is an associate editor at Business Week Online
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