The pressure's on for Net brokerages NEW YORK--When Morgan Stanley Dean Witter said yesterday it's planning to offer online trading to all its 4 million clients, it was another piece of news Internet brokers didn't need to hear.
The second-biggest securities firm joined Merrill Lynch, American Express, and other full-service financial
firms muscling in on Internet brokers just as an industry downturn and rising costs are threatening earnings.
Web brokers such as E*Trade Group, TD Waterhouse, and Ameritrade Holding have cut fees as much as
two-thirds and doubled spending to acquire new accounts, wiping out profits from some. A summer slump in
trading, the industry's first, has driven down online brokers' stocks as much as 70 percent since April, leaving
some vulnerable to takeovers.
"This is a sorting-out time, a decision time where the big players have decided they want to keep putting on
accounts and the smaller players will have to keep up," said Rich Repetto, a Lehman Brothers analyst. "This
could lead to consolidation."
Smaller firms may run out of money, sell themselves, assume a niche role or "just fade away," said Christos
Cotsakos, chief executive of E*Trade. "Imagine if you're a new guy spending $30 million to $40 million
trying to break through the noise," said Cotsakos. "The game is almost over and the ante is $2
billion. This is the year where a lot of their backs get broken."
The latest entrants are formidable. Morgan Stanley, with its 12,000 retail brokers, will offer accounts that
combine unlimited online trading with investment advice for a flat fee, a service yet to be mastered by pure
online brokerages. Merrill, with 14,800 brokers, offers a similar account. Both provide single Internet trades at
$29.95 each, the same as Charles Schwab, the online industry leader. Citigroup and Chase Manhattan plan
online forays in the next six months.
Spending more
To contend, smaller rivals will have to spend more. Ameritrade and five other brokers sold more than $1.5
billion worth of stock and debt in May and June. They're loading up for a marketing war that will see $1.2
billion spent industrywide in the next year, according to Lehman Brothers.
That's as much as the cosmetics industry spent in 1998, according to Advertising Age. E*Trade alone will
spend $350 million on ads in the next 12 months, more than Campbell Soup spent last year. In addition, one
E*Trade promotion offers $1 million to the contestant who best predicts the level of the Dow Jones Industrial
Average at the end of the year.
At Ameritrade, a $200 million ad drive will erase profits for a year. Even J.B. Oxford Holdings, one-fifth the
size of E*Trade, will spend $10 million on ads in the next quarter.
"What's the barrier to entry" in the industry now, asked Thomas K. Lewis, co-CEO of Ameritrade. "It's $200
million in advertising and $100 million in technology spending," Lewis said.
Charging less
As spending increases, fees are being cut. In August, E*Trade reduced commissions on some trades to $4.95
from $14.95. It's offering $75 rebates to new customers. American Express this month said it would offer free
stock trades for accounts containing over $100,000, and it recently cut its basic commission to $14.95 from
$24.95.
Such tactics will push down the industry's average fee, currently about $15 per trade, making commissions
alone a shaky foundation on which to build a profitable business, said Russell Keene, an analyst with Putnam
Lovell deGuardiola & Thornton.
"I wouldn't be surprised to see an incredible transition in two years, to have a nonbrokerage with an existing
business model--and Internet company--subsidize near-free trades to get more traffic," said Keene. "That
could throw a real wild hair at the industry."
The price cuts and higher spending come as the appetite for Internet trading has dwindled as the stock
market's surge cooled. A Credit Suisse First Boston report in August predicted Internet brokers' trades would
decline in the third quarter for the first time ever.
Fewer trades
Hambrecht & Quist Group now estimates trades fell 5 percent to 10 percent in the period, after growth rates
of 15 percent to 47 percent the previous three quarters. Among the reasons: the Internet shares online
investors favor have been in decline. The Bloomberg index of U.S. Internet companies has fallen 27 percent in
six months.
Profits are beginning to show the strain.
Third-quarter margins at Charles Schwab fell to 14.1 percent from 15.4 percent in the second as commissions
slid 17 percent. E*Trade lost $26.7 million in its fourth quarter, 75 percent more than a year earlier. At
DLJdirect, the Internet arm of Donaldson, Lufkin & Jenrette, third-quarter trades fell 14 percent while the cost
of acquiring accounts jumped 86 percent.
The profits gloom has prompted investors to sell Internet brokers' shares since mid-April, when the companies
reported first-quarter results that merely matched expectations. The Bloomberg U.S. Internet Financial
Services index is down 64 percent in six months.
Humbling year
"This has been a very humbling year,' Schwab's co-chief executive, David Pottruck, said in a speech last
Friday.
For the firm's founder, Charles R. Schwab, a shake-out is inevitable. It was Schwab more than any other firm
that popularized online trading, starting with the StreetSmart product, sent to customers on floppy disks, in the
early 1990s.
"As we finish up this third quarter, a lot of these little firms that have been operating at a loss will see
themselves with bigger losses," he said in an interview. "There's going to be a lot of pressure from their
investors to think about how they match up with another firm." |
