WEBS--Here is a recent Smartmoney piece about the coming consolidation in the industry. I think WEBS is a prime takeover target.
<<BRUCE ZUCKER, the president of Mydiscountbroker.com, sees a big shakeout coming to the online brokerage business.
With more than 130 companies now offering some form of online stock trading, Zucker says consolidation is inevitable. He predicts that by next spring, there will be a wave of mergers and acquisitions in the online brokerage industry. Zucker's goal is to make sure Mydiscountbroker is still standing when the dust settles. "The smaller companies are going to have a hard time keeping step-for-step," he says.
So that's why Mydiscountbroker, a subsidiary of Texas-based Southwest Securities Group (SWS), is spending $30 million on advertising over the next three years. The online broker hopes to get enough buzz from those ads to attract new customers and put itself in a position to be an acquirer. But with much larger online trading firms — like E*Trade Group (EGRP) and Ameritrade Holding (AMTD) — spending hundreds of millions of dollars more on advertising, will Mydiscountbroker's $30 million be enough?
Maybe not, if you listen to the Wall Street analysts who cover the online brokerage business. Josephthal & Co.'s William Wong, for instance, estimates that an online broker needs to spend at least $200 million a year on advertising to "build brand identity and critical mass." While cynics may question the value of those ads, most industry watchers say the high-powered marketing campaigns are adding thousands of new customers each month to the biggest online brokerage firms. And in the end, analysts say, bigger is better.
So what's to become of all those online brokerages that don't boast the hefty ad budgets of firms like E*Trade, Ameritrade, TD Waterhouse Group (TWE) and Charles Schwab (SCH)? Well, many of them will become acquisition targets for both bigger brokerage firms and commercial banks. In this screen, we compiled a list of some of the smaller publicly traded online brokerages that could make for attractive acquisition targets. But before you're likely to see any mergers happen, analysts say the stock valuations for many of these smaller online firms, such as National Discount Brokers Group (NDB), Siebert Financial (SIEB) and Southwest Securities, will have to come down. Right now, it's still cheaper for a big online broker to add customers by spending millions on advertising rather than through buying a rival firm.
But that dynamic may be changing. Next year it will become considerably more expensive for these contenders to advertise on CNBC. The financial cable-television network, which is a key marketing outlet for the online brokers, is tripling its basic advertising rates, sources say. Higher ad rates will not only make it almost impossible for the smaller players to hawk their services on CNBC, but they may crimp the ad budgets of big operations like E*Trade and Ameritrade. "The day is coming when new account growth from advertising slows and valuations drop," says Richard Repetto, an online brokerage analyst at Lehman Brothers. Meanwhile, other analysts say it may get more difficult in the coming year for online brokers to raise new financing to pay for advertising and marketing initiatives.
Another prospect that could hasten consolidation is the possibility that securities regulators will tighten the spigot on a common Wall Street practice called "payment for order flow." Many of the online brokers receive millions of dollars each from other financial institutions that pay them in exchange for the lucrative business of processing and executing trades for the online firms' customers. Recently, the Securities and Exchange Commission has made some noise about curtailing the practice. Payment for order flow accounts for nearly 8% of Ameritrade's annual revenue. But a much smaller firm like Web Street (WEBS), which gets roughly 40% of its revenue from payment for order flow, is even more vulnerable to potential regulatory action.
When merger fever finally does arrive on the scene, analysts say one online brokerage firm that's sure to be on most radar screens is JB Oxford Holdings (JBOH), a Los Angeles-based firm that also clears and processes trades for many day-trading outfits. JB Oxford, whose officials were unavailable for comment, expects to post a fourth-quarter loss because of higher costs associated with its $10 million advertising campaign. The brokerage firm is often mentioned as a possible acquisition target because its stock is trading well off its 52-week high of $25.75. Compared to other online brokers, JB Oxford carries a relatively low price-to-earnings ratio of 16. But an inquiry by regulators into the role that JB Oxford and other clearing broker firms play in processing trades for day-trading firms could make some suitors shy away.
Many small online brokerages dismiss the notion that they're simply prey for bigger fish. Farshid Tafazzoli, a co-founder and chief information officer of Onlinetradinginc.com (LINE), says the pint-sized company, with less than $15 million in annual revenue, sees itself as a niche player. Catering to wealthy investors with minimum balances of $100,000, Tafazzoli says the Florida-based firm has no need for "shotgun marketing."
Tony Huston, a co-founder and executive vice president of A.B. Watley Group (ABWG) says the analysts who predict that only the biggest online brokers will survive don't understand how the Internet is changing the brokerage business. A.B. Watley, which lost $800,000 on $20 million in revenue in its just-completed fiscal year, is going after well-heeled active traders — the kind of investors that E*Trade and Ameritrade generally don't focus on. The $4.5 million A.B. Watley will spend next year on advertising is enough to suit the firm's needs, he says. "There are very few analysts who understand market segmentation," says Huston. "We are not going toe-to-toe with E*Trade. We will not become a mass-market, mass-consumer, low-end provider."
But it's not just analysts with whom Huston has a beef. He takes issue with the unrealistic expectations of some of the posters on the various online chat boards for A.B. Watley. A number of posters seem disappointed that the company's stock price, after soaring to $22 following an initial public offering this year, has hovered around $13 a share for months. A common complaint on the Yahoo! message board is that the company's executives don't advertise enough or take the right steps to get the company more visibility. Huston says those investors, just like the analysts, miss the point: A.B. Watley isn't competing for attention with the E*Trades of the world.
Yet even executives at tiny brokerage firms like A.B. Watley and Onlinetradinginc.com concede it's possible to have too many niche players in an industry. Eventually, consolidation will come to some of these more specialized online trading firms.>>
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