The author of this is so full of crap his eyes are brown, but here it is... (SmartMoney.Com)
The Party's Over for Online Brokers
A Return to Reason?
April 17, 2000
The Party's Over for Online Brokers
By Matthew Goldstein
THE OWNERS OF online-brokerage stocks just can't seem to get a break.
A mere three weeks after most online brokerage stocks posted their biggest rally in months
(see story), the entire sector is again back in the dumps. A casualty of the recent bear market,
many are currently trading near their 52-week lows.
National Discount Brokers (NDB), for instance, is trading around $29 a share, a 46% drop in
value since March 24. And Charles Schwab (SCH), the nation's biggest discount and
online-brokerage firm, is now selling for $40. Three weeks ago, Schwab set a new 52-week
high when its stock peaked at $67.13.
Never mind that earnings for these companies are on fire due to heavy trading volume.
Schwab on Monday reported $284 million in quarterly profits, nearly double last year's figure.
With earnings of 33 cents per share, Schwab beat analyst expectations by a penny. But
despite that good news, Schwab's stock rose slightly. Things were even worse for E*Trade
Group (EGRP) and Ameritrade Holding (AMTD), two online-brokerage firms that had the
misfortune of announcing their quarterly earnings smack in the middle of last week's Nasdaq
bloodbath. Both companies posted strong results and both are trading near their 52-week
lows.
Now an optimist might say the online brokers are simply victims of bad timing. But even if the
Nasdaq starts rebounding this week as many market watchers expect, don't look for the online
brokers to join in the celebration.
That's because the just-completed fiscal quarter may have been a high watermark for a while
in terms of profitability. The Nasdaq Composite's six-month gallop above the 5000 mark led
to a surge in trading activity at all online-brokerage firms. Daily trading volume at Schwab,
for instance, was up 90% during the first three months of this year, compared to a year ago.
But many market watchers expect the sharp sell-off in the Nasdaq to lead to a decline in
trading activity, even if stock prices on the Nasdaq start to recover in the coming weeks.
"Online brokers are highly sensitive to trading volume and now there is a reasonable
likelihood that after a correction trading volumes will pull back a bit," says Lehman analyst
Richard Repetto.
The online-brokerage business also is moving into what traditionally has been its slowest
period of the year. Online trading activity tends to dip during the summer months, when
investors would much rather be outside than stuck in front of a computer terminal. And unlike
traditional Wall Street firms which also can count on revenues from underwriting deals and
merger-and-acquisition advisory work, online brokers feed mainly on trading commissions and
related transaction fees.
"We are going into a seasonal lull," says Josephthal & Co. analyst William Wong. "I think
transaction activity will decline a bit because of what's going on with the Nasdaq. It's a
cyclical business and a seasonal business."
These companies could also get stung by what is likely to be a slowdown in margin trading
? or using borrowed money to buy stocks. The practice is highly profitable for the
brokerages, who act as lenders at high rates of return. Many market experts believe the sharp
sell-off on Wall Street was exacerbated by the record amount of margin debt piled up by
investors. Many online-brokerage firms report having issued a heavier-than-normal amount of
margin calls to investors during the past few weeks.
For some new investors, this may have been the first margin call they've ever gotten and a
rude awakening to the danger of buying stock on borrowed money. When an investor gets a
margin call, he must either deposit more money into a brokerage account to bring the
balance up to a minimum level or sell some stocks in the account to raise the necessary
money.
Matthew Vetto, an analyst at Citigroup's Salomon Smith Barney, says investors who got
burned buying stocks on margin, may become wary about doing the same in the future. And
that could have a negative impact on online-brokerage firms, whose customers tend to buy
stocks on margin more frequently than customers of traditional brokerage firms. In addition,
Vetto says margin investors generally are more active traders than nonleveraged investors.
The interest charged on margin accounts ? usually around 8% ? also is a much more
important source of revenue for online-brokerage firms than full-service brokerage firms like
Merrill Lynch (MER) or Morgan Stanley Dean Witter (MWD). At E*Trade, for example,
interest on margin accounts accounted for roughly 25% of the $407 million in net revenues
that the online broker raked in during the first three months of this year. "With everything that's
been written about margin loans and margin calls, I think some people will pull back on
investing on margin," says Lehman's Repetto.
A prolonged slowdown in these stocks could lead to a much-anticipated wave of mergers and
acquisitions in the sector. With more than 150 investment firms offering some kind of online
trading, analysts have been predicting consolidation for nearly a year. If trading activity and
earnings slow, that could prompt the big players in the online-brokerage business to start
gobbling up smaller firms.
And after last week's market implosion, there are signs that some of the smallest
online-brokerage firms may be ready to hoist the white flag. Track Data (TRAC), a small New
York company that runs the MyTrack online-brokerage firm, announced last week that it has
hired an investment bank to consider a possible sale of the company. MyTrack is one of a
number of small-brokerage firms that caters to the active online trader. Track Data's stock,
now trading just under $3 a share, has tumbled some 64% over the past three weeks.
Industry analysts say that over the next few months, they expect other small online brokerage
firms to either be acquired, strike partnerships with larger players or simply disappear. The
likely suspects for some sort of combination: Southwest Securities (SWS), A.B. Watley
Group (ABWG) and Ameritrade.
So while all investors are looking for a sign that the big sell-off has come to an end and stock
prices are ready rebound, it may be a different story for investors in online-brokerage stocks.
The reality is you already may have seen the best days this year for many of your
online-brokerage stocks ? unless, of course, your company happens to get bought out. |
