From Santoli in Barron's:
It's easy to look at E*Trade and see a company whose historical moment has passed, a melancholy relic of a bygone market era.
That "E" prefix in E*Trade, once a signifier of forward-thinking cool, now wears like a bad haircut in an old yearbook photo -- lousy taste captured for posterity. And the "Trade" part doesn't help the company's cause, merely pointing up its former dependence on the hyperactivity of hobbyist bull-market investors with short attention spans and sparse analytical abilities.
Layered atop these handicaps is chief executive Christos Cotsakos, who, as Barron's has reported, has availed himself of lavish company pay and perquisites, extending all the way to free trans-Atlantic travel so he might earn a graduate degree.
But, despite appearances that it resides on the wrong side of history, E*Trade has spread itself cleverly away from the pure online brokerage game into consumer banking and wholesale trading. And its shares appear quite inexpensive based on its current business trends and sturdy balance sheet -- a picture that only improves with any potential rebound in retail investing activity.
At a recent price around 4.20, E*Trade is trading near its book value of $4.16 a share and at only a modest premium to its tangible book value (which eliminates goodwill and other intangibles). With a market value of about $1.5 billion, E*Trade has $1.8 billion in cash on its books. Set against about $790 million in debt, that amounts to well more than $2 a share in net cash per share for a company that's now functioning above breakeven and is expected to earn 44 cents a share this year and 63 cents in 2003.
Last quarter, the banking business -- much like thrifts, with mortgage assets delivering an attractive interest spread -- provided $100 million in revenue, up from $78 million a year earlier, while brokerage revenue slipped to $215 million from $229 million. E*Trade, in addition to launching E*Trade Bank, acquired an ATM network. These efforts have helped to steady its business at times, such as now, when the small investor is largely inactive.
E*Trade recently bought back 3.4 million shares at $3.60 from its longtime backer, Softbank, and E*Trade director William Porter last week reported an open-market purchase of 50,000 shares at $3.72, not far below the current price.
Skeptics have complained that E*Trade seems to carry extremely small reserves against loan losses. Yet Putnam Lovell Securities analyst Richard Repetto remarks that, as one of the first online-only banks, E*Trade has evolved under microscopic attention from regulators, who for years allowed the firm to acquire only high-quality mortgage securities and mandated that they be treated conservatively. That credit-quality mandate explains the low reserve levels, he says. News last week that expenses from a cash-flow hedge and losses on some Qwest Communications bonds would nick its bottom line also spurred some bearish talk, although no lasting damage is suggested by the moves.
CEO Cotsakos has been a lightning rod for bears, receiving justifiable scorn for his generous pay and benefits. Yet public shaming and the new ethic of corporate governance have been effective. E*Trade last quarter booked a $23 million reduction in operating costs from a renegotiated, less luxurious employment pact with Cotsakos.
With the banking operations essentially supporting E*Trade's entire valuation, the stock presents a good way to wait out the market lull while also positioning for an eventual revival of retail brokerage volumes. And when those trading commissions do begin flying again, it will benefit the relatively few firms (Charles Schwab, E*Trade, Ameritrade) that have survived and consolidated the business.
In this context, E*Trade seems the best bet, especially when considered against its close rival Ameritrade, which is now acquiring Datek Online. E*Trade is valued at 6.5 times projected 2003 earnings and trades at book value, Ameritrade at 12 times '03 earnings and more than twice book value. While E*Trade is able to profit from the hot mortgage market while the stock market suffers, Ameritrade is a virtual pure play on the active stay-at-home investor. E*Trade has some four million customer accounts of various sorts and $46 billion in client assets and deposits. Ameritrade has shallower market penetration, with 1.9 billion accounts and $27.5 billion in customer assets.
Meanwhile, Schwab, a much larger and more balanced company that's nonetheless still tied closely to retail trading, stubbornly retains a stout valuation at almost 20 times 2003 forecasts.
All things considered, E*Trade appears as the most attractive of the bunch, unfashionable haircut and all.
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