NXCD as takeover candidate?
E*Trade Is Expected to Announce Stock Deal to Acquire Telebanc
June 1, 1999
By STEVEN LIPIN, REBECCA BUCKMAN and PAUL M. SHERER
Staff Reporters of THE WALL STREET JOURNAL
E*Trade Group Inc., the online brokerage concern, is expected to
announce as early as Tuesday an agreement to acquire Telebanc Financial
Corp., one of the few online banking companies, in a stock transaction
valued at about $1.8 billion, according to people familiar with the situation.
The combination is the first of an online broker with an online bank,
allowing Telebanc to link up with a fast-growing financial player while
giving E*Trade a less volatile revenue mix. It gives a big boost to
E*Trade's long-term goal of becoming an online financial "portal" site,
offering all sorts of financial services other than plain-vanilla stock
brokerage. E*Trade, based in Palo Alto, Calif., already sells mutual funds,
for instance, and has a deal with online-mortgage provider E-Loan Inc.
that allows E*Trade customers to apply for home mortgages online.
The move comes as competition in the online-brokerage industry continues
to heat up, particularly with the splashy entrance of Wall Street titan Merrill
Lynch & Co. Merrill is expected to announce a major push into Internet
trading Tuesday, including a new account that allows investors to trade
stocks for just $29.95 (see article).
Two months ago, E*Trade bought ClearStation Inc., an online
financial-advisory and discussion service. The Telebanc acquisition,
however, would be the first to move E*Trade into an entirely new type of
financial service.
Telebanc Financial, based in Arlington, Va., is the holding company for
Telebank, one of several Internet-based banks that serve customers
without using "brick-and-mortar" branch offices. Since the banks don't
have to pay for branches, they say they can operate more inexpensively,
pay higher deposit rates and charge lower fees than traditional banks.
Telebanc's Rivals
Telebanc's Internet competitors include Net.Bank Inc. and Security First
Network Bank, a unit of Royal Bank Financial Group. But the firm's
biggest competition may be from traditional banks, which may be one
factor in its decision to sell. A handful of companies such as Wells Fargo
& Co. and Toronto-Dominion Bank have been offering Internet banking
for several years, while others such as Chase Manhattan Corp. have
recently been moving to bolster their Internet presence.
The transaction also reflects E*Trade's willingness to use its rich stock
multiple to acquire other online financial concerns. E*Trade trades at 13
times projected annual revenue, and is paying about five times projected
revenue for Telebanc.
People familiar with the matter say each share of Telebanc will be
exchanged for 2.1 shares of E*Trade, which translates into stock valued at
$93.45 a share. On the Nasdaq Stock Market Friday, Telebanc closed at
$66.50, up $4.25, or 6.8%. E*Trade closed at $44.50, up $2.50, or 6%.
Though most online brokers offer some banking services, such as bill
payment and limited check writing, only one other company -- Royal Bank
of Canada, which owns Bull & Bear Securities Inc. -- has tried to combine
large-scale Internet banking and brokerage. Royal Bank also owns
Telebanc rival Security First Network Bank, and Royal Bank is investing
$29 million in beefing up Bull & Bear's services, including links with
Security First.
E*Trade's venture will likely be much more far-reaching. E*Trade, one of
the pioneers in the online brokerage business, has more than a million
customer accounts, and could gain even more by marketing its online
brokerage services to Telebanc's customers. Telebanc's rates for checking
and savings accounts are also well above industry norms.
Diversifying Revenue Streams
Many online brokers are adding new services to diversify their revenue
streams, since most now depend heavily on stock commissions. That
revenue can fluctuate wildly according to market cycles, while recurring,
fee-based revenue, such as money made off bank deposits, is more stable.
E*Trade is ranked as the second-biggest U.S. online broker as measured
by trades a day, with about a 13.3% market share at the end of the first
quarter. Charles Schwab Corp. is the leader, with 27.9%.
As of March 31, Telebanc had more than $2.6 billion in assets, more than
$1.3 billion in retail deposits and nearly 60,000 customer accounts.
Revenue in 1998 was $107.7 million, up 70% from $63.4 million in 1997.
The company had a loss of nine cents a share, or a total of $737,000,
compared with a profit of $3.7 million, or 57 cents a share, in 1997. The
loss stemmed from higher marketing costs for customer acquisitions and
brand-building efforts, as well as the conversion of preferred shares into
common stock. Excluding charges relating to the conversion, the company
would have earned a profit of $1 million, or 13 cents a diluted share.
Telebanc predates the Internet era. In 1989, two attorneys purchased a
small Washington thrift for $5 million. They eventually shed its branches
and began operating it as a branchless bank, offering service through
automated teller machines, telephone, fax, mail and the Internet.
With online banking, customers can view their account balances and
transaction histories and make transfers and payments over the Internet.
Payroll checks can be deposited directly, while other deposits are mailed
in. The downside for customers is that they must withdraw cash by using
the automated teller machines of other banks, which usually require a fee.
The online banks lure customers by paying higher deposit rates than
regular banks. Telebank is offering a 5.4% annual interest rate on a
one-year certificate of deposit. On its own Internet site, Chase Manhattan
Bank advertises 3.87% or 4.11% for the same term, depending on the
account type.
But while high deposit rates are attractive for customers, for the Internet
banks they mean lower profits. Banks make much of their profit by paying
customers low rates on deposits and charging higher rates for lending out
the money. By offering higher deposit rates, the Internet banks earn
slimmer profit margins than traditional banks.
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