Selling The Guns
June 4, 1999
By Matthew W. Ragas, Editor
Swashbuckling online broker E*Trade (EGRP) announced plans Tuesday to acquire online bank Telebanc Financial (TBFC) for $1.8 billion in stock. The deal will pair the Web's second largest online broker with the U.S.'s largest online bank. Rest assured that traditional banks will now take serious notice of the online banking space.
Executives at Chase Manhattan (CMB) and Wells Fargo (WFC) may not have heard of small upstarts like Telebanc and Netbank (NTBK), but they have definitely heard of online trading giant E*Trade. With the millions in advertising E*Trade has shelled out in the past year it would be almost impossible for any banker not to be endlessly reminded that "one day we'll all invest this way." Earlier this week, E*Trade launched an aggressive print ad campaign that featured the line, "sorry bankers, the brokers should have warned you." Hmm, looks like someone is tweaking the lion's nose. Yes, the online banking wars have clearly begun.
Buying Rather Than Building
The Telebanc deal isn't so surprising when you consider that E*Trade has already branched out from its brokerage roots by partnering with other online companies to offer insurance and lending services. E*Trade Chief Executive Christos Costakos has long proclaimed the company is much more than an online brokerage and fully intends to be the Web's financial services leader. However, I had expected E*Trade to build their own online banking operation from scratch, rather than buy up an existing player.
I can't fault Costakos for doing the deal. He paid roughly a 40% premium to Telebanc's closing stock price last Friday, but when he's paying with Internet paper, what's the difference. Closing the deal and quickly integrating both companies' online operations is far more important. As we've seen time and time again on the Web, speed to market means everything. By acquiring Telebanc, E*Trade becomes one of the top forces in online banking almost overnight.
Not To Be Caught Off Guard
Unlike many of the traditional brokerage houses, which were caught largely unprepared for the explosion in online trading, off-line banks have spent the past few years preparing for the advent of online banking to hit the mainstream. Already, large banks like Wells Fargo, Bank of America (BAM), Bank One (ONE) and Citigroup (C) have spent millions building their online banking operations, and many have migrated their off-line customer base to the Web. First Union (FTU), for example, now has more than 700,000 online customers, making Telebanc's 50,000 customers look like chump change.
The customer will definitely come out on top as the online banking war heats up. More competition invariably means lower fees and higher rates for online customers. However, an even larger winner lurks in the form of the software and consulting firms that provide applications and expertise for enabling off-line banks to offer online banking services. After all, someone has to supply the ammunition for this online banking explosion.
The Arms Merchants
While, I can't easily predict which banks will win the online war, the leading arms merchants should win either way. At the head of the list is Securities First Technologies (SONE), the leading supplier of brandable Internet applications that enable financial institutions to offer a variety of Internet banking services. Securities First, or S1, is no stranger to the online banking space.
In 1995, the company launched the Web's first Internet bank, called Security First Network Bank. Then last March, S1 decided to sell its online banking operations to the Royal Bank of Canada (RY) in a $20 million deal. At the time, S1 was already providing financial software to a variety of banks that wanted to set up online operations. The sale of its online bank operations allowed the company to focus all of its energy on becoming the leading online banking software and consulting firm for financial institutions.
Financial Software Powerhouse
Let's fast-forward a few months. S1 was dominating the Internet banking applications market, but was looking to further solidify its position. So in mid-May S1 announced plans to acquire FICS and Edify Corp. (EDFY), two competing providers. The two acquisitions, which are valued at a combined $1.4 billion, eliminate two existing competitors and poise S1 to dominate the market with the most complete applications package available.
How can I be so sure? Consider that the combined S1 will have relationships with 35 of the world's 100 largest financial institutions. The newly combined client list will include financial powerhouses like Bank of America, Bank One, Chase Manhattan and Citibank. The company will combine Edify's expertise in small business banking and bill presentment; FICS' worldwide sales force and strong European bank client base; and S1's existing leading corporate and retail online banking products. By acquiring two of its largest competitors, S1 should enjoy better pricing leverage for its software. After all, when you're one of the only online banking software providers left on the block, it's harder for your clients to haggle over price.
Under The Hood
Pro forma revenue for the combined company was $150 million last year, $24.2 million of which belonged to S1. Piper Jaffray analyst Stephen Franco estimates the new firm will have sales this year between $180 million and $200 million.
S1 reported first-quarter 1999 loss of $3.3 million, or 13 cents a share, compared with a loss of $8.1 million, or 39 cents a share, a year ago. Revenue for the latest quarter was $12 million, a 250% increase from the year-ago period.
Even more promising than the company's narrowing losses was the fact that gross margins increased to 40% from a gross margin of 0% in the first quarter last year. The total number of accounts powered by S1 technology continues to surge, totaling more than 692,000 at the end of the March. That's an increase of almost 600% from a year ago. Clearly, S1 is heading toward profitability. Consensus estimates show S1 posting a loss of 12 cents a share next quarter, but turning a profit in the first quarter of 2000.
New Investors
S1's strong position in the online banking space has recently attracted a number of well known technology and banking names looking for a piece of the pie. In February, S1 announced marketing alliances with Hewlett-Packard (HWP) and Andersen Consulting. Both companies will promote S1's online banking software to their clients. In addition, Hewlett-Packard announced a $10 million equity investment in S1 and Andersen Consulting decided to take a $4 million stake in the company. The alliances give S1's software powerful direct distribution from two of the world's largest technology consulting sales forces.
Personal finance software maker Intuit (INTU) also announced a partnership and bought a 2.5% stake in S1 for $50 million last month. The investment gives Intuit an option to increase its stake to 9.9% at a later date. The deal will integrate Intuit's popular Web-based personal finance products into S1's existing software. The deal appears to be a win-win for both parties. Intuit gains new distribution of its Web-based applications to numerous online banking sites, while S1 gets a variety of "sticky" applications that should help increase the time spent on the online banking sites of its clients.
Online Banking Growth
If online banking follows research projections, S1's market could be at the beginning of a very steep growth curve. Cyber Dialogue estimates about 6.9 million people banked online at the end of last year. The research firm expects that number to grow to 24.2 million online banking users in the U.S. by 2002, a particularly relevant number to S1, because the company collects a monthly fee from many of its banking clients based on the number of end users. In addition, IDC estimates that $326 million in online banking applications will be sold this year in the U.S., a 250% increase from last year's numbers. Adding further fuel to S1's growth prospects are numbers released in February by the American Bankers Association. The ABA estimated 625 of the nation's 9,000 banks currently offer some form of online banking, while IDC estimates 7,200 banks will purchase Internet banking applications this year.
Most impressive is an estimate from Dove & Associates that the worldwide Internet banking applications market will reach $2.7 billion by 2003. Will online banking take off and live up to these projections? It's hard to say. One thing for certain is that E*Trade's Telebanc acquisition will force other banks to increase their online spending. With sales last year of only $24 million and a market cap of $967 million, is S1's Friday closing price of 38 1/4 justified? That's your decision to make.
All I know is that I'd rather be in S1's position, providing the swords and shields to the gladiators in the online banking war, instead of being thrown into the trenches to fight against powerhouses like Chase and Citibank. I'm sure S1 hopes the battle goes on for eternity - a nice thought for consumers and perhaps an even better thought for S1 shareholders. Cyberinvestors: May the best bank win.
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