E*trade - The Beginnings of a Financial Cyber-Behemoth
by Neil Sandhu
E*trade (NASDAQ: EGRP) is quickly emerging as the Internet's leading financial hub. It has spread its wings far beyond its humble beginnings as merely a niche brokerage firm. E*trade's recent forays include launching its own investment banking arm and, most noticeably, its pending acquisition of leading Internet bank Telebanc (a company that was profiled earlier this year in a Cyberstocks Report on Internet Banking). E*trade has also developed close ties to leading companies across a wide spectrum of financial services, including such companies as E-Loan, ECN Archipelago, and market-maker Knight-Trimark Group. Additionally, E*trade is set to launch major international initiatives, as well as initiatives in such areas as insurance, mortgages, and credit cards.
E*trade, like most Internet companies, is currently unprofitable due to major marketing efforts. Yet, in the case of E*trade at least, such marketing is a very wise move in the race to grab potential customers. These vast marketing outlays will potentially result in even greater gains down the road. The main reason why such outlays seem especially justifiable in the case of brokerage sites is due to their inherent stickiness as compared to other e-commerce sites. Once a brokerage such as E*trade is able to capture a customer, it is much easier for them to hold on to them for good, as compared to other e-commerce vendors. The reason for such a difference is that the brokerage relationship is inherently an ongoing relationship, given the fact that the brokerage has control over the customer's purse strings. In contrast, other consumer e-commerce relationships are one time deals where the vendor has no real control over where the consumer shops next. E*trade's underlying business model is, in fact, quite profitable. As a matter of fact, E*trade had been fairly profitable last year and, even given its massive marketing spending, is poised to return to profitability in the not too distant future.
Additionally, like most Internet companies, E*trade's cost structure is far superior to that of its land-based competitors. Not only that, but because it only exists in cyberspace, it is much easier for E*trade to enter new markets than it is a traditional financial firm. The capital outlays required for such expansion by E*trade are minuscule as compared to brick-and-mortar financial institutions. Similarly, it is much less costly for E*trade to move out of unprofitable markets during hard times, such as a financial downturn in a certain sector of the world.
The impending purchase of Telebanc represents the boldest move yet by the cyber-broker and is consistent with E*trade's goal of creating a global financial behemoth. Such a combination will present consumers with another reason not to take their business elsewhere. The purchase also enables E*trade to acquire new banking customers quickly and expose them to its brokerage services and other services as well. E*trade realizes that the customer land grab will never be as frenzied as it is today and, with its large cash reserve serving as fuel, is willing to capitalize on this unique window of opportunity.
By diversifying revenue streams, E*trade is also attempting to smoothen out quarterly revenue fluctuations. Likewise, its impending expansion into various world markets will provide for smoother revenues. The explosive growth of the Internet combined with the U.S. bull market has, up until now, presented an ideal world for cyber-brokers where sequential revenue growth is all but guaranteed. Lower trading volume on U.S. exchanges in recent months as well as the eventual maturation of the Internet is evidence that this nirvana will not last forever. With its recent initiatives, E*trade seems better prepared than others to thrive in such a less-than-ideal world.
E*Offering, the newly launch Internet investment bank closely associated with E*trade, is another way in which E*trade is attempting to distinguish itself from the cyber-pack. By serving as the leading underwriter in a number of impending offerings, E*Offering will allow E*trade customers greater access to IPOs. With E*Offering, E*trade is attempting to remove one of the last remaining advantages possessed by major brokerage houses.
E*trade's strategy seems to be working. It is among the fastest-growing and most-visited financial sites on the Internet. Recent studies seem to suggest that E*trade is growing at multiples of the already breakneck growth of the Internet financial industry. In fact, one study shows that the number of unique visitors to the E*trade site is more than that of its two nearest competitors, Fidelity and Charles Schwab, combined. Additionally, E*trade recently announced that it surpassed one million active customer accounts.
Many of the same arguments that I suggested in my Cyberstocks Report on Online Banking apply equally to the Online Brokerage Industry. As a result, I would argue that a company such as E*trade possesses an inherent advantage even over current online leader Charles Schwab, let alone the predominantly brick-and-mortar brokerages.
Increasingly, online customers have come to value superior service over rock-bottom prices. In fact, online commission rates have remained fairly stable over the last year, after having dropped fairly steadily in previous years. E*trade's commissions are low enough for the vast majority of customers, while their underlying costs are among the lowest in the industry. The real battleground in the online brokerage wars is being waged on other fronts now. E*trade management has consistently remained ahead of the pack in addressing the wishes of customers. Recent initiatives indicate that this trend is likely to continue. If E*trade continues to execute, it will be able to control a significant portion of the online financial services industry and, I believe, as a result, the entire world financial industry. That is a market that is mind-numbingly large.
Previous coverage of E*trade on cstocks.com (July 1998)
Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. This column merely represents the current views of Neil Sandhu, a contributing writer to cstocks.com, who currently maintains long positions in E*trade, Telebanc, and Knight-Trimark Group . Additionally, Neil Sandhu maintains a brokerage account with E*trade. Such views and positions may be changed at any time, without prior notification. We invite readers to comment on the column at cstocks@mygo.com.
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