Watershed Coming for Waterhouse?
By Bob Beaty, Canada Columnist
In the cutthroat online trading business, TD Waterhouse stands as the best bet.
So what's up with online broker TD Waterhouse (NYSE:TWE - news)? The number-two online broker - Schwab (NYSE:SCH - news) is number one - trades closer to its 52-week low than its high.
To be fair, the entire sector has been in the tank since mid-1999. The sector should recover, and when it does the smart money will have put its money with TD Waterhouse. That's because it's cheap, it's aggressive and, like any other company in a competitive industry, it's going to fight for the number-one position.
(Disclosure: TD Waterhouse is a subsidiary of Toronto Dominion Bank, whose venture capital subsidiary, TD Capital, is an investor in worldlyinvestor.com.)
Mid-Summer Swoon
Both companies peaked (TWE to $27.25 and SCH to $77.50) back in July 1999 and have been in decline ever since. Given the rise in trading volumes and online accounts, it seems reasonable to assume that the sector should turn around - soon. And though earnings are important, volume and volatility are the key words to online trading success. Needless to say lately, we've had plenty of both.
So who do you go with? Our feeling is both stocks will recover in coming months. But we happen to like Waterhouse a bit better due to the company's leaner, more aggressive approach -- no one tries harder than a number-two -- and of course due to our Canadian affiliation.
TD Waterhouse boasts 3.2 million accounts worldwide vs. Schwab's 5 million. Its trading volumes advanced 56% in the quarter ending December 31 to 108,000 per day from 69,000 at September 30, 1999. Account openings were up 18% to 1.3 million over the previous quarter. The 50%-plus daily trading increase at Waterhouse was echoed throughout the sector, including solid increases at Schwab, Etrade Group (Nasdaq:EGRP - news) and Ameritrade (Nasdaq:AMTD - news).
Waterhouse, like Schwab, makes money. Zacks forecasts the brokerage will make 36 cents per share by year-end and 43 cents for fiscal 2001. The current price of $14 is respectable at 41 and 35 times earnings for this year and next year respectively. With competitor Schwab trading at $37, its price/earnings number for 2000 is 45, slightly higher than Waterhouse.
Burn Rate
But the fly in the cyber-ointment for the sector is the amounts of money companies have spent to attract new customers. An analysis by Lehman Bros. pegged the number spent to open a new account in the fourth quarter at an average $325, up 35% from the previous three months. As a result, while behemoths Schwab and Waterhouse are profitable, Etrade Group and Ameritrade still show losses, although the numbers seem to be narrowing each quarter for these two.
However, profit margins are also narrowing as vicious competition rages for the huge pool of clients still offline - forcing commissions to drop. At $6 to $8 for an online trade, service and the attendant customer retention becomes key to realizing an eventual payback.
As the online market matures, the money spent should decline as ``word of mouth,' the Holy Grail of marketing, increases the number of investors who migrate to online trading. Consolidation of smaller players will continue as was seen with last year's multiple acquisitions by Waterhouse of the likes of California discounter Jack White and others.
Market Direction Doesn't Matter
Any attempt to re-align customer trends is always costly. Online investing is here to stay and as it becomes a universally accepted way of trading, customer acquisition costs will likely remain high. Offsetting this timeline is the introduction of new services, such as robust after-hours trading, as we move towards a 24-hour online market, and the linking of global trade through one online account.
One press report stated that a decline in the net stocks would hurt the online brokers. That would only be true if the infrastructure collapsed and investors were left hanging. Brokers, both traditional and online, care little if stocks go up or down. The profit mantra is volume and execution - no matter the direction.
The true test of these companies will come when and if the tech market reverses. With volumes on the Nasdaq routinely crossing 1.5 billion daily and the Dow volume consistently north of 1 billion daily, the systems are performing. Certainly online brokers such as Waterhouse and Schwab, the two largest, have the greatest potential, but they can't afford to continue spending the kind of largesse they have to date to attract new accounts.
Watch Marketing
The key number to watch is not earnings for these two, as they will continue to make money, but the amount of that money they plow back into marketing. As the business of online trading approach critical mass, still a ways off, those costs will decline, as will the number of competitors.
And as with most things Internet, savvy investors will survive and reap the greatest profits. So it will be with TD Waterhouse.
Bob Beaty is worldlyinvestor.com's Canada Editor. He worked for 20 years in the brokerage industry, in both Canada and the UK. Now primarily Internet-based, he writes extensively on stocks, bonds and market-related issues for a variety of Web sites. His column suggests investment and trading opportunities in the Canadian market. Beaty has no position in TD Waterhouse. |
