March 13, 2000; E-Trade Holds Merger Talks
thestandard.com
Although talks with American Express broke down, the online broker may yet be acquired.
By Megan Barnett
After years of hard work and smart moves, E-Trade's moment has come ? and E-Trade knows it. The second-largest online broker has held merger talks with several potential suitors ? most recently financial-services giant American Express (AXP) ? but has yet to find a partner willing to accept its terms.
According to four sources inside E-Trade, American Express had opened negotiations to purchase the online broker. Teams from American Express traipsed through E-Trade offices in early February performing due diligence on the brokerage's operations. The talks collapsed several weeks ago amid concerns about cultural incompatibility and the price E-Trade was asking, the sources say.
American Express is not the first major financial institution to walk away from E-Trade's Menlo Park, Calif., campus without a signature on the dotted line. During the last 18 months, people inside E-Trade say, numerous suitors have come knocking, including securities firms Goldman Sachs and J.P. Morgan, insurance giant AIG and commercial banks Wells Fargo and Deutsche Bank (DTBKY) . Even Fox Entertainment expressed interest in the online brokerage, perhaps to become part of E-Trade's financial media strategy. Discussions have ranged from exploratory talks to boardroom meetings with bankers.
"We're talking to a lot of companies across businesses to explore ways of expanding our offerings," says Patrick DiChiro, a spokesman for E-Trade. DiChiro declined to comment on the American Express talks. A spokeswoman for American Express also declined to comment.
With traditional banks and brokers linking up in the midst of a historical financial industry deregulation, it seems like just a matter of time before online financial companies undergo similar consolidation. That trend is hitting as competition among online companies intensifies.
"As the financial services [arena] gets deregulated, the big gorillas ? whether American Express or banks like Deutsche or big brokerage houses ? will all be getting into each others' businesses," says Gaurang Desai, a managing director at Deutsche Banc Alex. Brown, who hasn't been directly involved in any E-Trade-related merger talks.
While few mergers have taken place among financial services firms, many companies are putting out feelers in search of the right suitor. Ameritrade has denied news reports that it is looking for a merger partner, while Reuters' Instinet unit explored a deal with online broker Datek. According to investment bankers interviewed by The Standard, America Online (AOL) , Charles Schwab and Intuit (INTU) are talking with potential partners. "All of these [companies] have spoken with numerous players," says an investment banker who asked not to be identified.
For E-Trade, a marriage with American Express would give the electronic brokerage the presence it may need to catch up to Charles Schwab, the leading online broker. "The clicks-and-mortar model has worked very well for Schwab. And at the end of the day, E-Trade is going to have to come up with something similar," says a source close to E-Trade who wishes to remain anonymous.
The deal could have been a coup for American Express, which hasn't had much success extending its global brand to the Internet. The firm launched brokerage and banking services online last fall without making many waves in the industry.
The firm's biggest recent success was the Blue credit card launch last year. Perhaps a bit ahead of its time, the Blue card comes with an embedded smart chip, and although most people don't have smartcard readers currently, customers have been intrigued by its futuristic marketing campaign.
"[American Express] has done a lot, but they haven't had anything in the way of success," says Bill Burnham, general partner for Softbank Capital Partners. "Unless they radically change their operations, I don't know how they're going to do it."
Analysts and industry observers agree that E-Trade isn't desperate to sell, and some say it may wait out the year until the right partner comes along. E-Trade CEO Christos Cotsakos also may be asking a lot for his company, in both valuation and in the amount of control he would retain, sources say.
A clause added to Cotsakos' contract last summer indicates the brokerage's top executive might be getting more serious about listening to offers from outsiders. According to the contract, E-Trade's compensation committee "authorized a special enterprise value enhancement bonus for Mr. Cotsakos that will be payable upon a change in control of the company."
But the changes sweeping the online brokerage industry are dramatic, and E-Trade could get left behind if it stalls too long. "They've done an incredible job building a platform and market share," says another investment banker. "But its ability to thrive and succeed in a highly competitive, highly dynamic industry is open to question."
No one's quite sure what price Cotsakos has put on the company, but E-Trade's market capitalization today, at $7.4 billion, has dropped sharply from last spring when it topped $20 billion.
While online brokerages' revenue and new accounts continue to surge, their stocks have not even come close to the levels reached last April. Analysts say investors are skeptical about how long they can hold onto their business models in a severe market correction.
"Given where they are from a valuation point and given what they offer, I think it's likely" E-Trade will be bought, says Deutsche Bank's Desai. "Online brokers will spend $1.5 billion in advertising this year. They're killing each other, and finally some are saying 'I'm tired of fighting now.'"
E-Trade is not alone in facing what increasingly looks like an inevitable wave of mergers and acquisitions. "We're in a period of consolidation," says Kenneth Sawyer, managing director for Prudential Volpe. "The current thinking is that conglomerates are better. Traditional financial-services companies need to find out where the growth is. Right now, there is a huge shift of money moving into the stock market." Sawyer says he's constantly hearing rumors of talks among global banks, insurance companies, securities firms, securities exchanges and clearinghouses.
Last week Joe Ricketts, chairman and majority owner of Ameritrade, reportedly told the Financial Times he was interested in making "some sort of arrangement, whether it be a joint venture or a sale." Ricketts did not deny saying this, but Ameritrade released a clarification later the same day stating that the company is not looking for a buyer. Earlier, a report in the Wall Street Journal said electronic trading network Instinet had held talks to merge with Datek, owner of Island, the No. 2 ECN.
"Everybody is talking to everybody ? no one wants to get left behind," says Henry McVey, equity analyst for Morgan Stanley. Softbank's Burnham agrees. "If you're offline, the world is passing you by at this point," Burnham says. "If people come up with the right offer, anybody's a seller."
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Through E-Trade's Revolving Door
Several companies have discussed a possible partnership with or acquisition of E-Trade.
COMPANY MARKET CAP DESCRIPTION
American Express
$54.9 billion Diversified financial services
American Int'l Group $128.4 billion Insurance firm
Deutsche Bank $42.2 billion Commercial bank
E-Trade $7.4 billion Second-largest online brokerage
Fox Entertainment $19.2 billion Media company
Goldman Sachs $48.1 billion Securities firm
J.P. Morgan $17.7 billion Securities firm
Wells Fargo $53.9 billion Commercial bank
Source: The Standard
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Jonathan Rabinovitz contributed to this report.
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