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There's No Need For Us To Do Anything …

  • October 19, 2006

… said the E-Trade (ET) President and Chief Operating Officer Jarrett Lilien when asked about the bombshell Bank of America  (BAC) dropped last week by offering free online trades to customers who had at least $25,000 in their accounts. I am sure E-Trade investors are hoping that Lilien is right but I distinctly get the feeling that he is suffering from a dose of unbridled optimism. Online discount brokers like TD Ameritrade Holding Corp (AMTD), E Trade (ET) and Charles Schwab Corp (SCHW) have been battling the traditional full service brokers like Goldman Sachs (GS), Merrill Lynch (MER) and Morgan Stanley (MS) as well as each other for years to gain market share through low trading fees and strategic acquisitions. It stands to reason that Bank of America’s free offer to over 21 million qualified customers will have an impact on the discount brokers.

I have used an Ameritrade account for over five years and have also invested in their stock from time to time. The first time I invested in Ameritrade was back in 2002 when Ameritrade announced its decision to acquire privately held Datek Online Holdings, a deal that established Ameritrade as the top online discount broker. While I saw strength in the deal, the stock unfortunately followed the Nasdaq down in 2002 and lost half its value in the ensuing months. I held on to Ameritrade on account of its excellent management team, high insider ownership and margins that are the envy of even the most profitable tech companies. The stock did rebound and I sold it the following year for a handsome profit.

However Ameritrade’s market share was constantly under siege by rivals who were offering lower trading costs. I revisited Ameritrade as an investment early last year after opening an Ameritrade IZone account, which offers $5 trades for both market and limit orders. Clearly at this price point, Ameritrade did not have to worry about losing market share to competitors like Sharebuilder.com, Scottrade or BrownCo, which was acquired by E-Trade last year.

With the acquisition of TD Waterhouse in January 2006, Ameritrade wisely branched into asset management and according to the latest quarterly results, only 39% of revenue now comes from trading. But this is still a significant chunk of change and competitors such as E-Trade and Charles Schwab only derive 27% and 13% of their revenue from trading respectively.

I had been contemplating selling my TD Ameritrade stock over the last few weeks primarily because of a 7% drop in trading in August and my negative outlook for the economy in 2007. I also wanted to take some money off the table because my investment in Ameritrade had appreciated more than 110% (including the $6 per share special dividend that Ameritrade distributed in January 2006) since last April. The Bank of America announcement was the trigger that eventually led me to sell my Ameritrade shares last week.

There is a lot to like about Ameritrade with their excellent margins, the large $113.8 million insider purchase by Chairman and Founder Joe Ricketts just three months ago and an announcement by Ameritrade to buy back 12 million of its own shares. They are also aggressively trying to increase assets under management by offering a free iPod Nano to anyone willing to open and fund an Ameritrade account with $10,000 and recently offering me $1,000 at the San Francisco Money Show to fund my Ameritrade account with $30,000. All I had to do was place five trades within a month of funding my account and keeping the money there for at least nine months.

While I do not see a catastrophic drop in revenue or earnings at Ameritrade right away, I feel that as Bank of America rolls out this offer to all its customers by next February, it will take its toll on the discount brokers like Ameritrade. The market is “forward looking” and there is a good chance that Ameritrade will continue trending lower over the next few months.