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Analysts: Online broker can still weather storm, but worse-case scenarios spreading
By Murray Coleman (MarketWatch)
A few months ago, David Fisher says he never would've dreamed that he'd be fielding
questions about whether he had any interest in making a bid for industry heavyweight
E-Trade Financial.
But that's what the chief executive of rival OptionsXpress Holdings Inc. faced on Tuesday.
The day before, while shares of his stock and other online brokers like T.D. Ameritrade
and Charles Schwab & Co. Inc. were rising, beleaguered E-Trade lost roughly half its
market cap.
Shares of E-Trade plunged as the company acknowledged it faced more subprime-related
write-downs and as analysts at Citigroup suggested a possible bankruptcy for the online
broker.
"We started Monday at about half their size," Fisher said. "We woke up on Tuesday
actually a little bigger in terms of market-cap size. E-Trade's going through a very tough
ride right now."
But it's not one that should impact the entire online brokerage industry, he added. "They
got into trouble pushing the banking side of their business," Fisher said. "Not too many
online brokers have used that model as extensively as E-Trade. It's highly unlikely anyone
else is going to get as caught up in the problems of the mortgage market."
Despite such travails, E-Trade's stock rebounded strongly Tuesday, up 40.9% to $5 a
share on heavy volume. That followed an uptrend by other competitors, as online brokers
generally traded on the plus side in the session.
Much of E-Trade's surge came through block trades, according to Bruce Zaro, an analyst
at Delta Global Advisors Inc. "We're seeing a lot of volume and 650 different block
trades of at least 10,000 shares or more with E-Trade stock," he said early in the
day.
That indicates institutional and other big investors could be moving back into the stock.
"Our take is that speculation is building that someone's ready to jump in and buy
E-Trade," Zaro said. "We don't see the rebound by their shares today as a signal
financials have bottomed."
Still tough for financials
Basic materials and transports were the biggest benefactors of a bounce in
Tuesday trading, Zaro said. Trading ranges in both sectors remained tight, however,
Zaro added, and most leaders in those segments are still much closer to their
52-week highs than financials.
"Financials just haven't bounced back, particularly online brokers, like E-Trade did
on Tuesday," Zaro said. "Something seems to be up with expectations for E-Trade at
this point."
Until midday, shares of E-Trade still were selling at below what cash valuations
would suggest. The company reported some $1.9 billion in cash on-hand through
the third quarter. With about 423 million shares outstanding, Zaro said that would
mean E-Trade has $4.45 per share of cash in-hand.
"That's how much their shares are worth if they liquidated the company," he added.
"The caveat is how much subprime mortgage exposure they've got, which might subtract
from their overall valuation. But it wouldn't directly impact their cash position."
The result is that "someone could pick them up for basically nothing at this point,"
Zaro said. "Their cash value is now less than the value the market's placing on their
shares."
Some of the stock's price movement on Tuesday might've also been caused by sentiment
that it had taken too much of a hit. "E-Trade still has a lot of assets, besides cash on its
books, it'd have to unwind," said Patrick O'Shaughnessy, a Morningstar Inc. analyst.
A key question surrounding E-Trade's valuation is whether management believes it can
gain more from holding onto those assets.
"The real question is whether they think they can ride out the storm and survive as a
standalone entity," O'Shaughnessy said. "Some of what they have on their books probably
would take a large loss if put on the market right now."
"There's a significant worse-case scenario being priced into the stock. It seems to me a
little overblown. Their core business is growing significantly, and they probably have
enough capital on their balance sheets to survive," he said.
But if enough customers become scared and write-downs keep growing, O'Shaughnessy
said that any positive momentum E-Trade's fundamental operations can bank on could
slip.
For his part, OptionsXrpess CEO Fisher said the past 24 hours have seen a noticeable
uptick in new customers opening accounts. "Some of that has to be coming from E-Trade,"
he said.
"Consolidation is something that has been going on in the online brokerage business for
the past few years," Fisher said. "So what's happening with E-Trade and their mortgages
side isn't a negative for the industry."
Is a sale possible?
Fisher said making a bid for the once-bigger E-Trade wouldn't make sense.
"There are certainly advantages to consolidation in online brokerage operations in terms of
synergies and greater efficiencies," he said. "But there's too much uncertainty right now
regarding E-Trade's balance sheet for us to even consider whether an acquisition makes
sense."
A representative of E-Trade refused comment Tuesday, saying it was against company
policy to discuss rumors or speculation.
At least two new research reports came out Tuesday regarding the company's mortgage
woes.
"We believe E-Trade is exploring the sale of its troubled assets," said Matt Snowling, a
Friedman, Billings Ramsey & Co. analyst, in a Tuesday note. He downgraded E-Trade
shares from outperform to market perform and also lowered his price target by $5 to $12.
"Due to the lack of near-term catalyst, we remove E-Trade from the FBR Top Picks list,"
he said.
The most likely scenario for E-Trade, if put up on the block, would be a secondary stock
offering, Snowling wrote.
"In its effort to facilitate the sale and raise the necessary capital, we believe the buyers
would invest in a secondary stock offering by the company," he commented. "The
incentive would be an investment in a pro forma E-Trade with little remaining balance
sheet exposure, valued off the pure brokerage earnings."
Although agreeing that a buyout could take place, BMO Capital Markets analysts aren't so
sure that E-Trade is in such dire straights.
"The stock traded (Monday) as if it was a foregone conclusion that bankruptcy is in the
company's future," the firm wrote in new research. "We find that scenario highly unlikely."
But like others, analysts Michael Vinciquerra and Joseph Edelstein said that "the mere
suggestion of a bank run and the huge slide in the stock may get the attention of E-Trade's
clientele."
In fact, competitor TradeKing said Tuesday it was averaging 10 calls per hour in the past
24 hours from people identifying themselves as E-Trade account holders with concerns
about their assets.
These investors are looking for "a safe place to put their money," according to a TradeKing
representative.
The rival also said that nearly one-third of TradeKing's online customer service chat
sessions have been taken up by E-Trade customers looking for more information and that
some clients holding accounts at both services have already begun the process of
transferring assets from E-Trade to TradeKing. Still, Vinciquerra and Edelstein don't
expect a run on the broker's assets to take place. Others have pointed to certain
regulatory barriers built into modern financial systems to help minimize any potential
account losses. See related story.
"It's impossible to know just how great E-Trade's portfolio losses will be, but management
has stated that the company could absorb $1 billion in write-downs and still maintain
well-capitalized status," BMO Capital said. The firm has indicated it's trying to figure out a
way to cap or set aside any losses, they said, while maintaining an outperform rating on
the stock and a per-share price target of $18.
"A cap on its securities portfolio losses, even if costly, would immediately result in a huge
stock rebound versus Monday's close," the BMO analysts said. "In the event that it proves
necessary in a worst-case scenario, we also believe there are buyers that would find
E-Trade's entire business highly attractive at a meaningful premium to current levels."
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