Ameritrade Gets Datek, but Not Diversified

Updated from 5:02 p.m. EDT

With the $1.3 billion acquisition of Datek, which was announced Monday, Ameritrade(AMTD) might be putting all of its eggs in one basket when it instead should be considering diversification, some analysts worry.

The merger will boost Ameritrade's market share of the retail brokerage business and should lower costs, but it increases the company's reliance on the active online investor, without adding new sources of revenue, analysts said. That means it's at the mercy of a stock market that may or may not pick up.

The addition of Datek's clients will give Ameritrade the most actively trading customers in the business. In the fourth quarter, Datek investors averaged 23 trades per account on an annualized basis, compared with 12 at Ameritrade, eight at Charles Schwab and seven at E*Trade, according to J.P. Morgan analyst Adam Townsend.

Ameritrade's chief rivals have taken a different approach to surviving over the last two years, transforming themselves into full service brokerages through acquisitions and partnerships, building bricks-and-mortar offices and going after wealthier individuals. As the stock market plunged and retail volume dried up, both E*Trade (ET) and Charles Schwab (SCH) started offering banking and investment advisory services.

In the fourth quarter of 2001, E*Trade and Schwab got 26% and 29%, respectively, of their revenue from brokerage transactions, compared with 61% at Ameritrade.

"It's very difficult to run a business that's focused on the frequent trader when the frequent trader category doesn't exist to the extent that it did two to five years ago," said Jupiter Media Metrix analyst Robert Sterling. "[Ameritrade and Datek have] got scale, great brands and huge numbers of clients, but they're going to have trouble driving revenue off those clients, and getting them to trade probably isn't the right answer," he said. "These people are not trading right now. They're still holding mortgages, owning mutual funds and bonds, but Datek and Ameritrade are not positioned to take advantage of those activities."

Sterling doesn't expect active trading, which has fallen sharply in recent years, to come back any time soon. The number of U.S. households that trade heavily, or generate 51 trades or more a year, fell to 200,000 in 2001, from 700,000 in 2000, according to Jupiter data. And Jupiter projects it will get no higher than 500,000 before 2005.

Long Haul

Ameritrade said it expects cost savings from the deal of 17 cents a share in the fiscal year ending in September 2003, and 23 cents a year after that. Without those savings, and based on the current retail trading environment, the company projects earnings for the combined company of 14 cents a share in 2002 and 30 cents a share in 2003.

Putnam Lovell analyst Richard Repetto said that in order for the company to achieve its own earnings target of 30 cents a share for 2003, a jump in trading activity will have to take place. Repetto said the company is best poised to benefit if "trading were to materially increase," but he doesn't expect that to happen any time soon.

"In the near term, trading activity continues to be dormant with no catalyst (barring a significant market rebound) in sight," he wrote in a research note. "As we approach the normally seasonally slow, summer period, low volatility and declining markets could extend investor's inactivity." Repetto maintained his hold rating on the stock.

After losing 21 cents a share in fiscal 2001, which ended in September, Ameritrade earned 4 cents a share in the first quarter of fiscal 2002. Last week, the company lowered its earnings guidance for the second quarter. Ameritrade now expects fiscal second-quarter earnings "to be at the low end of its previously published range," given online trading activity levels.

Previously, the online broker said it earnings should fall between a penny and 4 cents a share on revenue of $111 million to $135 million. On Friday, it said revenue would be $105 million to $110 million.

Despite some analyst skepticism about the deal, investors liked Ameritrade's stock and the online brokers in general Monday. On a sluggish day for stocks. Ameritrade ended up 1.9% to $6.42. E*Trade rose 4.3% to $9.29, and Schwab gained 1.6% to $12.55.

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