The Real Story: TD Ameritrade Goes on the Defensive

But "everyone is courting money managers," says Lauren Bender, analyst with research and consulting firm Celent. "While [TD Ameritrade] should be, too, they need to differentiate themselves. Otherwise, what's their angle?"

The new company also has a focus on what it calls the "mass affluent"-- customers with less than $1 million in investable assets -- offering financial planning products and guidance for do-it-yourself investors who are focused on the long term.

But herein lies the problem. How does the company go about building up these new segments while maintaining the resources necessary to feed the beast that is its active-trader business? TD Ameritrade has 25% of the marketshare for online trades, according to the company. That's an impressive figure, certainly, but one that becomes worrisome in the face of falling commission rates and the commoditization of trading.

While the company undergoes its transition, trading volumes will be critical to meeting the Street's expectations. Average client trades per day have picked up in fiscal 2006. Trades have averaged over 220,000 per day during the current fiscal year, far exceeding last year's average of 156,000 and averages from the past four years.

Those figures were aided considerably by the Waterhouse acquisition, but it's important to remember that in this high fixed-cost business, additional trades are highly profitable. That also means the inverse is true. If traders and investors become discouraged with the market, trading volume could fall, hurting revenue and profitability. While TD Ameritrade is taking steps to remedy the situation, the company's performance still depends largely on active trading and the direction of the stock market.

Lucy, You've Got Some 'Splaining to Do!

In the wake of last week's technical problems, CEO Joe Moglia apologized to customers and the company said it is making amends on a case-by-case basis, but generally is offering free trades to investors who were affected by the outage.

The problems were unusual, because Ameritrade has a history of successful integration of acquisitions, including Datek in 2002 and JB Oxford in 2004. Celent's Bender was surprised at the technology issues. "In meetings with analysts, they boast about how good their integration of acquisitions is, so they have some explaining to do," she says.

Bender believes that if the company handles the situation well, it will be a nonevent. Both Wall and Main Streets will be watching closely for signs of any future integration problems. If any arise, don't be shocked to see investors head for the exits even before the customers.

Don't Pay Another Dime

TD Ameritrade is a solid company with very capable leadership. But good companies don't always go hand in hand with good stocks. Ameritrade is in that position. While slightly undervalued on a price-to-earnings basis compared to its peers, it is significantly overvalued based on P-E-to growth, price to book and price to sales bases, as the chart below illustrates.

Ameritrade Isn't Cheap The competition is heating up.
	Forward P/E	5 Year Growth Rate	PEG	P/B	P/S	P/CF
ET	15.4	14.5	1.1	2.6	3.6	11.7
SCHW	19.5	14.4	1.3	4.3	3.8	18.1
OXPS	19.7	25.3	0.8	10.1	9.2	22.3
Average	18.2	18.1	1.1	5.7	5.5	17.4
AMTD	16.9	11.3	1.5	6.6	6.3	16.7
Source: Thomson PEG: P/E-to-growth P/B: price-to-book P/S: price-to-sales P/CF: price-to-cash flow

Of the four companies in the above table, TD Ameritrade has the highest long-term debt-to-equity ratio, at 138.6%, followed by E*TRADE (ET Quote) with 137.4%, Schwab (SCHW Quote) at 11.1% and OptionsXpress (OXPS Quote), which is free of debt.

If the stock were cheap, I'd consider taking a shot, because Moglia and his team have a good track record. But with valuation concerns and an uncertain future, investors may be better off trading with TD Ameritrade rather than owning it.