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E*Trade Acquisition Debate Gets New Fodder

The debate about whether E*Trade could get gobbled up a larger competitor was stoked Tuesday by research from analysts at Keefe, Bruyette & Woods.

Updated to clarify compensation for new CEO Steven Freiberg.NEW YORK (TheStreet) -- E*Trade Financial (ETFC) - Get E*TRADE Financial Corporation Report is being talked about as an acquisition target once more.

There was some news ahead of the opening bell, as the New York-based online broker announced the launch of its Mobile Pro trading and market data application for


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iPad, but a research note from Keefe, Bruyette & Woods was also stirring up a familiar debate.

Citing persistent chatter over the past 18 months about the potential for a deal and the subsequent influence on valuations in the sector, especially when it comes to E*Trade, the firm decided to dig into how an acquisition by either

TD Ameritrade

(AMTD) - Get TD Ameritrade Holding Corporation Report

, or

Charles Schwab

(SCHW) - Get Charles Schwab Corporation Report

would be structured and try to determine the likely impact on profits for the acquirers.

Its conclusion was that while such a deal isn't imminent and any eventual transaction would be very complicated, the purchase could work for both companies if E*Trade is valued at $2 per share -- a premium of 18% to Monday's closing price of $1.69 for the stock. Under that base-case scenario, the acquisition would provide immediate earnings accretion of 14% for TD Ameritrade and 18% for Charles Schwab.

KBW views the $2 share price level, which values E*Trade at roughly $5.8 billion, as a minimum realistically acceptable price for E*Trade that would also allow for accretion in the first year for the purchaser.

"With the substantial consolidation that has taken place in the online brokerage industry over the past 15 years, the number of potential acquisition candidates has been greatly reduced," KBW said in its research note. "Consequently, we believe that E*Trade, despite its persistent credit issues, now represents the most attractive acquisition candidate for any large size firm that is looking to substantially increase it market share of online trades and increase its client asset base."

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The $2 share price, according to KBW, reflects adjustments made to a price paid per account of $3,450, which it sees as "one of the higher values" that E*Trade could potentially receive per retail account. The firm categorizes the $2 price as being at the "lower end of the range" but says the valuation reflects E*Trade's share count, potential future losses at its bank unit, and its long-term debt balance.

The $3,450 figure would value the broker business at $9.4 billion on a stand-alone basis, or $3.26 per share, but KBW stressed the need for adjustments related to debt, future charge-offs, and other items in its analysis.

Even before the financial crisis kicked in, E*Trade was periodically mentioned as a potential M&A target, most often linked up with Ameritrade, which was eventually bought itself by TD Bank. The most recent flare-up with a bit of substance occurred in mid-November 2009 when TD Ameritrade CEO Fred Tomczyk mentioned E*Trade by name at any industry conference when discussing potential uses for the company's cash.

KBW goes into extensive detail about how the potential deal might be structured for each acquirer, noting that

TD Bank

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would likely have to be involved for TD Ameritrade since the online broker doesn't have a bank charter. On the other hand, while the transaction involving Schwab would be more straightforward since it does have a bank charter, problems with capital levels could come into play.

"In the event that Charles Schwab acquired E*Trade and took on an estimated deposit base of $20 billion (this assumes it runs off a percentage of deposits tied to non-brokerage accounts), we estimate that Charles Schwab could have to issue an additional 126 million shares to maintain its target capital level."

Year-to-date, E*Trade shares were off nearly 4% through Monday's close at $1.69. The company is expected to report its first-quarter results on April 21. The current average estimate of analysts polled by

Thomson Reuters

is for a loss of 3 cents a share on revenue of $243.5 million in the March quarter. BMO Capital lifted its trading assumptions slightly for E*Trade on Tuesday, going to DARTs (daily average revenue trades) of 166,000 from a prior view of 161,000, but the firm still sees a loss of 4 cents a share for the first quarter.

BMO Capital attributed the higher DARTs figure to a new expectation for a sequential rise in activity of 10% to March from February. Previously the firm, which has a market perform rating on the stock, was looking for a 2% month-to-month increase.

E*Trade shares finished Tuesday at $1.71, up 2 cents. Volume picked up, however, toward the closing bell and ended at 49.5 million, more than 30% above the issue's trailing daily three-month average of 36 million. The high for the day was $1.77.

Also of interest, Steven Freiberg, the company's new CEO, filed his initial Form 3 statement with the Securities and Exchange Commission, showing that he didn't beneficially own any E*Trade stock as of his start date last week.

The company announced Freiberg's appointment by the board on March 22 and outlined his compensation at that time, saying he will receive an annual base salary of $1 million. Freiberg, a former executive vice president with Citibank, is also eligible for an annual cash performance bonus with a target of $3 million and annual equity incentives with an annual target initial value of $3 million that will be subject to vesting of up to four years.

E*Trade has said it expects to file its proxy statement in connection with its 2010 annual meeting to be held on May 13. The company will also be seeking shareholder approval for a proposed 1-for-10 reverse stock split at the meeting.


Written by Michael Baron in New York