Sometimes two wrongs can make a right.

The plan from

E*Trade

(EGRP)

and

Wit Capital

(WITC)

to play switcheroo with their investment banking and brokerage businesses should leave both companies better off.

E*Offering

, the West Coast investment bank in which E*Trade holds a 28% stake, will be merged into

Wit Soundview

, the investment-banking unit of Wit. Wit puts 32 million shares, or $356 million, into the new venture. E*Trade will buy 2 million Wit shares and, in return, get Wit's tiny retail-brokerage business.

The deal enables Wit to shed an online-brokerage business that couldn't catch up to the bigger players, and E*Trade to escape its piece of a struggling online investment bank.

Both firms tried to grow large enough to position themselves to both underwrite and distribute initial public offerings as clients clamored for pieces of the highflying deals. A cooled IPO market and competition from other electronic and traditional competitors such as

Morgan Stanley Dean Witter

(MWD)

and

Merrill Lynch

(MER)

, though, have made each firm's road more difficult.

Wit was the first brokerage to bring IPOs to retail investors in the late 1990s as the online-trading craze took off. In late 1998, E*Trade launched its own investment bank, E*Offering, and started distributing hot IPOs underwritten by it and investment banks such as

Robertson Stephens

, now a unit of

FleetBoston Financial

(FBF)

.

"I think both of these guys have been trying to stumble about for their place in this world," says Steve Franco, an analyst with

US Bancorp Piper Jaffray

, adding that E*Offering and Wit were often going head-to-head for pieces of the same deal.

"It was always either or, Wit or E*Offering, on a deal. Just by the nature of that merger, they're going to expand the list of potential deals by two," Franco said. U.S. Bancorp Piper Jaffray hasn't done any underwriting for the firms, has a strong buy on E*Trade and no rating on Wit.

The online-banking ranks are now down to

FBR.com

,

W.R. Hambrecht

and

Epoch Capitol

, the investment-bank venture involving

Charles Schwab

(SCH)

and

Ameritrade

(AMTD) - Get Report

.

"It highlights the potential for further consolidation. It could be the start of more of this because of current valuations and the need for scale," says Richard Repetto, an analyst at

Lehman Brothers

, which hasn't done underwriting for either company and has an outperform rating on E*Trade.

Those Online Banking Blues

By folding E*Offering into Wit, E*Trade and other investors such as venture capitalist

General Atlantic Partners

-- which had stakes in both E*Offering and E*Trade -- have managed to cash in on a previously money-losing unit. (E*Offering plans to book its first profit this year.)

E*Trade will own less than 10% of the combined Wit-E*Offering after the deal. It's also successfully cured its increasingly public headache with E*Offering, formed in 1999 by E*Trade, former Robertson Stephens' head Sandy Robertson and venture capitalists including General Atlantic.

Run by Walter Cruttenden III, the company's Newport Beach stride never seemed to fit E*Trade's Silicon Valley mold. Rumbles of trouble began last summer when high-profile analyst Gary Craft walked and ads for a chief executive officer ran week after week in the back of the

Industry Standard

.

Even talk of E*Offering's own IPO plans rankled some and sparked a competing tale that had E*Trade increasing its stake in the company. Cruttenden was replaced by E*Trade's Steve King as interim chief executive, and while its deal flow continued, no lucrative lead-manager assignments followed.

At E*Trade, its rapidly expanding customer base was clamoring for more IPOs and research. Through E*Offering and an agreement with Robbie Stephens, E*Trade tried to meet investors' insatiable demands for access to more IPOs.

Retail Malaise

Wit, despite acquiring private investment bank Soundview, is suffering from a similar problem with its retail business. In the first quarter, the number of shares distributed to online investors dropped as allocations shrunk and the ratio of follow-on offerings increased, feeding instead the appetite of Soundview's institutional customers.

Wit's retail account base grew, but at about 100,000 is still a fraction of E*Trade's 2.6 million. Customers complained about service and plans for an after-hours trading network -- part of founder Andrew Klein's dream to bring Wall Street to the little people -- were permanently shelved.

Those days are clearly in the past.

E*Trade expects to end up with 70,000 to 80,000 new accounts from Wit, E*Trade Chief Executive Christos Cotsakos said during a conference call in which analysts, but not journalists, were allowed to ask questions.

The balance of the accounts are expected to be overlaps, because many IPO-seekers tried to increase their odds by holding both E*Trade and Wit accounts. Financially, the deal will help, too. E*Trade will book a $50 million gain on the sale of much of its E*Offering stake during the third quarter.

Wit's gains, meanwhile, in addition to expectations for more earnings, will be an exclusive hold on E*Trade's rapidly growing distribution network (and vice versa) for the next five years.

If only the IPO market could hold up that long.