Ameritrade's Return to Glory Gets Postponed

Updated from 3:24 p.m. EDT

Ameritrade

(AMTD) - Get Report

continued to talk Tuesday about a bright future for online retail trading, but investors in the already battered shares weren't persuaded.

The company recently made a $1.3 billion wager on the comeback story, when it agreed to buy rival online brokerage

Datek

amid a wave of consolidation in the struggling online brokerage industry. Management is betting that consumers will start trading heavily again, at the latest in 2003, and that they will opt for the low-cost online alternative that Ameritrade offers in favor of its higher-cost online and offline rivals. But its outlook for 2002 tells a different tale.

Ameritrade said a 10% increase in trading activity could add 5 cents a share to the earnings of the combined Ameritrade and Datek. So far, there's no evidence any uptick is around the corner. In fact, Ameritrade expects trading activity in the second half of this year to decline from already dismal levels.

After posting second-quarter earnings of a penny a share, down from a profit of 4 cents a share in the fiscal first quarter, the company cut its revenue and earnings estimates for the rest of 2002, based on lowered trading activity forecasts. The company did reverse a loss of 30 cents in the year-ago quarter as cost-cutting offset a decline in trading revenue.

Second-quarter revenue fell to $106.7 million from $119.0 million in the year-ago period. Analysts were expecting a 2-cent profit and revenue of $110 million.

Excluding Datek, Ameritrade said it expects full-year earnings of 9 cents to 15 cents a share, below the consensus estimate for 17 cents a share. The company expects its trading activity rate -- the average number of trades each day divided by the average number of customer accounts -- to drop to between 4% and 5% in both the fiscal third and fourth quarters, from 4.7% in the first quarter and 4.8% in the second quarter. Originally, the company forecast a rate of between 6% and 7% in the third quarter and 4.5% to 5.5% for the fourth quarter.

Following the earnings report and a lowered outlook, Ameritrade lost 4 cents to $5.36. The stock has fallen 16% since the company announced the acquisition of Datek on April 7.

The Business of Hope

The lowered trading forecast "doesn't bode well for

the basic bet that trading activity comes back," said Todd Halky, an analyst with Putnam Lovell. "We are already facing year-over-year declines in volumes on

NYSE

and

Nasdaq

."

Through April 19, combined New York Stock Exchange and Nasdaq volumes were down 7% from the previous year, while Nasdaq volumes alone were lower by 14%. Volume and volatility levels typically decline during the summer, but after a lousy 2001, most observers hoped that year-over-year volumes would at least increase.

While management projects that Ameritrade and Datek combined will make 30 cents a share in 2003 without any improvement in the trading environment, investors want to see evidence of real earnings growth, analysts say. Despite deep cost-cutting, earnings growth has been severely lacking at Ameritrade. The company last posted an operating profit in 1999, with 7 cents a share. In 2000, the company lost 8 cents a share on an operating basis, and in 2001, that widened to a loss of 49 cents a share.

"Year in and year out, they haven't been able to expand their bottom line at all," said one analyst who didn't want to be named. "They are cash-flow positive, but overall they need to prove that they can start really growing the bottom line. There aren't that many institutional investors in this stock right now. It's a wait-and-see story."

Ameritrade currently trades at 36 to 40 times analysts' earnings estimates for 2002 and at 18 times the expected earnings of the combined Ameritrade and Datek for 2003. By comparison, the average multiple is 14 for the big investment banks. Ameritrade and the online brokers usually trade at a premium to the traditional full-service brokerages. But that premium is supposed to represent the kind of earnings growth that tends to comes with a smaller company in an emerging segment, the analyst said.

Pretty Pictures

In interview Tuesday, Chief Executive Joe Moglia said that investors shouldn't get sidetracked by any near-term worries on the Datek deal.

"You've got to look at this from a long-term perspective," Moglia said. If investors "don't anticipate a rebound in the equity market, they may feel, well there's no rush to do this. There is always the possibility, although it's incredibly remote, that it might not close. There's the possibility they may not achieve these synergies, which is probably not going to happen. We are going to achieve these synergies. But there's not yet a rebound on the horizon as far as the market goes.

"We appreciate why some institutional investors feel there's no rush to buy," he continued. "And I can also appreciate that some of the institutional investors that weren't particularly interested in our space three weeks ago, that are now, have more than they need to learn about."

Moglia also said that, despite the harrowing stock market losses of recent years, he believes that the online do-it-yourself model will thrive.

"Look at it from eyes of investors that have not been doing it themselves over the span of the last three years or so," he said. "They haven't done particularly well over the past three years. So I think there will always be investors that will be happy to take responsibility for their financial well-being. There will always be investors that are comfortable enough with technology that they're happy to do it online. There will always be investors that even if they want to have someone manage the bulk of their investments, they will still have trading money that they want to manage themselves."

Analysts agree that picture gets prettier as you look further out. The year-over-year declines in retail trading volumes can't last forever, said Putnam's Halky. Meanwhile, the $100 million in savings Ameritrade expects from the Datek merger should be relatively easy for the companies to achieve, analysts believe. Past experience and similar customer profiles between Datek and Ameritrade suggest Ameritrade should be able to overcome its biggest challenge -- to make sure it doesn't lose the customer accounts it acquired from Datek.

Each of the two companies has more than enough technology to handle total combined trading, while advertising spending for each of the brokerages was about $15 million in the December quarter. One analyst said that amount could conceivably be halved. Plus, they have many obvious redundancies in their clearing businesses, call centers and back office operations.

Ameritrade rival

E*Trade

(ET) - Get Report

has made a special offer to Ameritrade and Datek customers who agree to transfer their accounts, but analysts don't expect the ploy to hurt the combined company's customer base. They point out that Ameritrade had a very high retention rate after closing out inactive accounts when it acquired National Discount Brokers last year.

The company is moving quickly to complete the Datek deal, something executives expect to do within 30 days, which will help limit customer confusion. And if all goes well, it might even get a few more believers for the return-to-glory story.