Schwab Unwinds Costly Foray Into Research

Reports say it will sell its Capital Markets unit for $265 million.
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Charles Schwab's

(SCH)

foray into independent research is apparently nearing an end, and analysts say that's a good thing.

According to reports, Schwab is planning to sell its Capital Markets division to Swiss bank

UBS

(UBS) - Get Report

for $265 million. The unit includes Soundview Technology Group, which was acquired in January for roughly $340 million.

While the discount broker could face a big writedown, possibly as much as $500 million, analysts said the sale is a positive development for Schwab.

"It's a needed step," said Matt Snowling, analyst at Friedman Billings Ramsey. "It's not contributing to the bottom line. It's not a growth area for the company."

In the second quarter, the division posted a profit of just $1 million on revenue of $75 million. "Capital Markets is Schwab's lowest-margin unit," said Guy Moszkowski, an analyst at Merrill Lynch. "A sale would likely improve overall margins."

Schwab has been struggling this year amid intense competition from online brokers and from slower trading activity. But the company has also made a series of missteps, leading to the ouster of chief executive David Pottruck in July.

Analysts

complained about the Soundview acquisition from the moment it was announced in November. Deutsche Bank analyst Richard Strauss said it would do little to enhance the firm's retail business, which is "the key part of the franchise." And Daniel Goldberg of Bear Stearns questioned how profitable the unit would be, given its focus on research.

At the time of the deal, Soundview sold research on more than 180 companies and provided sales and trading services to institutional clients. The company had never turned an annual profit.

Ken Worthington, an analyst at CIBC World Markets, said Soundview Technology is now a shell of its former self.

"They fired a lot of the traders, and a lot of sales traders and research people left," he said. "The brand name is not worth nearly what it was before Schwab bought it."

Snowling agrees, saying that UBS is principally paying for Schwab's market making business. Schwab Capital Markets makes a market in about 12,000

Nasdaq

-listed stocks. "To me, Soundview

Technology Group is a complete write-off; you have to assign a zero value to it."

According to

The Wall Street Journal

, UBS will scale back what's left of the research operation when it takes control of the company.

"I don't think this

is an indictment of independent research," said Worthington. "This divestiture says management made a mistake by building into the institutional business. It spent too much money to focus on its core business, which is mainly retail investors."

Schwab, which has fallen 19% this year, has said it hopes to cut $175 million to $225 million in costs by the end of the year and has said it will do whatever is necessary to achieve that goal. The sale of Soundview will help to "trim some fat" and allow the firm to "reallocate resources," according to Snowling.

A spokesman from Schwab said he wouldn't comment on "speculation and rumor" regarding a sale of Soundview, but the company said in a regulatory filing earlier this month that it has been considering "strategic alternatives" for the operations. News reports suggest that the firm could announce something as early as today.

Last month, Schwab fired its CEO David Pottruck amid some disappointing financial results and brought back founder Charles Schwab to help restructure the company and cut costs.

As part of its turnaround strategy, Schwab has announced plans to cut commissions, close down 53 of its 336 branches, and lay off hundreds of workers. Analysts say Schwab also might be interested in selling its U.S. Trust unit, which has produced "suboptimal" results.

Despite the efforts being made, analysts generally remain cautious on Schwab's stock, which continues to trade at a richer multiple than its faster-growing peers, including

Ameritrade

(AMTD) - Get Report

and

E*Trade

(ET) - Get Report

. Schwab was last down 2% to $9.56. E*Trade was off by 2% at $11.86 and Ameritrade fell 2.7% at $11.71.

CIBC World Markets and Friedman Billings Ramsey have no investment banking business with Schwab, while Merrill Lynch has received noninvestment banking revenue from the firm.