With revenue in its core discount operations evaporating, Charles Schwab ( SCH) has been remaking itself in the image of the traditional brokerages it once sought to displace. It has extended a push into advisory and banking services and is going after wealthier clients.

The initiatives reflect the difficulty all brokers are having lately and particularly discount outfits that have seen their less affluent client base chased disproportionately from the market. Schwab's fourth-quarter revenue plunged 18% on a 26% decline in average daily trading and January trading volume was lower than December's.

The obstacles were the subject of a research note this week from Robertson Stephens analyst Justin Hughes, who predicted declines in Schwab's retail trading activity both for this month and the first quarter. After a year in which the company's shares shed 39%, the stock has fallen another 27% to $13.15 since a market minipeak on Jan. 4. Other major online, discount and full-services brokerage houses have also been losing ground since early January.

In an attempt to rein in costs, Schwab cut its staff by 25% in 2001, closed operations in Australia and Japan, and recently sold its Canadian unit to the Bank of Nova Scotia.

In the Crowd

Schwab is not alone in diversifying and going after deeper pockets. Other discount brokerages like E*Trade ( ET), which has made an aggressive move into consumer banking, are doing the same. But among its peers, it is probably the most committed to going outside its traditional offerings for new business.

Schwab already sells a number of products for the rich through its U.S. Trust arm. Last month, it announced plans to create a division dedicated to corporate clients, which would sell services like retirement plans to companies. And last year it began bulking up its investment advisory services, which cater to wealthy individuals. Schwab used to farm out much of its portfolio advice to independent professionals, but today outside advisers account for just 30% of its $850 billion customer asset base.

The move into advisory services will continue this year with Schwab's Private Client program, which is targeted at individuals with over $100,000 to invest and an interest in investment advice, but who want to invest on their own. Currently in its testing phase, the program will be fully launched by June.

Schwab is also planning to offer checking and banking products to the affluent, and is in the process of obtaining a national bank charter. And to induce small investors to get bigger, it's imposing minimum balance fees and rewards for asset consolidation.

Garageland

Some worry the brokerage will have a tough time making the transition to higher-end clients and could alienate smaller investors in the process.

"I certainly view it as a challenging task, the path that they're going down," said Glenn Schorr, an analyst at Deutsche Banc Alex. Brown, which has done underwriting for the company in the past three years.

In the advisory business, the main obstacle is competition from the likes of Merrill Lynch ( MER) and Goldman Sachs ( GS). Some worry that Schwab doesn't have the resources to get an adequate number of advisors on its payroll. According to Schorr's calculations, the company plans to have 10,000 customers per adviser vs. 250 per adviser at Merrill Lynch.

Given the costs of hiring the needed advisers, it's an unsure payoff, says Schorr.

Still, the increasing focus on banking and advisory services seems to be bearing fruit. Revenue from asset management and financial services totaled $436 million in the fourth quarter, a 6% increase from the year ago. That total also exceeded revenue from any other area. Commission revenue came to $330 million for the quarter, down 33% from a year ago, and net interest income totaled $230 million, down 25% from a year ago.

In the meantime, Schwab still gets two-thirds of its revenue from its retail brokerage and capital markets operations.

While Chief Financial Officer Chris Dodds said two weeks ago that the company expects to meet earnings targets for 2002, not everyone agrees.

Robertson Stephens' Hughes lowered his 2002 earnings estimates for the company to 41 cents from 50 cents a share and his price target to $12 from $15. He maintained his market perform rating. Bear Stearns analyst Amy Butte also cut her estimates for 2002 and 2003 on Schwab Wednesday.

Short-term goals aside, Schwab's foray into full-service brokerage means it faces competition from both old-line Wall Street firms and its discount rivals. It remains to be seen whether the company that popularized cut-rate investing can carve out a niche between the two worlds.

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