Why Morgan Stanley Is Choosing Now to Buy E*Trade

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Morgan Stanley is buying E*Trade for $13 billion in all stock, a digital-focused move that follows the footsteps of the recent Charles Schwab purchase of TD Ameritrade.

E*Trade shares rose 24% to $55.74 Thursday, as the $58.74 per share value offers a roughly 30% to E*Trade's Wednesday closing price. Morgan Stanley shares fell 4.17% to $53.96 a share.

Real Money’s resident chart professor Bruce Kamich expects Morgan Stanley to trade in a relatively tight range going forward as investors react to news of the deal. “Analysts will be diving into the books of E*Trade and some may be looking to see if a higher bid may come from someone else,” Kamich added.

The brokerage business in the past several years has been turning digital, and what the industry calls self-directed, rather than the traditional full-service. TD Ameritrade, E*Trade and smaller online platforms like Robinhood have been offering low-fee brokerage services. Older players have been looking for exposure to the new trend, as seen in Charles Schwab’s $26 billion November acquisition of TD Ameritrade.

But here’s the value E*Trade, specifically, can bring to Morgan Stanley:

Morgan Stanley wants to modernize its brokerage business and tilt it more towards the retail customer. Roughly half of Morgan Stanley’s revenue currently comes from institutional clients. Very little of its brokerage business is self-directed. It has no digital banking for individuals, and much of its wealth management business is full-service.

By comparison, E*Trade’s banking, brokerage and wealth management businesses are completely digitized and self-directed, a Morgan Stanley’s deal announcement release shows.

E*Trade has $360 billion in total client assets under management, all of which is self-directed or under a virtual adviser. This will bring Morgan Stanley’s total AUM to just under $3.5 trillion, about 10% of which will be from E*Trade.

Not only do all of these additions add a modernized and growing retail brokerage business to the mix for Morgan Stanley, but it gets the bank access to an entire demographic to which it can offer multiple services, across Morgan Stanley’s business, from deposits and lending, to wealth management and brokerage.

The bank said it wants to “deepen relationships with attractive demographics.”

“Wall Street banks continue to covet main street customers,” said Greg McBride, chief financial analyst at Bankrate.com. “Morgan Stanley’s acquisition of E*Trade gives them access to brokerage customers, employees with company stock, and the lifeblood of financial services — low cost retail bank deposits.”

E*Trade also carries much higher operating margins than Morgan Stanley does, in part because it cuts out the traditional full service broker customers used to call to execute trades. E*Trade’s operating margin sits at around 42%, compared to Morgan Stanley’s 27%. The bank sees its total operating margin moving to 30% in the next few years. Importantly, E*Trade analysts are only looking for roughly $2.72 billion of revenue for all of 2020, compared to Morgan Stanley's expected $41.9 billion.

Part of the higher margins will come from cost synergies of roughly $400 million over the next three years, says Morgan Stanley, which expects the acquisition to be accretive to earnings per share over that time period. Earnings accretion may not fully materialize immediately. 

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