Commentary

Taking Stock Of The Changing Market, Morgan Stanley Buys E-Trade

In an all-stock deal that its own investors are wary about, Morgan Stanley is buying E-Trade Financial -- and its legions of self-directed investors --  for $13 billion.

The deal “will combine a Wall Street firm in the late innings of a decade-long turnaround with a discount broker built on the backs of dot-com day traders. It is the biggest takeover by a giant U.S. bank since the 2008 crisis,” writes  Liz Hoffman for The Wall Street Journal in breaking the story.

“E-Trade brings five million retail customers, their $360 billion in assets and an online bank with cheap deposits that Morgan Stanley can funnel into loans. Its CEO, Michael Pizzi, is coming along to run the e-brokerage business, which will keep its brand, its handful of retail storefronts and its buzzy and well-funded ad campaigns, Morgan Stanley chief executive James Gorman said,” he continues.

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“We’ll take on Schwab. We’ll take on Fidelity,” Gorman, an Australian-American who has been CEO since 2010, tells Hoffman. “This isn’t about legacy-building; it’s about getting [Morgan Stanley] ready for prime time.”

“Shares of E-Trade rose 24% in early trading on the news while Morgan Stanley fell more than 4%. The deal comes nearly three months after E-Trade rivals Charles Schwab and TD Ameritrade announced a $26 billion merger,” reports  Paul R. La Monica for CNN Business.

“Discount brokers had to adapt their business models after just about every company in the industry eliminated commissions on online trades last year. That killed off what was once a lucrative revenue stream. Trading has become a commodity business because of popular trading apps like Robinhood, which recently raised money in a funding round that valued the company at $7.6 billion,” La Monica continues. 

But Robinhood may be commoditizing itself into the same fate as other low-margin would-be unicorns such as Uber, Lyft and WeWork, as Fortune’s David Z. Morris and Jeff John Roberts reported  in December.

“It may have a slick app -- as does Uber -- but at the end of the day it is scrounging for revenues alongside a growing number of other brokerages that have recently copied Robinhood’s main selling point of free stock trades,” they observed.

So what exactly is Morgan Stanley gaining for its $13 billion?

“The addition of E-Trade would allow Morgan Stanley to tap into a new source of revenue: the smaller-volume trades of the country’s so-called mass affluent, people who are wealthy enough to have some savings but not rich enough to buy into hedge funds or seek out a money manager. If it goes through, the deal will put Morgan Stanley, which does not have retail bank branches to draw in new asset-management customers, on firmer footing with competitors like Bank of America and Wells Fargo,”  write  Michael J. de la Merced, Kate Kelly and Emily Flitter for The New York Times.

Forrester analyst Vijay Raghavan said in a research note that “48% of E-Trade’s customer base is made up of so-called self-directed investors, who seek robust trading tools, real-time commentary, and charting tools, among other things,” writes  Gillian Rich for Investor’s Business Daily.

“Meanwhile, Morgan Stanley’s wealth management business serves affluent investors who rely on financial advisors to make investment decisions for them. E-Trade had been weakened by the zero-fee war as it relied more on commissions vs. its rivals, Raghavan added. It will now provide Morgan Stanley a direct-to-consumer brokerage business and $56 billion in deposits,” Rich continues.

And those deposits won’t just sit there.

“The interest from placing clients’ uninvested cash can be a profit center for brokers and affiliated banks, especially at a time when commissions at many brokerages have been driven to 0% and on the heels of a trio of cuts by the Federal Reserve to benchmark interest rates, which currently stand at a 1.50%-1.75% range,” points out  Mark DeCambre for MarketWatch.

Interactive Brokers Group founder Thomas Peterffy tells DeCambre that his firm cut off merger talks with E-Trade late last year “because they kept their customer money in long-term government bonds and so that’s something we as owners cannot afford to do.” Interactive Brokers instead puts its customer’s money into short-term securities like Treasury bills.

Federal regulators will be weighing in on these consolidation moves over the coming months.

“The Schwab-Ameritrade deal could still stall on antitrust issues. But if it wins approval, it is expected to close late this year. Similarly, Thursday’s merger will probably come under intense scrutiny from Washington regulators and congressional Democrats already skeptical of large banks such as Morgan Stanley growing any bigger,” write  Taylor Telford and Renae Merle for The Washington Post.

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