Thursday, May 12, 2005

The Big Picture: E*-Ameritrade? Why Bother


I caught Barry Ritholtz on CNBC talking about "hitting the AMTD bid". After seeing him on TV, I went back to the Big Picture and re-read his blog.

AMTD has been an excellent investment one for my family. We purchased a few years ago and have maybe 400% gains. We doubled up last Friday at $11 and change.

I respect Barry as a knowledgeable investor. He is correct that AMTD has already moved and there is the risk that AMTD will pay too much to buy TD Waterhouse or another firm. AMTD "paid too much" for Datec a couple of years ago which has turn-out to be a fantastic purchase.

I never hope to claim to be able to outguess the market short-term. ET is a better value than SCH which in turn is a better value than AMTD except that AMTD has shown the ability to buy and integrate smaller firms. AMTD has only a third of the revenues of SCH but it is fast approaching a competitive position. SCH, TD and ET would all like to see AMTD go away; they would all buy just to remove the competition. I have never known anyone who has gotten wealthy off of short-term trading. I doubled up on ET and AMTD after seeing the reports of growth and increasing profit margins. When my Dad was 83 years old, he very much enjoyed trading stocks online with a discount broker. The business is going to continue to grow.

AMTD and ET have built substantial and profitable businesses. There are clearly economies of scale and customers are "sticky"; they do not like to move accounts. Barry sees these businesses as "commodity businesses engaged in a price war". He agrees that ET has a diversified base which includes banking revenues. It is true that AMTD has less than 1 Billion in revenues and there are many alternative providers. My family trades through BrownCo. BrownCo is the low cost provider. AMTD and ET offer "trade platforms" that appeal to many consumers; consumers who will pay $5 per trade extra because of good marketing.

AMTD has just completed 3 quarters in a row with operating margins exceeding 50%! There are many businesses that pine for such nice spreads. Interest revenue is almost as large as commission revenue!

Compare what Apple must do to sell a 99 cent song with what AMTD must do for a $10 commission. The buyer from Apple and from AMTD must go through similar steps. After the song buyer makes his selection, he has to down-load the song. During the down-load time, the stock trader can sell two or three stocks and buy two or three more. The stock trader can easily generate $60 of revenue while using less computing power. It appears that there is a bigger profit margin on the $60 than on the 99 cents!

How about making money while you sleep! AMTD makes as much off net interest earnings as it does off commissions. Investors who trade on margin pay interest to AMTD even on days when they make no trades! AMTD does virtually no work to collect the interest spread.

AMTD has 3.6 Million accounts. Investors do not like to move accounts. The tax and trade history are important. AMTD customers are likely to keep the same accounts for 30 years or more. Yes, commissions rates have declined, but the 50% gross margins included months after rates declined. The price war has served to make more and more consumers aware of the tremendous spread between a Merrill Lynch commission and an AMTD commission.

Barry suggest that SCH is not going to sit on its hands. SCH has, in the past several months, had to dramatically lower its rates to stem the flow of accounts to AMTD. Moving an account from ET to AMTD is hardly worth the trouble as the commissions are similar, however, the spread between SCH and AMTD last year was over 100%.

I do not plan to buy more AMTD at the current price. My family owns a nice postion in ET already but chances are good that if I decided to buy more of one or the other, I would likely buy ET. Of course, ET could take a hit if it pays a high price to buy AMTD.

It is common knowledge that TD would like to do a deal with AMTD and that ET has made an offer. The founding family has enough shares to possibly stymie a hostile take-over. I suspect that they would sell at the right price. I am reminded of watching pin-hookers bid on beef cows. The smart old farmers always say the cows are not for sale, two or three times. When the pin-hookers see what they are up against, they increase their bid. The smart farmer lets the bidding go until the pin-hookers sweat. He does not sell unless the pin-hooker is clearly taking a chance. Indications are that AMTD is holding out for a good price or that it is serious about buying someone eles. If AMTD is able to buy Scott Trade, Harris-Direct or others (maybe even SCH), more power to them. The company may pass SCH or buy it someday.

In the mean-time, the current move in the overall market seems to have legs. If the market were to break to the high side, trading at AMTD would take off as would the online brokerage stocks. Investors with a long-term outlook have many ways to win.

Buy the Big, Bull, Boom, Bubble!