The E*Trade Sales Catastrophe

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Hedge fund Citadel wants E*Trade (NASDAQ: ETFC) to sell itself, so that it can make back the money it invested in the online broker. Citadel waited too long to make its suggestion. It should have taken the action over a year ago if it wanted to get the best value for its 9.8% stake in the company.

E*Trade posted earnings yesterday. It reported net income of $47 million on revenue of $518 million. The figures were about what analysts expected, but the stock traded higher by almost 17% to reach $14.72 because of Citadel’s comments. The stock price is still well short of its 52-week high of $18.13 and its two-year high of $19.90, which was reached in September 2009.

Citadel made a basic mistake. It got greedy. E*Trade rivals, Charles Schwab (NASDAQ: SCHW) and TDAmeritrade (NASDAQ: AMTD), also traded higher in the fall of 2009. Each was identified as a potential buyer of E*Trade then, just as they were yesterday. The higher share prices would have made it easier to make the acquisition. Management at each must have been confident in the online brokerage industry after their stocks reached multi-year highs in late 2008.

E*Trade may be too expensive now for Schwab or TDAmeritrade. They would likely use their stocks for at least part of the E*Trade purchase price. But that currency has fallen in value. Schwab has lost 40% of its market cap in less than two years, and it now stands at $18 billion. It might find E*Trade’s value has gone beyond its value as a part of Schwab. E*Trade’s market value is $3.4 billion now. A buyer will have to pay a premium, probably over $5 billion. Schwab’s management may look at E*Trade, which is worth 40% more than it was a year ago, and say it is better off without it.

The stock market appears to be due for a stumble. There is at least a reasonable chance for that because the economy has take a turn for the worst. Schwab and TDAmeritrade will take that into account as they look at a premium valuation for E*Trade, which has earnings sensitive to market movement. Better to pass on a buyout, at least until the lack of a buyer brings shares back down. Citadel will have to wait, perhaps a long time, before it is able to cash out on E*Trade, and the price is likely to be less than it expected yesterday.

Douglas A. McIntyre

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