Being in the brokerage business has become a harder and harder game in which to make money. After years of discounting commissions ever lower, now the recent move to zero-commissions has left brokerage firms with spreads on short-term rates and other management and advisory fees as their primary source of income. As the Federal Reserve has lowered rates and is expected to do so again, the spread on the cash holdings is no longer going to be that strong. Now is the time to wonder if Morgan Stanley (NYSE: MS) is going to reconsider or will want to renegotiate its acquisition of E*Trade Financial Corp. (NASDAQ: ETFC). The same will be true of the prior acquisition that really kicked this off.
On February 20, Morgan Stanley confirmed its $13 billion purchase price of E*Trade. The all-stock transaction price was a set ratio of 1.0432 Morgan Stanley shares per E*Trade share. According to the company’s release at the time, the move would “significantly increase the scale and breadth of Morgan Stanley’s Wealth Management franchise, and positions Morgan Stanley to be an industry leader in Wealth Management across all channels and wealth segments.”
Before getting further into the E*Trade analysis, it is important to consider the prior and pending transaction whereby Charles Schwab Corp. (NYSE: SCHW) is acquiring TD Ameritrade Holding Corp. (NASDAQ: AMTD). The details of that deal actually no longer matter because all these companies have seen a major sell-off in their shares. Any additional Federal Reserve cuts will only lower the spread of money they can make there as well. Schwab’s acquisition of TD Ameritrade was also an all-stock deal, and the closing price of $30.27 on Monday put Schwab’s shares down at a 52-week low, as well as down 41% from its 52-week high.
As for what Morgan Stanley stands to gain, E*Trade had over 5.2 million online trading accounts with a cumulative amount of $360 billion or so in assets. Morgan Stanley’s base of 3 million clients sounds smaller, but Morgan Stanley’s client assets are closer to $2.7 trillion, and it has its institutional relationships and investment banking revenues that E*Trade never had.
Another consideration about the E*Trade acquisition is that it is not expected to close until the fourth quarter of 2020. How long it takes to integrate the companies and platforms after that is also up in the air.
Morgan Stanley has been looking to generate more of its revenues and incomes from efforts that are considered to be “balance sheet light and more durable sources of revenues.” The combination of the wealth and investment management businesses is forecast to generate roughly 57% of the combined pretax profits, before considering cost synergies.
E*Trade shares closed down at $36.95 on Monday, and the good news here is that its drop was a less ugly 35.5% from its peak, while Morgan Stanley is also down just under 35% from its peak. TD Ameritrade, on the other hand, was down 46% from its peak of $56.37.
The good news about these transactions is that being all-stock deals means there are no investors who are actually forced into a realized price sale. The all-stock deal means they get the “come-along” option if they want it. Those investors could have also sold immediately upon the deal announcements and hindsight would dictate that they won.
Breaking up mergers is not an easy business, particularly if the board of directors and management have signed off on the deal. Also, none of these companies is at fault for the coronavirus spreading as much as it did. It’s also not their fault that the economic picture deteriorated so rapidly that the Federal Reserve made an emergency cut to the federal funds rate and it is expected to cut it further.
Anything is possible if it comes to losses involved, but the obvious issue was that these mergers were needed for better survival in a no-commission trading world more than they were wanted just to prop up their stock prices.