Bigger is Better: Digital Brokerage Charles Schwab Buys TD Ameritrade for $26 Billion

As predicted last week, online broker Charles Schwab (NYSE:SCHW) has announced the purchase of TD Ameritrade (NASDAQ:AMTD) in a deal worth $26 billion.

According to Schwab, the all-stock transaction represents a 17% premium of TD Ameritrade’s average share price as of November 20, 2019. Shares in TD moved little in pre-market trading as much of the gain had already taken place when word of the acquisition became news last week. Shares in Schwab held steady in the pre-market too. TD Ameritrade stockholders will receive 1.0837 Schwab shares for each TD Ameritrade share.

The combined entity will handle 24 million client accounts with more than $5 trillion in client assets. Schwab + TD Ameritrade will generate a total annualized revenue of $17 billion and pre-tax profits of approximately $8 billion.

Schwab President and CEO Walt Bettinger issued the following statement:

“We have long respected TD Ameritrade since our early days pioneering the discount brokerage industry, and as a fellow advocate for investors and independent investment advisors. Together, we share a passion for breaking down barriers for investors and advisors through a combination of low cost, great service, and technology. With this transaction, we will capitalize on the unique opportunity to build a firm with the soul of a challenger and the resources of a large financial services institution that will be uniquely positioned to serve the investment, trading and wealth management needs of investors across every phase of their financial journeys.”

TD Ameritrade EVP and CFO Stephen Boyle said that partnering with Schwab on this transformative opportunity makes the right strategic and financial sense for TD Ameritrade:

“We share a common history—a journey since 1975 that has made Wall Street more accessible and financial dreams more attainable for millions of Americans. Our associates are fiercely proud of that legacy and all that we have accomplished to make TD Ameritrade one of the premier firms in financial services. Now we look to join forces with a respected firm like Schwab that shares our relentless focus, and to do more than we could do apart. Together, we can deliver the ultimate client experience for retail investors and independent registered investment advisors. We can continue to challenge the status quo, pooling our resources and expertise to transform lives—and investing—and deliver sustainable, long-term value to our many stakeholders.”

The deal is expected to close in the second half of 2020. “Integration,” a term that may also be construed as workforce reduction, will begin soon after. Schwab stated that “reductions in staff are a necessary part of achieving overall expense synergies.”

Synergies generated by the deal are expected to be 10-15% accretive to GAAP EPS and 15-20% accretive to Operating Cash EPS in year three, post-close. Expense reductions are predicted to be approximately $1.8 to $2 billion. Overlapping services will be rationalized along with the extensive real-estate holdings of the two firms. Schwab currently has over 365 physical branches. TD Ameritrade operates over 275 branches nationwide. These need to go as the cost to operate them is high.

Schwab stated that the transaction is squarely in line with Schwab’s long-term strategy – part of which is the sheer economies of scale accomplished by an instant doubling of their client base.

“It allows Schwab to continue to add scale on top of its organic growth, with the addition of approximately 12 million client accounts, $1.3 trillion in client assets and $5 billion in annual revenue. We expect this added scale to lead to lower operating expenses as a percentage of client assets (EOCA), which helps fund enhanced client experience capabilities, improve the company’s competitive position and further its financial success. This is our Virtuous Cycle at work.”

While both Schwab and TD Ameritrade are far bigger than many of the Fintech upstarts nipping at their heels, the digital brokerages have shifted from being the disruptors to becoming disrupted by these more agile Fintechs.

In recent weeks, emerging Fintech competitors to traditional online brokerages had worried the sector with their no-commission approach to trading along with their asset-light operations. Both Schwab and TD Ameritrade had announced the removal of trading commissions following the lead of Fintechs like Robinhood – an investment platform that has been hoovering up customers at a rapid rate. The elimination of commissions gave rise to the question if the competition was becoming a race to the bottom.

Earlier this year, Robinhood raised $323 million in financing at a $7.6 billion valuation. Robinhood prominently promotes zero fees on trading in stocks, funds, and options while also providing crypto trading. In October, Robinhood announced FDIC insured savings accounts with a high promotional interest rate to encourage more account creation (2.05% APY at the time of the announcement).

Schwab and TD Ameritrade provide trading and wealth management platforms, custody platforms, retirement services, banking, and asset management.

Of note, Schwab operates Charles Schwab Bank an entity that provides banking and lending services and products – a service TD Ameritrade clients will now find as part of the basket of product offerings.

So is bigger better or will this be another merger that suffers from hubris and a clash of cultures? The jury is out on its verdict.

Technology is at it is best when it is ubiquitous but not obtrusive. We want access to it when we need it otherwise don’t be a bother.  This holds true for Fintechs as well. While Fintechs like Robinhood have caught the wave of digital innovation boosted by its ethos of democratizing financial services, Schwab+TD are positioned to challenge Robinhood head-on – if corporate strategy allows it to make the right decisions. We live in a world where brokerage (and bank) branches are not necessary at all. Between Schwab and TD the two companies have over 640 offices.

New services by the traditional brokerage must be part of the package. This includes access to alternative investments like crypto, real estate and non-traditional funds. Schwab recently announced a partnership with iCapital that enables wealthier clients to access alternatives. Sophisticated services need to filter down to the regular guy.

The Charles Schwab Bank is key to the success of the merger. The digital bank offers unlimited ATM fees and 0% foreign transaction fees for consumers – a big deal. Unfortunately, savings rates have lagged the competition but this can be easily addressed. Schwab needs to bring its banking services out of the shadows and promote it more effectively. The Charles Schwab Bank is also in desperate need of a digital makeover.

The combination of the two brokerages will take some time. It is not clear how the two cultures will mix. Meanwhile, Fintechs will continue to iterate, adapt, add new services and expand, unhindered by a long legacy of financial service tradition.

 

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