Morgan Stanley & E-Trade

Strategic Merger — American Investment Bank and Commission-free Brokerage Services

Source: Fort Myers Florida Weekly
  • The combined entity is expected to have have $3.1 trillions client assets, ranked third amongst North America asset manager behind Fidelity and Charles Schwab
  • As Morgan Stanley step into wealth management competition, E-Trade might have to encounter anti-trust issues
  • M&A activities in the wealth management industry has accelerated due to changes from the brokerage fee-driven model to interest earning model

Morgan Stanley announced that it is acquiring discount broker E-TRADE for $13 billion on the date of Feb 28. According to management, the post-acquisition trading platform will have $3.1 trillions client assets, 8.2 millions retail client relationships and accounts, and 4.6 millions stock plan participants. It will also result in 400 million cost synergies phased in within 3 years and it will cost approximately 800 million to integrate the business segments together.

To Morgan Stanley, the acquisition has added 360 billions in asset and 5 million customers to Morgan Stanley, as a result Morgan Stanley is able to reach a dominant position in North America. The deal was also driven by the short-falling from deal activities and economy well-being, as investment banks have began to look forward to target wealth management fields which include advisory and brokerage services.

With E-Trade’s products and its established brand among millennials and Generation Z, Morgan Stanley will be well-positioned across all three channels: Financial Advisory, Self-Directed, and Workplace

Source: Statista

To E-Trade, the competitive brokerage environment has become tough as more commission-free brokerage services have arisen , their value chain has only limited to brokerage services. Being associated with legacy financial institution will add protection and credentials towards the operators and customers, in addition to the cross-sell strategies between E-trade services and Morgan Stanley advisory services. Therefore, they were able to extend their competitive advantage at brokerage services and drive traffic to established financial advisory services.

TD Ameritrade & Charles Schwab

Earlier in late 2019, Charles Schwab acquired TD Ameritrade in US$26-billion deal, which consolidated two of the biggest retail brokerage companies. It is a disruptive move as post-acquisition they managed the second largest North American pool of assets. With similar acquisition thesis, Schwab is widely appreciated by investors and both stocks have gotten up over 10%. In contrast, Morgan Stanley stock has decreased by 4.3% the day after the announcement was made.

With Schwab and Morgan Stanley’s deals, the retail brokerage industry, a well-established financial institutions with commission-free stock trading will only be available at Schwab and Morgan Stanley which will place them in a advantageous position over asset management firms and retail banks. Clearly, it implies a huge bet towards the wealth management industry in the mid to long-term.

Analysts have also suggested the anti-trust and anti-competitive issues occurred in the TD Ameritrade trade could also pull back Morgan Stanley’s deal as well. In Feb 8, 2020, The United States Department of Justice has proceeded to its second-phase of review and due diligence. It signifies a great deal process regardless of anti-competitive act and trust-conflicted post-merger integration processes, which could be beneficial for Morgan Stanley to follow through.

Wealth Management Expansion

The Wealth Management industry has grown at CAGR of 13.7% in 10 years, outpacing the growth of hedge funds (7.5%) and asset management (7.7%). Given the fact that different facets of investment banks have been punished for instance, the decreased interest rate has diminishes profit from lending services, decreased consumer spendings have led to lower growth in stocks and bond markets, weaker economy has led to fewer M&A deals in North America. In contrast, the advancement in technology (brokerage, digitalization, media information) have given wealth management a boost because more people are able to afford these advisory services.

Wealth Management and brokerage services are intertwined, as transactions of assets and contracts required licensed brokers to proceed. A shift from a commission-heavy revenue stream to one more reliant on interest income and client services will extend competitive advantage to these commercial banks like Morgan Stanley. Yet in 2020 and beyond, new ventures like E-trade and Schwab will be harder to complete with competitors today.

Generation Z Investors

According to Forrester Analytics Consumer Technographics® data, 48% of E-TRADE’s customer base comprises self-directed investors. It is critical to Morgan Stanley because self-directed traders are the primary target market for financial advisory services, given they are (1) driven to invest to grow their wealth, (2) have basic yet inadequate understanding about the market, (3) working individuals with disposable income. Outside of the 48%, there are people who rely on external financial advisors, people who are inactive in frequent trading and people fix a particular portfolios for retirement.

To banks, Generation Z normally comprises a really small portion and yet they are catching banks’ attentions. Not because of their relative long-lived life cycle nor the capital they have to invest. Generation Z and Millennials differ from the older generation as they are self-driven and value experience, which made advisory services particularly receptive and attractive to these populations.

Valuation

Given the 26 billion all stock deal from Ameritrade, given the 12 million incremental users, it is relatively cheaper by margins than Morgan Stanley’s acquisition. An average of $2167 per acquisition for Schwab and $2600 for Morgan Stanley.

E-Trade has also operated more efficiency than TD Ameritrade, as they have incurred more income from interest and administrative fees in % of sales. Less reliance in broker’s trading revenue is determined as beneficial to discount brokers as it reflects profitability in other segments mainly comprises of interest and security income.

Source: Bloomberg

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