Tuesday, July 15, 2008

Scotiabank Buys E*Trade Canada

TD Securities, 15 July 2008


Yesterday after market close, Scotiabank announced the purchase of 100% of E*Trade Canada.


Not our first choice, but deal adds clients and makes financial sense. We have made no changes to our estimates, and continue to view Scotia as one of the best operating outlooks in the group, although we note that the stock has now moved to trade at a healthy premium. Reiterate 'Buy.'


Wouldn't have been our first pick, but hard to argue with. Discount brokerage wouldn't have been our first priority for Scotia's expanding domestic wealth business as the industry continues to bear the pressure of ongoing price erosion and remains subject to volatile trading activity. That said, we find it hard to argue with the logic of acquiring one of the few remaining wealth management assets in the country, in a deal that adds a high margin business at a price that is accretive out of the gate and which contributes to Scotia's over-riding domestic objective; adding customers.

No change in our estimates. The acquisition is set to close in the fall of 2008 and is expected to be accretive in year one and add two cents in year three based on what the bank views as conservative assumptions that reflect the current challenging environment for trading activity and take into account the impact of E*TRADE Canada’s lower pricing alternatives. Also, the outlook has not factored in any potential revenue synergies.

The impact on capital is relatively modest (20bp) for a well capitalized bank; Scotia had a Tier 1 of 9.6% as of the end of Q2/08 (Basel II). We don't expect material integration challenges as Scotia has proven to be a capable buyer over the years and appears intent on moving judiciously. Ultimately, the key upside to the deal is likely to come from leveraging the potential cross-sell opportunities to the expanded client base, but that will likely only happen gradually.

What can we infer of ETFC's intentions? Beyond Scotia, the question remains; what will ultimately become of ETFC and a potential transaction with AMTD? To us this move, along with ETFC’s 2008 Turnaround Plan and other efforts to recapitalize, suggest a strong desire to remain independent. Quality story, premium valuation. Scotia remains one of the best operating outlooks in the group in our view underpinned by the strong medium-term outlook of the international business and increasingly supported by an improving domestic profile. However, on the back of strong relative performance amid a very weak tape for financial services, the stock has now moved to trade at a wide relative valuation premium. We still see attractive upside in the name on a 12-month view, although relative out performance may be constrained.

Conference Call Highlights

Transaction details. The purchase price of approximately US$442 million (or approximately C$444 million) will be made with 100% cash and is expected to close by the end of September/October 2008.

Market share. Scotia expects the addition of E*TRADE Canada to increase the banks market share from 6% to 10% (based on # of accounts), ranking Scotia #2 relative to the industry. The deal is expected to bring in over C$5B in Assets Under Administration and Scotia expects AUA to double by 2016.

Future cross sell opportunities. The bank expects opportunities to cross sell Scotia products to E*TRADE Canada customers and providing them the ability to transfer funds between their trading account and a Scotiabank retail account along with the full suite of Scotia banking products. Through this online channel, Scotia anticipates being able to offer their products on a lower cost basis.

Business mix. Scotia indicated that approximately 80% of E*TRADE Canada sales are retail focused and 20% are institutional. During year end December 31, 2007, E*TRADE Canada contributed nearly U$93M to ETFC’s net revenues. Also, the addition of E*TRADE Canada should complement the active trader focus with Scotia’s previous acquisition of Trade Freedom.

Margins. Margins from E*TRADE Canada are similar to ScotiaMcLeod Direct, which the bank views as a high/attractive margin business.


We have made no material changes to our outlook and our estimates remain unchanged at C$4.10 for 2008 and C$4.50 for 2009.

Justification of Target Price

We expect Scotiabank to hold its premium valuation relative to the Big-Five Canadian banks, reflecting superior growth prospects, strong return on equity and healthy excess capital. We base our target price on 12.50x forward earnings, a premium to our outlook for the group.

Key Risks to Target Price

The following are key risks that we have identified for Scotiabank and could prevent the stock from attaining our target price. These include: 1) the continued weakening of the U.S. dollar, 2) country and political risk in its international markets such as Mexico, 3) integration challenges associated with its recent and future acquisitions and 4) adverse changes in the credit markets, interest rates, economic growth or the competitive landscape.

Investment Conclusion

Bottom-line, this deal should help Scotia drive their ‘client acquisition’ strategy and adds to what we view as an improving domestic story. We view Scotia as one of the best operating outlooks in the group, but the stock’s premium valuation tempers our enthusiasm. Reiterate 'Buy.'
Financial Post, David Pett, 15 July 2008

The Bank of Nova Scotia's acquisition of E*Trade Canada could be followed by more acquisitions, says National Bank Financial analyst Robert Sedran.

On Monday, Scotia said it was purchasing E*Trade Canada from US-based parent E*Trade Financial Corp. for US$442-million in an all cash deal. In addition E*Trade Financial will withdraw US$69-million of capital from the Canadian division, bringing total proceeds to $511-million. The deal adds about $4.7-billion in assets under administration and 190 employees to Scotia's wealth management business.

"In our view, this transaction sharpens the focus on a key component of our investment thesis: those companies that do not have to concentrate on retrenchment and risk reduction are better positioned to grow - both organically and via acquisition," wrote Robert Sedran, analyst at National Bank in a research note.

"Given Scotiabank's well-earned reputation as a shrewd acquirer, we expect more transactions to be announced in coming quarters as this theme matures."

Mr. Sedran added that while the deal is not financially material, it does add to Scotia's wealth management earnings.

He maintained his "outperform" rating and left his $55 price target on the stock unchanged.

Desjardins analyst Michael Goldberg, meanwhile, reiterated his "top pick" rating and $57.50 price target for Scotia.

"Yesterday's announcement that Scotia will acquire E*Trade Canada is a tangible example of a Canadian bank benefiting from the US turmoil," he told clients in a note.

"While it is not an entré into the US for Scotia, it avoids the risk of doing so and instead furthers Scotia's goal of continuiing to strengthen its Canadian wealth management franchise."
The Globe and Mail, Tara Perkins, 14 July 2008

July 14, 2008 at 9:34 PM EDT

Bank of Nova Scotia is cashing in on the deal-making opportunities arising from the U.S. mortgage turmoil, picking up online brokerage E*Trade Canada for $444-million.

The deal becomes the biggest part of the turnaround plan that New York-based E*Trade Financial Corp. announced in January, after it dangled dangerously close to bankruptcy over worries about mortgage loan losses.

With this deal, E*Trade, which originally aimed to raise $500-million (U.S.) by selling non-core assets, will have raised more than $700-million this year.

In return for the cash, Scotiabank's Canadian wealth management business, which has become a key priority for the bank, will receive a major boost. The transaction will double the size of Scotiabank's presence in the direct investing sector while adding 125,000 active accounts.

“This is truly a unique opportunity to acquire the last significant independent player in the direct investing market in Canada, and one with an exceptionally strong platform,” Scotiabank chief executive Rick Waugh said on a conference call Monday.

Seeking to expand its wealth management operations, Scotiabank bought TradeFreedom Securities Inc., a Canadian online brokerage boutique, last year, and more recently acquired Dundee Bank and a stake in DundeeWealth.

“Direct investing is an important and growing segment in Canada, even much more so in Canada than other markets,” Mr. Waugh said Monday. “We see this acquisition as a unique opportunity to immediately become a leader in this very attractive market.”

The deal is expected to make Scotiabank the second-largest brokerage in the industry based on number of accounts, and third largest in assets.

E*Trade Canada has roughly $4.7-billion (Canadian) in assets under administration and 190 employees. Scotiabank executives said they recognize that E*Trade's pricing strategy is key to its success.

“Online brokerage is playing an increasingly significant role in wealth management as more Canadians are using online investing solutions, and many are becoming more active traders,” said Chris Hodgson, head of domestic personal banking at Scotiabank. “This is a growing market,” he added, noting that it has a compound annual growth rate of 15 per cent over the past five years and assets under administration are expected to double over the next eight years.

Scotiabank also hopes this deal will prompt some E*Trade customers to open bank accounts so they can easily transfer money between accounts. The bank will also pitch products, like mortgages, to E*Trade customers online.

In an interview, E*Trade Canada president Duncan Hannay said the deal represents a great opportunity for E*Trade Financial to free up more than $500-million (U.S.) of capital to move forward.

The Canadian brokerage business has been shopped around for a number of months, and “I think it's fair to say that we had a very robust process, there was lots of interest in the business,” he said.

Like its competitors, revenue growth at E*Trade Canada's operations has been stung this year by the market environment.

One analyst called the deal reasonable but expensive, noting it's one of the last books of business left to buy. However, he added that it's safe to say Scotiabank is benefiting from having been more patient than some of its peers to take advantage of the troubles in the U.S. financial sector. For example, TD's $8.5-billion acquisition of New Jersey-based Commerce Bancorp in March would have been significantly cheaper had the bank waited.

Analysts said the $444-million (Canadian) E*Trade purchase would not prevent Scotiabank from making another acquisition, such as a U.S. regional bank. This spring, the bank took a look at National City Corp., a troubled Cleveland-based bank that would have cost billions. However, executives at the bank have recently downplayed the idea of any imminent foray into U.S. retail banking.

The acquisition of E*Trade is expected to close in September or October, following regulatory approvals.
Duncan Mavin, Financial Post, 14 July 2008

Bank of Nova Scotia has boosted its online wealth-management business by picking up the Canadian unit of struggling U.S. broker E*Trade Financial Corp. which is in the midst of a turnaround plan.

The Canadian bank has made no secret of its aim to build a bigger presence in the lucrative wealth-management space and said Monday the $444-million acquisition of E*Trade Canada will double its online investing business, adding about $4.7-billion in assets under administration and 190 employees.

The all-cash deal "demonstrates our commitment to pursuing opportunities to grow our wealth-management business," said Scotiabank chief executive Rick Waugh.

Scotiabank pounced after E*Trade reported a record loss last year that led to several senior executives leaving the company. The U.S. discount brokerage was rocked by rising losses on home loans, and a new executive team committed to selling off parts of the business in an effort to steady the balance sheet.

After the deal with Scotiabank, E*Trade chief executive Donald Layton said, "We continue to make solid progress against our 2008 turnaround plan by monetizing non-core assets to generate capital."

Combined with the other planned non-core asset sales announced this year, E*Trade has generated more than $700-million in proceeds, Mr. Layton said.

E*Trade Canada was launched in 1994 as Versus Technologies Inc. and Versus Brokerage Services Inc. The retail business was launched in 1997 through a perpetual licence agreement with E*Trade. In 2000, E*Trade acquired Versus for US$174-million in stock. At the time, Versus had 37,000 retail clients and handled about 13% of all trading volume on the Toronto Stock Exchange.

The addition of the E*Trade Canada is the latest in a series of moves by Scotiabank to bulk up its presence in wealth management, where it has lagged its domestic rivals.

"This announcement is consistent with our overall strategic focus on growing our wealth management business in Canada and around the world," Mr. Waugh said.

After the deal, Scotiabank will become the second-largest online broker in Canada by number of accounts, with a 21% share of the trading volumes in the market, it said.