10 October 2006

TD Ameritrade Investors Put Stock in Merger Success

Special to The Globe and Mail, Peter Moreira, 10 October 2006

In case you hadn't noticed, Sam Waterston has replaced Stuart the multicolour-mohawked day trader in Ameritrade's advertisements.

It's not just that Stuart -- the guy who called his girlfriend's dad a chicken for not investing more -- now seems a relic of the dot-com boom. Mr. Waterston, who was once cast as Abraham Lincoln, personifies strength and dignity, which is more fitting for Ameritrade since it added the initials "TD" to the beginning of its name.

The new image is the result of Toronto-Dominion Bank merging its TD Waterhouse USA unit with Omaha, Neb.-based Ameritrade Holding Corp. in January, to form TD Ameritrade Holding Corp., the No. 3 discount brokerage in the United States.

The deal, announced in June, 2005, was something of a coup for both TD Bank chief executive officer Ed Clark and his Ameritrade counterpart, Joe Moglia. Ameritrade at the time had two problems: Not only was it a unidimensional business designed almost exclusively for on-line day traders, but it also was facing an unwanted $6.2-billion (U.S.) takeover bid from New York-based rival E*Trade Financial Corp. TD's Mr. Clark had a different problem: He wanted to merge the Waterhouse wealth management unit with another discount broker, but he also wanted to retain control of the merged entity.

To solve these problems, TD agreed to wrap Waterhouse into Ameritrade, taking 32 per cent of the merged broker, then purchase an additional 7.9 per cent of the TD Ameritrade stock at $16 a share. Existing Ameritrade shareholders received a $6 dividend, while TD was able to add $900-million (Canadian) to its valuation of Waterhouse on its balance sheet. Since it would exercise considerable control over the board, TD would retain a say, if not absolute control, in how the business was run.

The deal created a discount brokerage with about six million accounts, ranking behind only Boston-based Fidelity Investments and San Francisco-based Charles Schwab Corp.

After the deal closed Jan. 26, the hard part came. The two companies had to combine a predominantly trading brokerage like Ameritrade with Waterhouse, which had become a vehicle for wealth management.

"The major issue for them is integration," said Sang Lee, a managing partner at Boston-based research consultancy Aite Group LLC. "How do you get a company that has focused on its on-line channel to focus on different channels?"

Ameritrade says the integration is proceeding well. The company originally forecast cost and revenue synergies of $578-million (U.S.) within 12 months of the close of the deal, and chief financial officer Randy MacDonald said in an interview he now believes revenue synergies alone will add a further $100-million to the total.

"And we haven't yet put the firm together at the back end," he said, referring to the administrative side of the business, "and that's where you really get the [cost] synergies." The big event so far in the integration process was the launch on April 24 of the new "value proposition," meaning Ameritrade told clients of the merged group what services it would offer and how much it would charge for them.

The proposition was the beginning of a shift in culture that would allow it to manage the wealth of the upper middle class rather than just lead the industry in the number of trades it executed. Mr. MacDonald said the broker is now targeting people with $100,000 to $1-million in liquid securities, who make up 30 per cent of the U.S. population and own 40 per cent of its wealth.

Although shares in the company fell in the first six months of the merger, they are now rising on an improved outlook. After closing at $19.38 on the day the deal closed, the shares slipped to $13.84 in July, largely because of concerns about customer satisfaction, and have since rebounded to $19.13 on the Nasdaq Stock Market.

"The environment now is probably better than what was expected when they announced the deal, so I think the synergies will be of a greater magnitude than expected," said David Trone, an analyst with Fox-Pitt Kelton Inc. in New York. He now has an "outperform" rating on the stock and a price target of $22.

A survey of seven analysts by Zachs International shows share profit forecasts for the 12 months ending Sept. 30, 2007, average $1.20, up 33 per cent from the estimate of 90 cents for 2006.

Mr. Trone added, however, that it will take time to "bring these two disparate customer bases together" and there are risks involved in rebranding the product and appealing to a different client base.

Then again, some of those day traders who were enticed by the mohawked Stuart may be greyer and wealthier now and feel more comfortable with Sam Waterston.