The online brokerage business may be on the verge of another big consolidation wave -- which also could mean a halt to ever-sliding stock trading commissions for small investors.
Merger rumors involving three of the industry's largest brokerages began to swirl around Wall Street on Friday, and drove some of the players' stocks up sharply Monday.
E-Trade Financial Corp., the third-biggest online broker ranked by daily trade volume, has sent a letter to No. 2-ranked Ameritrade Holding Corp. suggesting that the two should discuss a merger, the Wall Street Journal reported Monday.
Meanwhile, Ameritrade has been trying to work out a deal for TD Waterhouse, an online brokerage owned by Toronto-Dominion Bank, the New York Times said.
Spokespersons for E-Trade, Ameritrade and TD Waterhouse all declined to comment on merger speculation. But Ameritrade's stock soared $2.11, or nearly 19%, to $13.42 on Nasdaq. E-Trade shares jumped 69 cents, or 5.8%, to $12.62 on the New York Stock Exchange, and Toronto-Dominion rose 50 cents, or 1.2%, to $41.25, also on the NYSE.
Some investors were betting that more marriages among major online brokers could lift industry earnings, because mergers could ease competitive pressures that have driven average commissions to the $10-a-trade range, analysts said.
"Consolidation might help stem the price war," said Seth Dadds, an analyst at stock research firm GARP Research Corp. in Towson, Md.
And if some of the biggest names in online trading join forces, smaller players could also feel the need to partner-up.
Online trading boomed with the dot-com stock mania of 1999 and 2000, then slumped in 2001 and 2002 as the bear market drove away many investors.
Trading revived in 2003 as the stock market rebounded, but many analysts say the online brokerage infrastructure built up in the late 1990s still is too large relative to the number of Americans who want to trade stocks regularly.
Heavy competition for a smaller-than-expected audience has helped to push trading commissions down sharply in this decade. Last year the battle intensified, as No. 1 online brokerage Charles Schwab Corp. in San Francisco sought to shore up eroding market share by slashing its standard commission rate from $29.95 to as low as $9.95 for active customers.
Schwab's strategy appears to have worked: It reported 191,300 daily average revenue trades (meaning all securities trades on which it earned commission or markup) in the first quarter, up 7.6% from the fourth quarter.
By contrast, average trades at Omaha-based Ameritrade dipped 2.4% to 167,209 a day in the first quarter from the fourth quarter, the company said. E-Trade reported a 1% drop, to 134,770, for the same period.
A union between E-Trade and Ameritrade would create the largest online brokerage in terms of daily trading volume, but the firm still would rank far behind Schwab's $1-trillion-plus in total customer assets. E-Trade had $95 billion in client assets as of March 31, and Ameritrade had $76 billion.
E-Trade, which earned $389 million last year on revenue of $1.5 billion, has grown since 2001 in part by beefing up its banking business, including mortgage and consumer loans.
Ameritrade has stayed focused on the serious stock trader, and has been aggressive in buying smaller online brokerages in recent years. The company earned $272 million on revenue of $880 million last year.
E-Trade sees an opportunity in Ameritrade to bolster its competitive position in trading volume, while also gaining millions of new customers who could be sold other financial products and services, analysts said.
E-Trade this year has rolled out a new account which, among other features, helps customers find the highest potential returns on cash balances.
Matt Snowling, an analyst at brokerage Friedman Billings Ramsey in Arlington, Va., said E-Trade is trying to address a problem that has dogged most of the online brokerage industry: Many of the companies' clients have the bulk of their assets at other financial firms, such as big-name brokerages and banks.
The dollars invested with online brokerages tend to be relatively modest -- what the customers regard as "play" money, Snowling said. The companies' challenge is to attract more of investors' serious money and generate ongoing fees from those assets, he said.
That could smooth out online brokerages' earnings by making them less dependent on stock market swings.
But product and service diversification is risky, analysts note. In the view of some on Wall Street, Schwab has struggled with poor earnings because it has tried to attract a broad swath of customers but hasn't executed that strategy well.
With online brokerage commissions already so low, however, Snowling said it makes little sense for brokerages to believe that long-term success would depend on another round of price cuts.
"I expect to see pricing stabilize" with or without another round of mergers, he said. At about $10 for the average commission, "The next incremental price cut wouldn't do much" to change customers' loyalties, Snowling said.
Times staff writer Kathy M. Kristof contributed to this report.