By Angela Xia, Adit Rajeev, Karthik Neelamegam (University of Cambridge), Orlando Poraqi, Iulian Paval (Bocconi University)
Overview of the Deal:
Acquirer: Charles Schwab
Target: TD Ameritrade
Transaction Value: $26bn
Announcement Date: 25th November 2019
Acquirer Advisors: Credit Suisse
Target Advisors: PJT Partners, Sandler O’Neill and Partners
Charles Schwab plans to acquire brokerage rival TD Ameritrade in an all-stock deal valued at $26 billion. Ameritrade shareholders will receive 1.0837 Schwab shares for every share held, which is a 17% premium over the stock’s 30-day average price before the deal announcement broke. Schwab’s current shareholders will own 69% and TD Ameritrade’s current shareholders will own 18% of the new entity.
The merger is estimated to close in the 2020 H2 and will create a mammoth in the wealth management space with the firm managing more than $5 trillion in client assets and serving more than 24 million clients.
Company Details (Acquirer – Charles Schwab)
The Charles Schwab Corporation is one of the largest banks and stock brokerage firms in the USA. It offers an electronic trading platform to trade securities, such as common stocks, preferred stocks, futures contracts, ETFs, options, mutual funds and fixed-income investments. Additionally, the company provides margin lending, cash management services, and advisory services through registered investment advisers.
- Founded in 1971
- Headquartered in San Francisco, USA
- CEO: Walter W Bettinger II
- Number of employees: ~19,500
-Market Cap: $60.3 billion -EV: $-6.12 billion
-TTM Revenue: $10.7 billion -LTM EBITDA: $4.94 billion
-EV/Revenue: -0.57x -EV/EBITDA: -1.24x
Company Details (Target – TD Ameritrade)
TD Ameritrade is a broker that offers an electronic trading platform to trade securities, such as common stocks, preferred stocks, futures contracts, exchange-traded funds, options, cryptocurrency, mutual funds, and fixed-income investments. The company also provides margin lending and cash management services.
- Founded in 1971
- Headquartered in Omaha, USA
- CEO: Tim Hockey
- Number of employees: 9,183
-Market Cap: $26.6 billion -EV: $23.2 billion
-TTM Revenue: $5.9 billion -LTM EBITDA: $2.93 billion
-EV/Revenue: 3.95x -EV/EBITDA: 7.92x
Projections and Assumptions
In October, Schwab removed commissions for online trades to compete with modern brokers like Robinhood, which pressurised rivals, including TD Ameritrade, to follow suit. Ameritrade’s quarterly revenue is expected to fall by about $230 million, which could severely impact the income sources of the company, especially as it is not as large or diversified as Schwab. This merger would thus provide Ameritrade some protection, while also benefitting Schwab as explained below.
Cost synergies for this deal amount to between $1.8 billion and $2 billion – approximately 20% of the NewCo’s cost base, as the post-merger integration would eliminate the high amount of overlapping back-office operations and vendor costs, while also cutting down on real estate and administrative spending. According to a JMP Securities analyst, the merger would also lead to additional synergies through streaming new revenue opportunities and improving the platform for clients. It would allow Schwab to expand its customer base with the firm gaining 12 million retail and adviser accounts, increasing its total to 24 million (5 million behind competitor Fidelity).
However, the integration of the two firms is likely to incur substantial costs. While some parts of the merger, such as branch consolidation and hard assets decisions are expected to be decided and achieved in a relatively short time frame, elements such as systems and technology platforms are likely to require significant organisational resources. With the new headquarters for the NewCo moving to a new campus in Westlake, Texas, a plethora of issues relating to logistics, staffing and general office operation will need to be solved. Also, the merger would ask for a substantial marketing effort, both internally and externally. Estimates suggest that integration would take up to 36 months after the deal is closed and would cost a total of $1.6 billion.
This deal could have significant long-lasting impacts on the RIA (Registered Investment Advisor) space, which has become a sizeable force in the industry, partly because of its ability to select custodians from various broker-dealers. The vast market control the merger would give to the combined entity may threaten RIAs’ scope to offer flexible, customer-centric services. As a result, RIAs and firms directly impacted, will need to adjust their product-service mix, marketing and branding, as well as technology.
Focusing more on the merging companies themselves, costs of integration may force cutbacks in spending on other areas in the medium-term. As mentioned above, the resources, technology and staff buy-in required to integrate the two firms into one entity successfully will be substantial, and the impacts of these integration costs may stretch beyond the short term. Alongside a significant financial outlay by Schwab (to complete the deal), this will likely detract from other areas of spending. In the BD space, this commonly involves less expenditure on innovations in technology as well as support services for advisors, translating into less service for the client, who is the most considerable potential medium and long-term downside of the Schwab - TD Ameritrade merger.
The deal would allow Schwab to cross-sell additional products to make the most of a looming bear market, allowing it to expand its customer base and sell them an array of services. More specifically, cross-promotion of robo-products may be induced by Schwab’s potential inheritance of TD Ameritrade’s zeroed-out commissions. Thus, as part of Schwab’s attempt to ‘make the difference up’, retail investors may see an uptick in the cross-promotion of these products, such as the Schwab Intelligent Portfolios Premium.
The strategy behind the deal could also point towards some of its key long-term implications. Schwab, with a market cap of $60 billion, is paying a stock swap transaction for Ameritrade (which has a market cap of $27 billion), involving a massive dilution of shares, suggesting a defensive play. This strategy comes amidst a price war that has disrupted the industry in recent years, in which Schwab may gain a long-term edge via the $5 trillion in client assets of the combined entity alongside cost synergies. Bill Capuzzi, CEO of Apex Clearing, said he sees the deal “as a strategic move on the part of Schwab—one focused on long-term market dominance, rather than one architected for immediate value creation”.
Risks and Uncertainties
One of the biggest challenges the deal will face is undoubtedly regulatory approval from the US competition watchdog. The projected NewCo would comprise 24 million client accounts, becoming the third in line in terms of deponents’ funds after Fidelity and Vanguard, surpassing all the major banking groups, with a forecasted market share of 11% (post-merger projection by Charles Schwab). Even if consolidation is a widely encouraged strategy in the retail brokerage industry, there is a risk that smaller brokerage firms such as E-Trade or Robinhood will lose market participation. These smaller players are unable to match the resource allocation or strategy targets adopted by the big industry players, thus elevating the regulatory risk for this acquisition. Considering execution risks, UBS analysts point that Schwab’s large deal experience is limited, as it has not yet finished the post-merger integration process of USAA, a small asset manager it bought in July 2019 for $1.8bn.
In October 2019, Schwab dropped commissions and tariffs for online stock and ETF trading for its clients, responding to other competitors’ strategy shift in delivering more affordable and customer-oriented services. Though the decision was in alignment with the market trend, Schwab’s investors rightfully feared that cutting a source of funds will affect future profitability. Moreover, such a measure will distort a safety cushion of additional funds for the group in case of substantial volatility or similar down-turning market events. To compensate for the loss of the individual trade execution commissions, the acquirer will be pushing a strategy focused on capturing more market participation, increasing the number of client accounts, attract more trades from market makers and cross-sell of investment products across the newly acquired client accounts. The group must adequately manage an inherent operational risk associated with the trading and customer relationship activities and their fee structure.
Part of the cost-cutting restructuring envisaged by Schwab is the elimination of ‘duplicate positions’ to obtain the run-rate expense synergies. In this instance, the group will need to balance the human capital with the technological developments it runs. Algorithm-driven investment accounts using Schwab Intelligent Portfolios® have been successful in recent years, enabling clients to obtain more accurate and custom-created information for their standing investment portfolios. However, by their construction, automated systems will need a manual revision of the trading parameters in case of unexpected market conditions. In the event of a severe financial downturn, clients who will continue to be active in the market will need assistance from the group’s human investment advisors, whose headcount must be attentively managed to avoid supra-solicitation or challenges to the group’s daily operations.
© 2019 The MergerSight Group