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Margaret Moran
Margaret Moran
Articles (352) 

TD Ameritrade Posts Strong Organic Growth Leading Up to Schwab Acquisition

The elimination of trading commissions cuts into fiscal first-quarter earnings, but increases assets under management

January 22, 2020 | About:

After market close on Jan. 21, TD Ameritrade Holding Corp. (NASDAQ:AMTD) reported earnings for its first quarter of fiscal 2020, which ended on Dec. 31.

Revenue for the quarter came in at $1.29 billion, compared to $1.48 billion in the prior-year quarter, which is in line with analyst estimates of $1.29 billion. Diluted earnings per share came in at 70 cents, compared to $1.07 in the prior-year quarter and below analyst estimates of 76 cents. Net income was $379 million, lower than the prior-year amount of $499 million but not as bad as the company’s initial estimates that revenue would suffer by $220 million per quarter.

As of Jan. 22, TD Ameritrade has a market cap of $27.56 billion, a price-earnings ratio of 12.96 and a three-year revenue growth rate of 16%. According to the Peter Lynch chart, the stock is currently undervalued.

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No more trading commissions

The decline in earnings per share was largely attributable to the decision to cut out trading commissions from the company’s brokerage services entirely. Mere hours after Charles Schwab Corp. (NYSE:SCHW) eliminated trading fees for stocks, exchange-traded funds and base options, TD Ameritrade announced it was making the same changes, effective on Oct. 3, 2019. Share prices had already been deteriorating as online discount brokers raced to cut fees more than their competitors, but their elimination temporarily drove investor sentiment to a new low, plunging 25% to $32.85 before immediately beginning to recover.

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The reason for the quick turnaround in outlook came from the potential for high organic growth, which the company delivered in the recent quarter. New client assets were $29 billion for the quarter, representing a growth rate of 9% year over year. TD Ameritrade’s interim president and CEO, Steven Boyle, commented:

“History was made on the first day of our new fiscal year when the cost to trade went to zero for most trades, resulting in a new world in discount brokerage where price no longer clouds the comparison for trades. Trading was very strong in the first quarter averaging 1 million trades per day – for the first time in our history – which helped offset a portion of the revenue impact from zero commissions. We had 38 days eclipsing 1 million trades in the first quarter, compared to 23 days in all of fiscal 2019. The increased trading volume, reflecting more frequent, smaller trades, was driven largely by an uptick in equity trading following our pricing changes, as well as market volatility, geopolitical headline news, and strong retail news heading into the holiday season. Trading is up roughly 40 percent January to-date, averaging 1.4 million trades per day.”

With trading volume helping to make up lost ground on commissions costs, the company has high expectations for future growth.

Schwab acquisition

About a month after both online discount brokerage giants eliminated their trading commissions, Charles Schwab and TD Ameritrade entered a definitive agreement for Schwab to acquire its rival in an all-stock transaction valued at $26 billion. The deal is expected to be completed in the middle of calendar 2020, with TD Ameritrade shareholders receiving 1.0837 Schwab shares per TD Ameritrade share.

“Partnering with Schwab on this transformative opportunity makes the right strategic and financial sense for TD Ameritrade,” Boyle said in a Nov. 25 press release. “We share a common history—a journey since 1975 that has made Wall Street more accessible and financial dreams more attainable for millions of Americans.”

The deal means the creation of an online brokerage behemoth with approximately $5 trillion in client assets. In addition to providing clients of the combined company with a greater selection of trading opportunities, the merger will allow them to access a greater variety of resources, such as education materials and retirement services.

One less rival

While the combined company will naturally have more attractive offerings for clients, another big value creation opportunity coming from the merger is the fact that Schwab’s biggest rival will no longer be competing with it.

The ability to offer clients an unparalleled service offers a prime opportunity for the combined company to seek additional methods of monetizing its user base. For example, it might be able to go a similar route to online newspapers, bringing in high ad revenue or offering premium subscription services for written content. Increases in the promotion of trading algorithms and the consulting services of registered investment advisors seems particularly likely.

Looking forward

While the ever-present fear of a bear market is on the horizon, many analysts predict that we will not see any major changes in the overall U.S. economy until after the next presidential election, though it is impossible to predict this with any degree of certainty.

With the elimination of trading commissions, it is possible that TD Ameritrade and its competitors will see more losses in future recessions than they did in the past, as they will not be able to benefit from sell commissions during a selloff.

TD Ameritrade’s shares, which were trading at a 17% discount to the acquisition price that Schwab set on Nov. 20, 2019 based on the 30-day volume weighted average price exchange ratio, have recovered to their pre-commission-cut prices of around $50. A price of $50 would represent buying a share of the combined company post-merger for approximately $46.30 (Schwab shares are trading at $48.84 as of the writing of this article). In the upcoming half-year before being acquired by Schwab, TD Ameritrade has a high potential upside due to organic growth, but its share price growth may be locked to a level where it doesn’t surpass (or go too far under) the value of Schwab’s all-stock acquisition deal.

Disclosure: Author owns no shares of any of the stocks mentioned.

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