A New Trade for E*Trade

It bets big on diversifying into consumer finance

What does E*Trade Group Inc. (ET ) want to be when it grows up? In a flashy presentation to investors Feb. 6 in San Francisco, the pioneering online broker's CEO, Christos M. Cotsakos, said earnings could quadruple in 2002 despite the bear market. Yet the glitz didn't obscure a key change: Discount brokering is no longer its big moneymaker. With 2001 brokerage revenues down 28% year-on-year, E*Trade's profits now come increasingly from banking services: auto loans, mortgages, checking accounts, and ATMs. As Cotsakos put it: "We're counting on our other products to carry the day." Says Banc of America analyst Robert Sobhani: "E*Trade is definitely becoming a bank."

So why is E*Trade bidding between $700 million and $800 million for Datek Online Holdings Corp., a privately held brokerage? Neither Datek nor E*Trade would comment, but industry insiders say E*Trade, which has 3.5 million brokerage accounts to Datek's 830,000, wants to hike its 18% of the online brokerage market and preempt rivals. The strategy is risky. If it wins Datek, E*Trade must digest a big acquisition while its new business is getting off the ground and its old one is struggling. Datek, which doesn't release financials, is profitable, analysts believe. But E*Trade's trading volumes have fallen for four straight quarters. The average account size is down about 13% from a year ago to $12,728.

The banking and consumer-finance bet has problems, too, pitting E*Trade against banks' bread-and-butter business. Home refinancings fueled E*Trade's recent profit. "We think they'll get another quarter out of that [but] then everyone who wants to refinance will have done it," says Standard & Poor's analyst Charles Rauch. E*Trade expects its refi business to drop sharply in 2002.

Another pitfall: credit risks, which Cotsakos downplays: "We're not going to have a gazillion credit cards out there. We want to stay with the crème de la crème of the credit market," including E*Trade's well-off customer base.

No doubt, diversification helps. E*Trade shares, though far from their $50 peak, are up about 54%, to $8.19, since September 11. In contrast, Charles Schwab & Co.'s (SCH ) are up 30%. E*Trade boasts that for the last six quarters it posted a profit from ongoing operations, which excludes goodwill amortization, investment results, and other nonrecurring charges. On Jan. 14, it reported a $24.7 million fourth-quarter profit from ongoing operations, more than quadruple the year-ago level, on a 3.5% revenue gain. Analysts doubt E*Trade can keep it up. "Don't expect that kind of geometric growth rate for '02," says Rauch. E*Trade posted a net $241.5 million loss for 2001.

Ei*Trade is in a hard spot. Online brokering has become a brutal mass-market business. Getting into another--consumer banking--may not offer much relief.

By Louise Lee in San Mateo, Calif.

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