Commentary: Hunkering Down May Not Save Ameritrade's Skin

By Timothy J. Mullaney

Once upon a time, it would have seemed like a ton of money. But Ameritrade Holding Corp.'s (AMTD ) Apr. 8 deal to buy rival Internet broker Datek Online Holdings Corp. for $1.3 billion says more about the weaknesses of online trading than its strengths. The merged company is likely to make more money than the two would have separately--at least for a while--but it doesn't mean the online trading boom is coming back. Instead, the deal is about preparing online brokers to live off the land for some time to come.

Here's why. When trading at Net brokers peaked at 98 million trades in early 2000, it was an extraordinary time. The stock market was roaring, the Net was white-hot, and, to a hardy few, day trading seemed a viable profession. No more. As a result, online brokers' volume has plummeted to 54 million trades. More worrying, e-brokerages are losing market share to traditional houses. In early 2000, online brokers accounted for 45% of trades on the New York Stock Exchange and Nasdaq--but only 22% now.

Ameritrade's problem is stark: Its commissions fell 31% for the fiscal year ended in September and signs point to a tepid recovery. So Chief Executive Joseph Moglia has been cutting costs. Advertising was slashed 77%, to $14.6 million, for the quarter ended in December. Staffing went from 2,500 in 2000 to 1,737 at 2001's end. The effort has worked, up to a point: The broker made $9 million in the calendar fourth quarter 2001.

Now, Moglia's plan is to merge with Datek and cut costs some more. The CEO says the merged company can lop off $100 million in expenses. Why? Both firms have infrastructures built to support 2000 trading levels. Datek's average daily trades are off 50% since March, 2000.

But it may not be enough to keep Ameritrade independent. That's because rival online brokers are hedging their bets by diversifying into more stable financial services, while Ameritrade is doubling down on the volatile brokerage business. Charles Schwab Corp. (SCH ) is building up asset-management businesses. E*Trade Financial (ET ) bought a bank and a mortgage company. Ameritrade and Datek are likely to do well in a modestly rebounding market. But analysts suspect the company will sell out to a more stable, diversified financial institution once trading volume recovers enough that they can get a decent price. "The trading levels of 1999 and 2000 aren't coming back," says UBS/PaineWebber Inc. analyst Eric E. Wasserstrom.

In the short-term, Ameritrade is building a strategy in which top-line growth is a luxury--great if it happens, but not essential to increasing earnings. Over time, though, you just can't shrink your way to greatness.

Mullaney covers e-finance from New York.

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