Schwab: Selling at a Discount

The brokerage is taking a bath on the deal with UBS for its Soundview Capital Markets division

By Justin Hibbard and Emily Thornton

Brokerage Charles Schwab (SCH ) will sell its Schwab-Soundview Capital Markets Division to investment bank UBS (UBS ) for $265 million in cash. The sale marks Schwab's exit from institutional trading and research and boosts UBS's trading volume from U.S. retail investors.

Schwab Soundview Capital Markets was created in January when Schwab bought the research and institutional sales operations of boutique tech investment bank Soundview Technology for $321 million and combined them with Schwab Capital Markets, the institutional trading and market making division that Schwab acquired in 1991 under the name Mayer & Schweitzer.


  UBS is buying the combined division's trading and sales operations -- but not the research operations -- for $265 million, approximately $70 million to $80 million below the book value of the entire Schwab-Soundview Capital Markets division. Schwab will take a $70 million to $80 million noncash, after-tax charge in the third quarter to reflect the loss on the sale of the division and will exit its institutional research operations "in the near future," the company said in a statement.

Brokerages like Schwab take orders from customers to trade securities and then forward those orders to trading houses like Schwab-Soundview, which are paid for every trade they execute. Without a steady flow of orders, idle trading capacity is merely a cost. That's why, as part of its $265 million purchase, UBS secured an eight-year agreement in which Schwab will route orders for equity and listed options trades to UBS, provided UBS maintains certain standards for speed and low-cost execution.

"It's a significant amount of order flow," says Todd Halky, an analyst at Sandler O'Neill & Partners. Indeed, the deal will make UBS the second-largest trader on Nasdaq in terms of volume.


  The sale ends a long, strange trip for Soundview Technology, which grew out of research firm Gartner in the 1980s and merged with investment bank Wit Capital in 1999. Schwab acquired it earlier this year and dumped its banking operations. Prior to the UBS purchase, Schwab-Soundview Executive Vice-President Mark Loehr had discussed a management-led buyout of the Soundview assets, but the plan fell through, according to sources close to Schwab-Soundview.

When Schwab bought Soundview Technology, Loehr and two other former Soundview executives, John Hervey and Bob Meier, signed employment contracts with Schwab that allow them to fully vest on their Schwab stock options in the event that Soundview is sold. It's not clear whether the UBS purchase will invoke those contract terms (see BW Online, 8/11/04, "Schwab's Strategy: Buy High, Sell Low?").

For Schwab, the sale to UBS is part of a "back to basics" strategy that calls for the brokerage to focus on its core constituency: individual investors. As recently as January, the firm was diversifying beyond that core by adding SoundView's research and sales expertise to its institutional business.


  On July 20, when Schwab reported net income of $113 million for the second quarter, down 10% from last year's second quarter, the board fired CEO David Pottruck and replaced him with founder and Chairman Chuck Schwab. Soon afterward, reports began surfacing that Schwab Soundview was on the block.

Speculation had also swirled around whether Schwab will sell U.S. Trust, a high-end wealth-management firm the brokerage acquired in 2000 for $3 billion. But in a recent interview with Dow Jones Newswires, Chuck Schwab dispelled those notions. As part of the outfit's refocused strategy, he said, it will seek to serve individual investors at all levels of wealth and not concentrate solely on discount brokering, the business that launched Schwab in the 1970s. Chuck Schwab may be back, but the brokerage isn't completely tied to its past.

Hibbard is a correspondent in BusinessWeek's Silicon Valley bureau, and Thornton is Finance & Banking editor for BusinessWeek in New York

Edited by Patricia O'Connell

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