E*Trade: The Merger Buzz Grows

Press reports that the embattled online brokerage may be discussing a tie-up with AmeriTrade or Schwab boosted the shares Friday

E*Trade Financial (ETFC) continued to claw its way back from the abyss on Nov. 23, fueled by a CNBC Business News report that the company is thought to be discussing a merger with rivals TD AmeriTrade (AMTD) and Charles Schwab (SCHW).

Shares of the embattled online brokerage closed 25% Nov. 23, to $5.33, perhaps causing some rattled market players to count their blessings anew the day after Thanksgiving.

The talk about E*Trade being bought by another online brokerage has been circulating for a while, but the company's recent credit problems have "forced the situation" over the past 10 days, said Richard Repetto, an equities analyst who covers the firm for Sandler O'Neill & Partners in New York.

"The credit issues have definitely brought the situation to a decision point," Repetto said. E*Trade is in need of financial restructuring, whether through an infusion of cash or an outright sale, something that will provide help to its balance sheet, he added.

On. Nov. 12, E*Trade revealed that the fair value of its $3 billion asset-backed securities portfolio had deteriorated further since Sept. 30, resulting in larger-than-expected writedowns. The company also backed off from prior profit projections, citing rating agency downgrades and further upheaval in the credit markets.

A provocative research report from Citigroup (C) that raised the possibility of bankruptcy for the first time, said E*Trade could sustain more than $5 billion in losses if forced to liquidate its loan portfolio and downgraded the stock to a sell from a hold rating exacerbated market jitters and helped drive a 59% plunge in the share price on Nov. 12.

TD AmeriTrade has been mentioned as a potential buyer of E*Trade for a long time and it's in a better position to separate E*Trade's brokerage and banking businesses by using its affiliation with Toronto-Dominion Bank (TD) to acquire E*Trade's troubled banking assets, Repetto said. Toronto-Dominion owns a 40% stake in TD AmeriTrade.

Schwab doesn't have that capability at the moment, though it could partner with another institution to do so, Repetto said.

Although he said he doesn't know how high a price E*Trade could command, he estimates the brokerage alone is worth about $10 per share. With a current share count of 423.8 million, that puts the value at roughly $4.24 billion, but that would be partially offset by losses in E*Trade's banking division, he said.

Analysts have said that losses in the home equity and asset-backed portfolios could be as much as $1 billion to $3 billion.

In a Nov. 12 research note, analysts Michael Parker and Matt Snowling at Friedman Billings Ramsey (FBR) said they saw "significant upside to the intrinsic value of the standalone broker," but added that that value wouldn't be realized until the company disposes of its impaired assets.

If the company were to take a 15% haircut, amounting to $1.2 billion after taxes, on the sale of its $12.4 billion asset-backed portfolio, the bank would fall well-below capitalized levels and would require a cash infusion of around $800 million to stay afloat, the FBR note estimated. (FBR makes a market in E*Trade's securities and has provided non-investment banking services for the company within the past 12 months.)

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