E*Trade Seeking Exit From Market-Making Unit

E*Trade Financial Corp., the online brokerage with six chief executive officers since 2007, wants to sell a market-making unit that handles orders for its customers.

E*Trade plans to exit the Chicago-based business, G1 Execution Services LLC, according to its second-quarter earnings release yesterday. Chief Financial Officer Matthew Audette told analysts during a conference call that New York-based E*Trade is looking for buyers and expects to announce a divestiture within six months. The company’s shares surged 7.9 percent today, the most since August 2011, after E*Trade beat earnings estimates.

Market-making profits are under pressure in the U.S. as computerized trading squeezes margins and volume stagnates. G1 Execution, also known as G1X, proved a distraction this year when E*Trade disclosed that it found “shortcomings” in how it measured whether trades were struck at the best prices.

“It’s a tough business, especially in a declining volume environment,” Larry Tabb, CEO of Tabb Group LLC in New York, said in a phone interview. “It takes a lot of investment and the pricing has gotten so competitive, so for a lot of the retail brokers it’s tough to justify developing it.”

E*Trade concluded that it should sell G1X due to “the tightening economics for that business coupled with a potential associated risk, both operational and regulatory,” Audette said during yesterday’s call. Most importantly, “it is not core to our retail customer business,” he added.

Stagnant Trading

Daily U.S. equity trading volume has averaged 6.37 billion shares in 2013, down from 6.42 billion in 2012 and 9.77 million in 2009, according to data compiled by Bloomberg.

The decision to exit G1X was announced as E*Trade said it lost $54 million in the second quarter, compared with net income of $40 million a year earlier. The New York-based company booked a $142 million goodwill writedown tied to G1X.

Excluding the goodwill impairment and restructuring charges, E*Trade said it earned 21 cents a share last quarter, topping the average analyst estimate of 12 cents, according to data compiled by Bloomberg.

The company’s “earnings power has taken a step upward,” said Richard Repetto, an analyst at Sandler O’Neill & Partners LP, in an e-mailed note. “It was a broad-based beat aided by general market conditions and ETFC’s conservative guidance,” he wrote, referring to E*Trade by its stock symbol. Repetto raised his 2013 profit estimate for the company by 35 percent to 62 cents a share.

Potential Buyers

Potential buyers of G1X include KCG Holdings Inc., Citadel LLC and UBS AG, according to James Angel, a finance professor at Georgetown University’s business school in Washington. Goldman Sachs Group Inc. is another potential suitor, said Javier Paz, a senior analyst at Aite Group LLC.

Sophie Sohn, a KCG spokeswoman, UBS’s Megan Stinson, Goldman Sachs’s Michael DuVally and Mike Geller, who represents Citadel at Edelman, declined to comment on whether the firms would consider buying G1X.

“Market making is a very thin-margin business with a risk of catastrophic losses like with Knight Capital Group,” Angel wrote in an e-mail.

Knight Capital reached the brink of bankruptcy in August after a computer malfunction caused it to lose more than $450 million on a single day through erroneous trades. Getco LLC then bought the company, creating KCG.

E*Trade’s board decided against pursuing a sale of the entire company in 2011. Earlier this year, it lost Chicago-based Citadel, the hedge-fund operator that bailed the company out in 2007, as a shareholder. Citadel runs its own market-making unit called Citadel Execution Services.

“Market making as of late has been doing pretty poorly,” Paz said in a phone interview from Salt Lake City. “It is a tough business all around for market making as markets are getting a little more wild and up and downs are harder to predict, and that impacts the results in this unit.”

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