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What Schwab's TD Ameritrade Buyout Plan Means to Peers

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Charles Schwab (SCHW - Free Report) is in advanced talks to take over its biggest competitor TD Ameritrade Holding (AMTD - Free Report) . The news was first reported by CNBC, citing persons familiar with the matter.

Besides, the Financial Times noted the deal value at approximately $25 billon. In case the talks succeed, it will lead to the creation of a financial behemoth with combined client assets worth more than $5 trillion.

Nonetheless, the deal will require regulatory approvals, with all major agencies — the Securities and Exchange Commission, the Financial Industry Regulatory Authority, the Federal Reserve, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation —likely to have a say. 

Though the present finance sector regulations are not as stringent as they were but a deal as big as this is likely to face a fair share of regulatory and compliance issues. Further, as two of the biggest online brokers are involved, the transaction could face tough antitrust scrutiny.

Also, the expected merger is likely to hit the competitive position of the likes of E*Trade Financial , Fidelity Investments and Interactive Brokers (IBKR - Free Report) . Thus, while the shares of Schwab and TD Ameritrade climbed 7.3% and 16.9%, respectively, following this news, E*Trade tanked 9.3% and Interactive Brokers was down nearly 1%. Meanwhile, Fidelity Investments is not a listed company.

Need for Consolidation

At the time when the online broker industry is going through massive disruptions, the deal seems to be a way forward. It was only last month that all major industry players had begun offering commission free trading, with Schwab leading from the front.

Notably, while Schwab expected 3-4% adverse impact on quarterly net revenues from the move, for TD Ameritrade (generating about 25% of revenues from trading), it was likely to result in a 15-16% decline in quarterly revenues. (Read more: Online Brokers' Price War Likely to Affect Revenue Growth)

While investors at that time were concerned about the companies’ foregone trading fees (constituting a significant part of total revenues), performance data for October show a marked improvement in client assets for all. Schwab was the biggest gainer here, with the opening of 142,000 new brokerage accounts in a month’s time as retail investors took advantage of free trading service.

Apart from this, lower interest rates are building pressure on net interest margins and the near-term financial performance is expected to be weak. So, consolidation seems like an apt move to overcome the challenging operating backdrop and diversify revenues.

Moreover, last month, Schwab’s founder and Chairman Charles Schwab, while responding to a question in an interview with CNBC as to whether the company is mulling over the acquisition of any other brokerage firm, said, “Certainty at the right valuation, we would do it, but we are really strong and very independent the way we do things, and so if its happens that it’s appropriate for our shareholders we will do it.”

It looks like Schwab has found its match!

Nonetheless, consolidations are not going to stop here. More such deals are expected to be executed as competition intensifies amid a lower interest rate environment.

Of the online brokers mentioned above, Schwab and TD Ameritrade carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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