Charles Schwab plans to acquire TD Ameritrade in a $26 billion, all-stock deal, the companies announced Monday, as the brokerage giants dramatically change a business model that has been crushed by the race to zero commissions.
The tie-up of the brokerage companies, which helped revolutionize stock trading by making it affordable and easy for the masses, reflects the shift from a commission-heavy revenue stream to one more reliant on interest income and other client services.
“These companies have figured out other ways to make money,” said Jeffrey DeMaso, director of research at Adviser Investments. “Commissions simply weren’t as big a piece of Schwab’s business and revenue. By going to zero, they weren’t giving up much. But everyone else had to follow them. In the short term, it looks like a savvy competitive move by Schwab. Longer term, we’ll see.”
The combined company would have assets north of $5 trillion.
“This would create a Goliath in wealth management,” wrote Wells Fargo’s Mike Mayo in an analyst note.
San Francisco-based Schwab, the bigger of the two, is as much a bank as it is a brokerage. It manages more than $3.85 trillion in client assets, has a workforce of 19,500 and a market cap of $60 billion. It makes most of its money—around 57 percent—from interest on the uninvested cash that people leave in their accounts. Schwab invests that money at a higher return than it pays its clients. It is expected to earn more than $3 billion in 2019 on more than $10 billion in revenue.
Omaha-based TD Ameritrade is a $26.2 billion company with more than $1.3 trillion in assets. It projected earning of $2 billion on more than $5 billion in revenue in 2019.
The acquisition comes as financial management companies, from mutual fund giants like Fidelity Investments to Schwab and Ameritrade, scramble to gain client share and assets by offering free trades. The competition has been heightened by retail investors choosing low- and zero-cost index funds and leaving the stock-picking market.
Morningstar’s Michael Wong wrote in an analyst note that Schwab has a much more vertically integrated business model, as it both manufactures and distributes financial products through its asset management business. Ameritrade doesn’t have as much exposure to proprietary financial products, Wong wrote, so there would be an upside for the merged company if Ameritrade’s customer base started to use Schwab’s products, like its exchange-traded funds.
But the deal could bring its own set of hurdles, Wong wrote. That includes the risk of antitrust—a combined company with $5 trillion of assets would be significantly larger than its publicly traded peer E-Trade, which has about $500 billion of client assets. Still, Wong noted, other rivals like Fidelity, Vanguard, Bank of America and Bank of New York Mellon manage client assets from hundreds of billions to trillions of dollars.
In August 2018, Fidelity announced that it was launching two zero-cost index mutual funds, escalating a price battle that could leave investors questioning whether to pay mutual fund management fees at all. Brokerages have followed suit. Online brokerage E-Trade last month eliminated commissions on client trades. And Interactive Brokers Group recently began a new service called IBKR Lite, which also eliminated commissions for US-listed stocks and ETFs.
“In a market experiencing significant contraction in fees and commissions, the merger makes a lot of sense,” said David Poppe, former chief executive of investment firm Ruane, Cunniff & Goldfarb who owns Schwab shares in a personal account. “The combined company would get scale leverage on technology investments, public company costs and the back office, and would be able to exert even more pricing pressure on the rest of the industry.”
“Schwab also earns better spreads on customers’ cash balances than Ameritrade, so should be able to earn quite a bit more money on cash balances than Ameritrade does,” Poppe said. “It seems like a very smart combination.”