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Schwab's Buyout of TD Ameritrade to Shake Up Online Brokerage

Zacks Equity Research

Charles Schwab SCHW has inked an all-stock deal to acquire TD Ameritrade Holding AMTD for roughly $26 billion. This will create a behemoth in online brokerage space with combined client assets worth more than $5 trillion and serving nearly 24 million brokerage accounts.

Schwab President and CEO Walt Bettinger said, “With this transaction, we will capitalize on the unique opportunity to build a firm with the soul of a challenger and the resources of a large financial services institution that will be uniquely positioned to serve the investment, trading and wealth management needs of investors across every phase of their financial journeys.”

Exchange Ratio, New Headquarter & Other Details

Under the deal terms, shareholders of TD Ameritrade will receive 1.0837 Schwab shares for each TD Ameritrade share. This represents a 17% premium over the 30-day volume weighted average price exchange ratio as of Nov 20, 2019.

The transaction, still subject to regulatory approvals and consent of shareholders of both the companies, is expected to close in the second half of 2020. The integration process will start immediately thereafter, which is likely to take around 18-36 months.

As part of this process, the combined company’s headquarter will be shifted to Westlake, TX from Schwab’s current base in San Francisco. Nearly $1.6 billion charge related to the integration is expected to be incurred over three years after closing.

The deal has been approved by the board of directors of both the companies as well as the Strategic Development Committee of TD Ameritrade’s board (formed to supervise and conduct the process and all negotiations concerning the transaction).

Following the deal closure, The Toronto-Dominion Bank TD, which has nearly 43% stake in TD Ameritrade at present, is likely to have an ownership position of roughly 13% in the combined company. Other TD Ameritrade stockholders and existing Schwab stockholders will hold approximately 18% and 69% stake, respectively.

Moreover, TD Bank will have two new seats on the combined company’s board, while TD Ameritrade will have one.

Further, TD Ameritrade has halted previously announce process of searching for new CEO and named Stephen Boyle, the company’s EVP and CFO, as interim President and CEO.

Accretive to Earnings, Cost Synergies

The deal is expected to result in substantial strategic benefits for the combined firm. Also, clients of both Schwab and TD Ameritrade will benefit from enhancement of “investing and trading experience.”

Boyle said, “Partnering with Schwab on this transformative opportunity makes the right strategic and financial sense for TD Ameritrade.”

The deal is expected to be single digit percentage accretive to operating cash earnings in the first-year post closing and 15-20% accretive in the third year. Further, it is projected to be 10-15% accretive to GAAP earnings in the third year, post completion.

Also, the deal is estimated to result in $3.5-$4.0 billion in total synergies. This will be mainly derived from expense savings and the Insured Deposit Account renegotiation transaction between Schwab and TD Bank.

On cost front, the current projection is for nearly $1.8-$2 billion run rate expense synergies, representing about 18-20% of combined company’s cost base. A part of this synergy is expected to be realized from “elimination of overlapping and duplicative roles.”

More synergies are likely to be generated through real estate, administrative and other savings. Nonetheless, no details related to these were provided at present.

Overall, all these are anticipated to reduce operating expenses as a percentage of client assets and help further diversify revenues. Notably, the deal is expected to increase percentage of trading related fees to total revenues to about 19% from nearly 9% for Schwab at present.

Our Take

A deal as big as this is likely to face a fair share of hurdles. Further, as two of the biggest online brokers are involved, the transaction could face tough antitrust scrutiny. The transaction is likely to hit the competitive position of the likes of E*Trade Financial ETFC, Fidelity Investments and Interactive Brokers.

Nonetheless, Bettinger downplayed the antitrust risks for the deal. In the conference call following the announcement, he said, “We have numerous competitors, many of which are far larger than us today and far larger than a combined organization. They’re going to continue to come right after us, as they are now in all aspects of the business.”

Further, investors seem to be bullish on the announcement. Shares of both the companies have been rallying since last week when the news related to deal talks hit the markets. Shares of Schwab and TD Ameritrade are up 10.2% and 25.1% since then.

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. This are expected to hurt the companies trading fees. (Read more: Online Brokers' Price War Likely to Affect Revenue Growth)

This, coupled with lower interest rates, will continue to put strain on net interest margins. So, consolidation seems like an apt move to overcome the challenging operating backdrop and diversify revenues.

Earlier in July, Schwab had announced a deal to acquire certain assets of USAA’s Investment Management Company, including brokerage and managed portfolio accounts. The all-cash deal, valued at $1.8 billion (to be funded by available corporate cash), is expected close in 2020.

Currently, both 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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