The trend of financial technology roll-ups that hit credit card processors is now hitting brokers, as Charles Schwab (NYSE:SCHW) makes a bid for TD Ameritrade (NASDAQ:AMTD).
The bid, for a reported $26 billion, sent TD Ameritrade shares up 17%, slightly over the bid price. It means Schwab itself, with a market capitalization of $61.7 billion, could be in the crosshairs.
The catalyst is said to be Schwab’s move to eliminate commissions on common stock trades. The October decision sent TD Ameritrade stock down by nearly one-third. The bid price is near where AMTD stood prior to slashing commissions.
But the Schwab bid didn’t come out of the blue. It was prompted by competition from a smaller fintech, Robinhood. It launched no-fee trading in 2013 and was valued at $7.6 billion in its latest funding round.
The Debt, The Debt, The Debt
The problem for Charles Schwab and for all brokers is technology debt, the same force driving credit card processors together to compete with Square (NYSE:SQ).
Once a technological solution is put in place, a company immediately starts accumulating technology debt, as new and cheaper solutions become possible. Robinhood is built on the Amazon (NASDAQ:AMZN) AWS cloud, while older brokerages were built on mainframes.
Assuming the deal gets done, Schwab and Ameritrade face the task of integrating disparate hardware operations, software teams and tools. Only their larger scales will let them do this. Schwab has also been gearing up to allow the purchase of fractional shares, which is expected to be a challenge to the mutual fund industry.
Schwab’s elimination of trading fees brought it 142,000 new accounts in October alone. Another big surge is expected early next year, when Schwab takes on 11 million brokerage accounts from USAA, a privately owned organization. That deal also brings $7 billion of cash on which Schwab will pay much less than USAA was offering. It’s small spreads on cash balances, and other fees earned from just handling money, that make up for the elimination of commissions.
Should You Buy Schwab Stock?
Schwab was founded in 1971 and TD Ameritrade four years later. Schwab spent a reported $313 million in advertising last year. TD Ameritrade was reported to be spending $62 million per quarter on ads three years ago. Together they probably represent $2 billion in ad billings. Some of that money, along with management savings, can help offset system integration costs.
Schwab brings in $10 billion of revenue each year and Ameritrade about $5.8 billion. Together they reported net income of $5.8 billion last year. This may be why Schwab stock also popped, by over 7%, once its bid was announced. E*Trade (NASDAQ:ETFC), on the other hand, dropped by 9%.
Consolidation could continue if larger financial players decide to come in. The big banks, Bank of America (NYSE:BAC), JPMorgan Chase (NYSE:JPM), Wells Fargo (NYSE:WFC) and Citigroup (NYSE:C), all do brokerage, and their systems are now as automated as the discounters. The merger mania, in other words, may have just begun.
The Bottom Line on Charles Schwab and TD Ameritrade
The cost of bringing financial transaction processing from the mainframe era into the cloud era is enormous. For companies to survive, they must do it at scale, so the costs are spread out across giant balances and transaction volumes.
That’s why the rise of fintech has caused a merger mania across the financial landscape. Robinhood has been trying to obtain a bank charter, but various technology missteps have so far kept it out.
Once it does get such a charter, expect banks to start merging the way the credit card processors and brokerages are.
Dana Blankenhorn is a financial and technology journalist. He is the author of the environmental story, Bridget O’Flynn and the Bear, available at the Amazon Kindle store. Write him at danablankenhorn@gmail.com or follow him on Twitter at @danablankenhorn. As of this writing he owned shares in SCHW, AMZN and JPM.
