Most of the bulls have trotted meekly from the ring, but not James Marks.
Here at the bottom of the cycle there are still very profitable companies, said Mr. Marks, director of e-commerce equity research for Credit Suisse First Boston Corp. Even without cutting back on expenses, theyre very profitable, even in this horrible market.
Mr. Marks, a longtime analyst who is not known for contrarian views, is especially buoyant about online brokerage firms, which have recently been the subject of many dire predictions. Despite the job cuts and earnings disappointments at these companies and the decrease in trading activity that has accompanied the stock markets decline Mr. Marks sees only strength.
In his report on fourth-quarter performance, Mr. Marks asserted that online brokerages are weathering the Nasdaq storm with surprisingly strong results. Though the Nasdaq declined 33% in the fourth quarter, the online brokerages continued to gain accounts, and their transaction volumes rose 3.7% from the previous quarter. Customer assets at the 12 leading brokerages fell 11.7%, and revenues dropped just 0.6%. Moreover, most online brokerages generated premarketing operating margins of more than 25%, he said.
This silver-lining view is something of an anomaly. Some of Mr. Marks analyst colleagues are predicting the demise of at least a few brokers through consolidation. A front-page story above the fold in the Sunday New York Times March 4 had a picture of a woebegone Henry Blodget of Merrill Lynch & Co. as the poster child for brokers in distress.
Mr. Marks said a realistic outlook for online brokerages lies somewhere between the euphoria during Nasdaqs ascent and the pessimistic projections now that the technology-heavy market is in bear territory.
People were way too enthusiastic with these stocks when the market was soaring, creating levels of customer activity that clearly werent sustainable, and now theyre projecting the activity levels produced by a bear market indefinitely, he said. Neither of those is economic reality for these businesses.
But even Mr. Marks does not deny that the immediate outlook for online brokers is gloomy. Analysts have reduced earnings projections, and numerous firms have announced measures to cut costs, boost revenues, or bring in active traders as a buffer against the volatile market.
This month three brokerages have either announced or hinted at layoffs. Charles Schwab & Co. said Thursday that it will cut advertising spending and review staffing levels. Schwab, which has already reduced full-time staff by about 850 in the past two months through attrition, has reported a 32% decrease in average daily commission trades since February 2000.
CSFBdirect, the mostly online brokerage arm of Credit Suisse First Boston, said Wednesday that it would cut 150 jobs, or 10% of its work force at various call centers. The annual cost saving of about $11 million is expected to help the firm make up for decreased trading volume.
We have to take a hard look at whether we need to make some adjustments to our capacity, said Blake Darcy, CSFBdirects chief executive officer. Volume doesnt appear to be coming back the way wed hoped.
Two weeks ago, TD Waterhouse, a brokerage house mostly owned by Toronto-Dominion Bank, said it would reduce spending and cut an undisclosed number of jobs through attrition. A company spokesman would not say how many employees are expected to leave or how much the measures would save.
Ameritrade Holding Corp., which made layoff announcements in January, reduced revenue estimates for its fiscal second quarter, which ends March 30, to between $107 million and $126 million, down from the earlier estimate of $115 million to $138 million. Last month, in a bid to attract active traders, the brokerage announced a deal to buy TradeCast Ltd., which offers technology that allows for direct trades in the stock market.
Online brokerages also are facing increased competition from full-service brokerages that have online trading services as well as advice, a combination that may be more attractive to investors in a tumultuous market.
Full-service firms are becoming a threat, said Shalin Patel, a research analyst at Gomez Advisors Inc. They already have the advice element, and incorporating the transactional element is really helping these firms out. If you dont provide that advice, investors know whos offering it, and theyre going to move to other firms who are.
Some observers say that mergers among online brokerage firms are inevitable. Were going to see a significant wave of consolidation in the online broker sector, said Henry McVey, an analyst at Morgan Stanley Dean Witter. Theres too much capacity out there right now, and we think the leaders will take market share, even in a bumpy equity environment.
Mr. Marks said that though E-Trade, Ameritrade, and Datek Online Holdings could potentially be bought such deals are unlikely unless the stock prices of these companies languish at their current low levels for several months or rise enough to reduce the premium a buyer would have to pay.
In the meantime, he said, online brokerages could cushion the blow of a revenue squeeze by cutting marketing costs. Ameritrade spent 44% of its revenues in the fourth quarter on advertising, he said, compared with 6.6% for Schwab. And online brokerages can reduce their fixed costs more easily than traditional brokerages because they do not have the expensive analysts, bankers, and salespeople that full-service firms do, Mr. Marks said.
Thats a competitive weapon in their arsenal that theyre not using at the moment, he said. The next step for these companies is to ease up on the marketing spending so the stock market can see just how profitable the underlying companies are and to disassociate themselves from the less robust dot-com models with which theyve been lumped.
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