E*Trade to Buy Harrisdirect as Industry Aims
To Offer Broader Array of Investment Service

By JEFF D. OPDYKE and JANE J. KIM
Staff Reporters of THE WALL STREET JOURNAL
Subscribe now to The Wall Street Journal and get up to 8 weeks FREE
August 9, 2005; Page D1

E*Trade Financial Corp., one of the largest players in the discount-brokerage industry, yesterday agreed to acquire rival Harrisdirect for $700 million. The move is part of an effort by online trading firms to offer investors a broader array of investment products.

The acquisition of Harrisdirect, a unit of Canada's Bank of Montreal, is the latest step toward consolidation in an industry whose fortunes have sagged in recent years as investors have pulled back from active trading. The deal, which is expected to be completed by next May, would leave only five major discount-brokerage firms.

All of the big players now have similar low-priced trading plans, and prices aren't expected to move much lower as a result of the Harrisdirect purchase. Yet the move represents another important step in the blurring of lines between traditional banks, full-service brokerage firms and their online counterparts. The online firms, which once aggressively courted day traders, are also increasingly targeting affluent investors.

The E*Trade deal comes on the heels of Ameritrade Holding Corp.'s agreement in June to buy TD Waterhouse, the online brokerage unit of Toronto's TD Bank Financial Group. That deal is expected to close later this year. Earlier, E*Trade had failed in its efforts to hook up with Ameritrade in a deal that would have made E*Trade the industry's largest online firm. The last major merger among discount-brokerage firms occurred when Ameritrade purchased Datek Online in 2002.

When the deal is completed, E*Trade will have more than four million customer accounts, generating about 130,000 trades a day. The firm also will have cumulative customer assets of about $130 billion.

E*Trade is betting that online brokerage customers are no longer focused solely on getting the lowest commission, but rather on what firm provides the broadest range of services and products. E*Trade in recent years has become the nation's ninth-largest savings bank and one of the largest online mortgage-origination services. E*Trade expects that of the $5 billion in cash that Harrisdirect customers will bring with them, $3 billion will be swept into E*Trade's online bank, increasing its banking assets by about 11%.

With Harrisdirect, E*Trade also gains access to customers whose average account balance is more than double what they maintain with E*Trade.

Getting consumers to open more accounts has become a key strategy, since it becomes harder for clients to defect if they have more money parked at the firm and if their brokerage and banking accounts are more tightly integrated. Ameritrade's proposed acquisition of TD Waterhouse, for example, gives it access to TD Waterhouse's branch network and the online broker's banking license. Earlier this year, Wells Fargo & Co. was one of the first major banks to link its online-trading commissions with its clients' bank balances by cutting trading costs for investors who hold at least $25,000 in combined balances at the bank. Charles Schwab Corp., meanwhile, has recently rolled out a new account in its two-year-old retail bank that lets customers move money between their checking and brokerage accounts.

Total assets in customer accounts at the major online discount-brokerage firms are estimated to be about $1.3 trillion, up from $617 billion at the end of 1998, according to SNL Financial, a Charlottesville, Va., research firm.

BRANCHING OUT

E*Trade's deal to buy fellow discount brokerage firm Harrisdirect highlights recent trends in the industry:
• Discount brokerages are expanding their reach by adding new banking products, such as mortgages and savings accounts.

• The firms are also stepping up efforts to introduce things like financial-advisory services and options and futures trading.

• The firms hope to attract higher-net-worth clients by offering a broad suite of products and better service.

The five major online brokerage firms left after the deal are Charles Schwab, Fidelity Investments, Ameritrade, E*Trade and the privately held Scottrade Inc. Beyond these, the size of the remaining firms "falls off pretty quickly," says Richard Herr, an analyst at Keefe, Bruyette & Woods.

In buying Harrisdirect's 430,000 active accounts and 300,000 inactive accounts, E*Trade expects to generate further cross-selling opportunities outside of the brokerage business. About 40% of E*Trade's current banking customers started as brokerage customers, and those with assets on deposit of between $50,000 and $100,000 tend to be the ones who have more than one financial relationship with the firm. Harrisdirect's customers have, on average, in excess of $70,000 per account.

Individual investors will get access to a broader range of products and services, says R. Jarrett Lilien, E*Trade's president and chief operating officer. Harrisdirect, for example, highly rated for its customer service, will bring some of those capabilities to E*Trade, while E*Trade, which expanded into banking with its acquisition of Telebanc Financial Corp. in 2000, is likely to offer a greater array of financial products, such as checking accounts, mortgages and credit cards, to Harrisdirect's customers.

As a combined firm, E*Trade expects to simplify its pricing structure for trades. Currently the firm prices equity trades at five different levels between $6.99 and $14.99 a trade. Mr. Lilien says the combined firm will go to two tiers, though he didn't say what those prices will be. Commissions at other discount-brokerage firms generally fall in the range of $5 to $15 a trade.

This industry diversification decreases the discount firms' reliance on online trading and commissions, which have been falling over the past several years as individual investors cut back on buying stock and returned to traditional brokerage firms or financial planners for professional guidance, or invested in the booming real-estate market.

Depending solely on stock trades for growth can be tenuous since the volumes will fluctuate along with the market, says Bill Cline, managing partner in Accenture Ltd.'s Capital Markets practice. The firms are seeking more diversification and more stable sources of revenue, he says. At E*Trade, for example, about 18% of revenue now comes from online trading, compared with 100% six years ago. Although there will be fewer players, investors are likely to still continue to benefit from lower trading costs.

Subscribe now to The Wall Street Journal and get up to 8 weeks FREE