Morgan Stanley's well-timed purchase gives ETrade new life

Morgan Stanley's acquisition of ETrade Financial Corp. is being interpreted as a reflection of the current state of the financial services industry, where fee pressures and regulatory fears continue to drive consolidation.

The $13 billion all-stock deal announced just three months after Charles Schwab Corp.'s $26 billion acquisition of TD Ameritrade Holding Corp., looks like another ripple from last fall’s wave of brokerages cutting their trading fees to zero.

But the pace at which the deal unfolded might also be tied to the surging strength of Vermont Sen. Bernie Sanders in the Democratic presidential primaries.

“This is about how to get away with a merger should Bernie Sanders have a chance at the presidency,” said Pauline Bell, an equity analyst at CRFA.

“The financial services industry is definitely ‘feeling the Bern,’ because they know they have to get these deals done and the window of opportunity is pretty tight,” she said.

Ms. Bell said she suspected a deal was imminent given regulatory filings a month ago that indicated increased payouts to ETrade executives in the event of an ownership change.

“Morgan Stanley jumped on this because they know they have to do it now,” she said. “When Schwab dropped fees to zero, they poisoned the well for everyone else, so the price point for ETrade is lower now than it would have been a year ago.”

In a conference call with analysts Thursday morning after the deal was announced, Morgan Stanley Chief Executive James Gorman didn’t specifically respond to questions about when talks about buying ETrade began, but the message was clear that negotiations were swift. “The more we looked at this, the more attractive it became,” he said.

In response to a question about buying a discount brokerage platform instead of building one, Mr. Gorman said, “We didn’t just buy a platform, there are millions of clients here. This takes us on a one-step leapfrog. We’re not messing around.”

In addition to its fledgling $20 billion RIA business, ETrade comes with 5.2 million client accounts and more than $360 billion in retail client assets. The deal, which is expected to close by the end of the year, will create a combined platform with $3.1 trillion in client assets, 8.2 million retail client relationships and accounts, and 4.6 million stock plan participants.

At first blush, the deal is being dubbed as more of the same in an industry seemingly drunk on consolidation.

“We see this as a continued validation of the financial services momentum toward greater consumer engagement, and ETrade brings that to Morgan Stanley,” said H. Adam Holt, chief executive of Asset-Map.

Allan Katz, owner of Comprehensive Wealth Management Group, attributed the deal to fee compression.

“I think this is a further step in the race to zero in regard to fees,” Mr. Katz said. “However, I also believe this is mainly cosmetic in the sense that nobody can operate for free. This will basically just give Morgan Stanley a way to market to people who are fee-adverse, and eventually try to switch them into accounts managed by financial advisers.”

Meanwhile, the referral potential for independent advisers now working through ETrade could dry up under the deal, according to Michael Kitces, director of wealth management at Pinnacle Advisory Group. Mr. Kitces was not available for an interview but referred to his comments on Twitter earlier in the day.

“For advisers, significance is that ETrade will no longer have referrals for large firms? And may not even remain a custodial RIA platform for small firms, which either way, won't likely want to affiliate with Morgan-Stanley-owned ETrade custody and its blatant channel conflict,” he posted.

During the call with analysts, Mr. Gorman referred to ETrade’s RIA business as “obviously interesting,” but said that it “wasn’t the primary motivator of the transaction.”

But Ms. Bell of CFRA said that even if ETrade’s RIA business wasn’t the main attraction, it can serve as part of Morgan Stanley’s efforts to expand its wealth management business.

“In this environment, bigger is better, and it’s less risky to go out and buy someone,” she said.

Morgan Stanley is also expected to capitalize on the 1.9 million stock purchase plan accounts that are serviced by ETrade.

“That’s the business line where they can still go after some fees,” Ms. Bell said. “Morgan Stanley really wanted ... the stock plan business; the RIA part is probably the icing on the cake.”

Then there’s the wallet potential of ETrade’s current customer accounts, which Morgan Stanley estimates to be around $3 trillion.

“Right now, ETrade only gets about 10% of its customers’ wallet share, but if this deal goes through there will be plenty of cross-selling opportunities,” Ms. Bell said.