2HRS2GO: Market could catch up to e-brokers
Now is not the time to buy online brokerage stocks, says Sanford Bernstein & Co.
The New York-based investment firm restarted its coverage of the brokerage industry with "underperform" ratings for three well-known Web brokers: Charles Schwab, E*Trade Group and Knight-Trimark. Today's market doesn't care, judging by the upward movement of all three stocks. But the concerns of Sanford Bernstein analysts Steve Galbraith and Mary Medler are worth noting for anyone looking ahead.
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"While all may have robust long term business models, we are quite leery as we enter an upcoming period in which the high end will be test driving new value propositions while all players scream to raise share of voice," Galbraith and Medler write in a report released today.
Web trading is maturing, the analysts believe. As the market slows down -- most stocks continue to underperform the indices -- individual traders aren't likely to trade as much as before. Unfortunately, most online brokers continue to get most of their revenue from trading.
"Investors will increasingly focus on what the mature economics might be for the surviving players," say Galbraith and Medler. "In this sense, we suspect the Internet part of the analysis will become less important, while the financial services element of the equation becomes more relevant."
That's where traditional players such as Merrill Lynch, Morgan Stanley Dean Witter and their ilk hold an advantage, Sanford Bernstein's analysts believe. Conventional wisdom has held that Wall Street's Old Guard moves too slow and doesn't understand the Web. But their other businesses, such as investment banking, bring in enough money to subsidize their way long enough to build a Web audience.
Schwab, E*Trade and Knight-Trimark are e-trading leaders, but their advantages are eroding. Schwab used to offer the most robust content for its customers, but others now offer just as much at a cheaper price. E*Trade still relies too heavily on pure trading and it's getting less and less money from "marginal" customers. Knight-Trimark, the leading market maker for Web brokers, will see its margins hit hard because competition is coming hard and fast from electronic communication networks and other psuedo-exchanges.
Not that you'd want to write off those three completely, since they're certainly capable of adjusting. But now might be a good time to look elsewhere for awhile.
Nextel's blush fades
Poor Nextel. Who will dance with it now?
MCI Worldcom went for PCS and suddenly Nextel's Wall Street boosters find reasons to back away. After gaining on initial optimism that merger mania might spread, shares of the wireless service provider are down today as the market remembers that MCI Worldcom was considered the most likely buyer. Downgrades from ABN Amro and CIBC World Markets reinforced the pessimism.
"MCI Worldcom's acquisition of Sprint is a slight negative on the margin for Nextel," CIBC analyst Harvey Liu writes in a research note released this morning. "Not only did the merger eliminate a logical partner for Nextel, the merger also created a stronger competitor for Nextel."
While Liu did downgrade the stock, he still rates it a "buy" because business is growing rapidly. Nice to see fundamental analysis remains in the equation, but still depressing (though not surprising) to hear that some ratings are built on such soft ground.
The trend has been happening for quite awhile, but I still wonder: when did traditional Wall Street research to move from investment advice to mere trading tips? Ranking something based (even just partly) on its takeout potential doesn't seem to fit in fundamental analysis.
Liu now has an 18-month price target of $85 for Nextel. Although he still likes Nextel, he can't stop himself from expressing worries about merger difficulties; even his analysis of possible technology shortcomings are colored by takeover thoughts. "Lack of a migration path to third generation technology could be a sore issue for potential acquirors of Nextel," Liu says.
Specifically, Nextel's silence so far on high-speed wireless data plans could be a problem. It's a legitimate concern in and of itself, so there's no reason to frame it in acquisition terms. Let traders play their games; analysts have better things to do.
Other issues:
Lehman analyst Karl Keirstad worries about industrywide slowdowns affecting Computer Sciences, but CS First Boston's Mark Wolfenberger and Wayne Segal still believe CSC remains protected with its long-term contracts. "Essentially, CSC is tracking to meet our $9B FY00 rev est with six months of booking potential remaining and at least three $1B+ contracts in the pipe," Wolfenberger and Segal write. "An above average win rate should create incremental upside." 22GO>