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Ameritrade, E*Trade debate tools of the trade

Investors are watching eagerly as a battle of business plans erupts in the world of online finance at the two-day Pacific Crest 2000 e.conference in Colorado.

    VAIL, Colo.--Investors are watching eagerly as a battle of business plans erupts in the world of online finance.

    On one side is Ameritrade, an Omaha, Neb.-based retail brokerage that is focused almost exclusively on using the Internet to simplify investing for individuals.

    Ameritrade's mantra is "focused and deep," referring to its refusal to broaden its scope beyond online investing. Its goal is to overtake Charles Schwab as America's largest broker as measured by agency trades.

    On the other side is E*Trade, a Silicon Valley company that aspires to become a "financial services powerhouse" providing a broad array of banking services to a diverse swath of customers--even those who don't have Internet access at home or work.

    E*Trade offers automated stock, option and mutual fund order placement and may soon offer bill-payment and broad insurance services. It has 9,000 ATMs where customers can deposit and withdraw cash, and in early 2001 the company will begin a program that allows people to buy and sell stock through ATMs.

    The two companies are fierce rivals, despite their divergent strategies. At the two-day Pacific Crest 2000 e.conference today, senior executives from each company blasted the other's business model--though both refrained from specifically naming the other company.

    Ameritrade chief financial officer J. Randy MacDonald said brokerage firms that try to expand into broader financial services "spread management too thin." Giving telephone stock order specialists expertise on subjects such as insurance is expensive, he said, and the new market requires a boost in advertising expenditures.

    "You've weakened your brand?and you're easily displaced," MacDonald said. "We are laser-like in our focus. We are not worried about banking and mortgage."

    Not to be outdone, E*Trade executive vice president and CFO Len Purkis extolled the virtues of diversification. E*Trade now has deposit, insurance, loan and credit card offerings; soon it will add government-insured cash management accounts, business checking, consumer and business lending, expanded insurance and credit offerings, and a revamped bond center.

    The company already has 9,000 ATMs through a recent partnership, making its ATM reach broader than that of Wells Fargo, which has 6,300 machines, or Citigroup, which has 1,900. Eventually, the company hopes to transform into a "virtual credit union." Database software giant Oracle will be among the first companies to use E*Trade for such services, and next year, E*Trade ATMs will be installed in Oracle's headquarters in Redwood Shores, Calif.

    "We've never really been about delivering a cheap trade," Purkis told analysts at the conference. "We're about simplifying the financial decisions?so customers can anticipate and fulfill their financial needs."

    Despite the seemingly noble intentions of each company, it's unclear whether Ameritrade's online focus or E*Trade's diversification will ultimately become the business model of choice for the financial services sector. Wall Street is scrutinizing both companies to see which company, if either, can grow fastest and become profitable.

    "E*Trade gives customers multiple access points--the more access, the more customers," said Timothy Butler, senior research analyst at Pacific Crest. "But Ameritrade's focus on brokers has advantages. At this point, they're both leaders. It's just a matter of who can execute their strategy best."

    Their own financials
    Ameritrade's operating expenses are $10.27 per trade, compared with more than $20 per trade for E*Trade. But Ameritrade's focus and potential customer base is more limited than E*Trade's. Ameritrade must spend $222 to acquire each new customer, while E*Trade spends $286.

    It's hard to tell which company investors will favor in the long term. Shares of each have taken hits in recent weeks as investors lose enthusiasm for the sector.

    E*Trade shares gained 94 cents today to close at $16.31, well below their 52-week high of $40. Ameritrade shares climbed $1.06 to $14.69, about half their 52-week high of $31.

    Part of the slide is a result of Wall Street's skittishness for the entire tech sector, which has lingered since the second quarter. But Ameritrade and E*Trade have unique problems.

    Ameritrade announced last week that chief executive Tom Lewis would resign less than two months after assuming full responsibility as CEO. The company has been mum as to Lewis' departure, sparking concern among investors of more senior-level defections.

    Ameritrade's fiscal third-quarter earnings were down 48 percent from the same period in 1999 as the company increased the amount it spent on advertising by 238 percent year over year. The company earned $4.6 million, or 3 cents per share, compared with $8.9 million, or 5 cents per share, in the third quarter of 1999.

    Ameritrade has also taken heat for its Freetrade.com division, which allows traders with at least two years of investing experience to execute trades of at least $5,000 for free. Critics say the division will cannibalize the better known Ameritrade, which charges $8 per trade.

    E*Trade has also suffered blows to its reputation.

    Two people were arrested July 21 on charges of draining $1.5 million from credit card companies and online stock-trading accounts, including those at E*Trade. Apparently a young hacker used computers at a small community college in Texas to break into the accounts, sparking security concerns among other online investors about E*Trade's security.

    About two weeks later, E*Trade had to pay $61,000 to an irate investor after a power outage temporarily shut the site, causing E*Trade to book the customer's large order on a falling stock. An arbitrator determined that the customer canceled the order during the outage. E*Trade, which couldn't register the cancellation because of the outage, was found liable.

    Meanwhile, investors have backed away from the broader online brokerage niche. Analysts at tech-oriented investment bank Chase H&Q recently lowered revenue estimates for both Ameritrade and E*Trade. Since last spring, online trading volume dropped 20 percent to 33 percent.