Crazy like a fox--or just crazy?

What does Ameritrade CEO Joe Moglia know that his rivals don't? While other online brokerages are rushing to diversify, he's sticking with the online stock brokerage model. Here's why.

7 min read
Day trading may be so 1999, but don't tell that to Joe Moglia.

Moglia, the chief executive of Ameritrade, is placing a big bet on the revival of online stock trading. Bucking the conventional wisdom, Ameritrade agreed one week ago to buy rival brokerage Datek for nearly $1.3 billion in stock. The combination will result in the biggest online brokerage measured by equity trades per day, operating margins and growth in the number of accounts.

But here's the disconnect: With the stock market wilting and the number of trades per day falling off a cliff, Ameritrade rivals Charles Schwab and E*Trade are going in a different direction. Instead of focusing on online trading, each is steadily diversifying away from its core brokerage business into other areas, such as insurance, banking and mortgages. By contrast, the beefed-up Ameritrade will have little presence outside the stock market.

Ameritrade, which last fall acquired online brokerage National Discount Brokers, is acting very much the part of the contrarian. Yet Moglia describes it differently. In an interview with CNET News.com, he called it good business sense.

Q: Why did you decide to buy Datek?
A: From a client perspective, both Datek and ourselves have the fastest-growing account base in the industry, and it's not an accident that that happens to be the case. We both cater to the active investor. We both have guarantees on our execution qualities. We've got good trading tools, and, across the board, we have high customer satisfaction rates. If you combine the best of what they had with the best of what we have, we think that will just enhance the client experience.

And from the shareholders' perspective?
When you look at it from the shareholders' perspective, it is immediately accretive. It improves our balance sheet. Because both companies are pure-play models, there are a lot of excellent fits that take place relatively easily. We're very confident that we should be able to obtain at least $100 million in after-tax synergies. You can put whatever multiple you want to on that, and that obviously has a significant impact on our company.

What's the larger strategy here?
When you look at it from a strategic perspective, (the acquisition) does a nice job of positioning us in the industry. We'll be the number one broker-dealer in the industry in equity trades per day. We already had the highest operating margin in the business. The two firms together--if there was not $1 worth of synergies--our operating margin would still be around 30 percent. That's 25 percent or so higher than our next-closest competitor. With the synergies, we think we have a shot at getting around 50 percent.

Ameritrade paid about $1,500 per account for Datek. Is Datek worth what you paid for it?
When you're actually doing an acquisition, you've got to look at it a lot more holistically than that.

"You clearly don't need everything that currently exists at Ameritrade and currently exists at Datek."
We're buying their entire franchise. We're buying their products, we're buying their technology, we're buying their talent. Ameritrade has one of the more active account bases in the industry. Datek has an account base that does twice as much business on a per-client basis than what we do and probably three to four to five times what's done in the rest of the industry.

Plus, Datek's been profitable for the last three years. So you add all those things up and then add to that $100 million in after-tax synergies. From a business perspective, it's a bargain.

Will these "synergies" entail significant cutbacks after the merger?
Yeah. I think when you look at what it takes to run the combined company and you look at it in terms of marketing or advertising or technology or clearing or the call centers or human resources or administration or management, you clearly don't need everything that currently exists at Ameritrade and currently exists at Datek. We've estimated what it would cost to run those respective areas with both of the companies joined together. And that's how we come up with those numbers. There are certainly going to be cuts, but we haven't yet decided exactly where they come from. There will also be some job cuts associated with that.

By maintaining its focus on the online brokerage business and not diversifying, Ameritrade seems to be moving in the opposite direction of brokers such as Schwab and E*Trade. What do you know that they don't know?
I don't know if that's the case. I'm sure they know as much as we do and vice versa. I've been at Ameritrade for one year, but prior to this, I was at Merrill Lynch for 17 years. Merrill Lynch has a fairly sophisticated global, diversified model. So I have a pretty good understanding of the diversified model. They're just different business models.

When I asked both analysts and people in the media why they felt we needed to be more diversified, they would tell me that in difficult market environments, you need diversification to hedge your revenue stream. But history tells us a lot here. Over the span of the last 30 years or so, whenever there's been a prolonged downturn in the equity market, the financial services industry has always done poorly. It's always gone through some problems. And there have always been issues. That's been true for firms that have diversified models. And it's true for firms that don't have diversified models. So that argument doesn't necessarily hold up.

Aren't there benefits with a more diversified model?

"The vast majority of financial services companies in the United States offer full-service options...It's a model that may work with them, but it's not what we're trying to do."
I very much understand the benefits associated with a diversified model, but there's also some drawbacks that come with that. By definition, your technology has to be more complex, your infrastructure has to be more complex. By definition, your fixed costs have to be higher. By definition, you've got more complex regulatory issues. When you get into different lines of businesses, you also assume greater liabilities on your balance sheet. If you start to get involved with the international scene, all of these issues just get compounded by globalization.

Now, in a pure-play model, at least as far as we go, we know who we are and we know what we are good at. We have one platform. We have simple infrastructure. We have the number one operating margin in the industry. Because of that pure play, we're able to know what our priorities are. We can make decisions very quickly. Look at our track record. We are more profitable today in an environment that is far more difficult than the environment was last year, when it was very difficult. I'm not sure many firms can say that.

Schwab and E*Trade are moving toward offering more full-service brokerage options. Do you see Ameritrade doing this also?
No. That's the point of offering a pure play. The vast majority of financial services companies in the United States offer full-service options. They're in the wealth-management business. That's a very competitive landscape with high costs. It's a model that may work with them, but it's not what we're trying to do.

From an investment perspective, our customers make their decisions themselves. We allow them to do that at a price that's a good value. Full service is not where our strength is.

So when Mark Constant, who is the e-brokerage analyst at Lehman Bros., says that an online brokerage by itself is not a viable business, is he wrong?
Yeah. He is wrong. I think it is a scale business in a consolidating industry. So, for example, we have the capacity to do a quarter of a million trades a day without adding one nickel of expense. We could do double that with a minimal $5 million, $10 million in expenses. That's nothing to double our capacity.

Today, with Datek, we're going to do about 165,000 trades at this type of level in the marketplace. We can then increase our capacity by 350,000 trades a day without increasing our cost other than the variable piece. So our incremental variable cost is 15 percent, which says 85 percent of every incremental dollar in revenues we generate drops to our pre-tax line.

I don't know how you can understand those numbers and not say that's a viable business.

The New York Times called your acquisition of Datek a "contrarian bet." What do you think of that?
I actually read that article. The point to the contrarian piece was that because the markets in general are down, when you step up and buy, some people might call that a contrarian bet. All that to me is you're buying low. You want to buy low, you want to sell high. In the type of market environment that exists today, if you want to position yourself for greater market share in the future and sustainable long-term growth, it is in Ameritrade's best interests to be aggressive in the difficult markets so you reap that much more benefit when the cycle turns.

Are the day traders coming back? And how important is it to Ameritrade that they do?
In the next 10 to 15 years, I don't ever expect the activity levels to be anywhere near what they were three years ago. Now, if you look at the historical levels and you look at what's going on, it could be that the number of people trading online grows from about 20 million today to about 50 million over the next several years. What we're doing is we're building a platform now that offers a great value proposition and a reasonable return to shareholders. We have to be profitable in positive and negative cycles. And we've positioned ourselves to do that.

Do you see Ameritrade making more acquisitions in this space?
There's not that many more acquisitions out there--not of the quality of a Datek. I don't see us making any more like Datek.