November 22, 2019

Breakingviews: Schwab-TD merger too appealing for its own good

by Breakingviews.

Some things are so inevitable it makes sense to get them over with. A month ago, that logic drove Charles Schwab and TD Ameritrade to drop commissions on bread-and-butter trades, temporarily wiping $12 billion off their market value. A merger of the two, floated by CNBC on Thursday, would add that much and possibly more. The catch is that it’s too appealing for its own good.

Mergers between brokerages tend to yield huge cost savings. That’s why this particular $80 billion combination has been tossed around for years. Activist investor Jana Partners back in 2007 tried to push TD into merging with Schwab, arguing it could unlock $1 billion of savings.

Today that number looks modest, measured against recent tie-ups. TD recently said it would buy the investment management bits of USAA, a financial firm for military personnel, and rip out 50% of the target’s expenses. Three years ago, TD bought Scottrade for $4 billion and sliced off 60% of its costs, recently saying it had reaped roughly $150 million in revenue synergies too. If Schwab could halve TD’s costs, it would squeeze out $1.5 billion a year.

That’s an opportunity, and a problem. It’s probably worth a lump sum of just over $11 billion after tax, enough in theory to pay a premium of 50% to TD. And that’s before revenue that may come from deploying a larger pool of customers’ cash balances cleverly. That, though, gives TD room to ask for a high price.

It certainly should. A Schwab deal would be somewhat opportunistic, since TD’s boss Tim Hockey is due to stand down by February. More importantly, TD has other options. A merger with the smaller E*Trade Financial, half TD’s size by market capitalization, would also create significant savings. Smaller brokerages which previously competed on price have a new reason to seek scale post haste. And an $80 billion merger would be a rag to Washington’s antitrust bulls – another reason for TD to demand danger money.

What’s clear is that mergers will happen one way or another. Brokerage firms face fierce competition dealt by everyone from JPMorgan to nimble upstarts like Robinhood. What Jana argued 12 years ago – that scale is better – still holds true now. The challenge won’t be explaining the benefits, but holding on to them.

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