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Morgan Stanley acquires E-Trade — Why this makes sense

A few weeks ago in January in Davos, James Gorman, the CEO of Morgan Stanley was interviewed by Bloomberg. The reporter noted that today everybody wants to go into wealth management, which Morgan Stanley did 10 years ago, and he asked whether Morgan Stanley had anything new up its sleeve. Little did Gorman say and little did anyone expect that one month later, Morgan Stanley would buy E-Trade.

About this article: Brokerchooser is the leading global broker comparison tool. We analyze and live test 58 online brokers globally, and counting. We understand the international brokerage industry very well. In this commentary, we would like to give our view on why Morgan Stanley’s E-Trade acquisition makes sense for Morgan Stanley. 

This article will be constantly updated over the next couple of days. Tell us what you think, write to us at [email protected]

We think there are three very clear reasons why Morgan Stanley acquired E-Trade. It is a capital-light business line, it can be used very well to serve affluent customers, and E-Trade helps to capture digital B2C know-how. Some analysts have already covered these points, but we go a little deeper. We explain how the stockbroker industry stacks up and how E-Trade's service differs from its peers. After an industry analysis, we will go against two mainstream opinions and claim that the acquisition is not because of Robinhood, a zero-commission broker, and the E-Trade acquisition is not a big bet, but experimentation. Lastly, we will give our most interesting take: what if the E-Trade acquisition is about to set the stage for digital international expansion?

Morgan Stanley acquires E-Trade
Three clear reasons why Morgan Stanley acquired E-Trade

There are three clear reasons for the E-Trade acquisition:

  • gaining a capital-light business line
  • targeting the mass affluent, and
  • capturing digitalization know-how

Let's go through these one by one.

 

Capital-light business lines

 

As a traditional Wall Street bank, Morgan Stanley has relied on serving institutional clients. Its sales and trading business lines in Institituionsal Securities have not just been struggling with declining revenues over the years, but are also very capital intensive.

Morgan Stanley acquires E-Trade - Wealth and Investment Management contribution

Source: Morgan Stanley

This is especially worrisome for Morgan Stanley, as it lacks the massive deposits of other big banks such as JP Morgan or Bank of America.

Morgan Stanley acquires E-Trade - Morgan Stanley and E-Trade client assets

Source: CNBC, Morgan Stanley to buy E-Trade for $13 billion in latest deal for online brokerage industry

Morgan Stanley took over Smith Barney from Citi in 2012, becoming the largest wealth management business in the world. This acquisition has been broadly regarded as a masterful deal, as it was the major driving force behind how Morgan Stanley ensured high ROE, surpassing its peers. The purchase of E-Trade, an online self-directed brokerage service, is a further step in moving into a business line that is capital-light and profitable.

 

Managing wealth and serving the affluent segment 

 

Global wealth is on the rise. It has been rising strongly and will continue to rise in the next few years. Wealth management traditionally focused on serving high net worth individuals, also known as "the rich". This made sense, as wealth is concentrated, and in wealth management, you earn money based on the amount of assets you manage. 

With wealth rising, the wealth of the mass affluent segment is also on the rise. Mass affluent refers to the higher end of the mass market, up to around $1 million in assets.

Morgan Stanley acquires E-Trade - 20% more affluent individuals

Source: BCG wealth management report 2019

Morgan Stanley acquires E-Trade - 6.2% CAGR rise in affluent wealth is expected

Source: BCG wealth management report 2019

However, this segment is extremely underserved. Plus, not just is it underserved, but the winning model on how to serve this client group is also unclear. Retail banks, private banks, insurance companies, and fintechs are all trying to figure out how to serve affluent customers — as are discount brokers, such as E-Trade. 

Morgan Stanley’s E-Trade purchase can be seen as a step in opening toward the affluent segment. 

 

Capturing digitalization know-how

 

The more clients you want to serve, the more digital you need to go. Top investment banks like Goldman Sachs or Morgan Stanley have very limited experience in serving a large number of clients through digital platforms. Banks with retail banking arms, like JP Morgan, definitely have more experience in this field. Did you know that JP Morgan launched Chase You Invest in 2018? Chase You Invest is a direct brokerage, providing commission-free trading, like Robinhood.

Going for direct access to retail customers is a strategic question for other investment banks and asset managers too. This is also why Goldman built Marcus, a low-cost online bank, from scratch. Blackrock invested in Scalable Capital, a European robo-advisor, also for the same reason: to have direct, digital access to the end-investor. 

Instead of building something from scratch, or buying a fintech in the scale-up phase, Morgan Stanley bought E-Trade as it has a good track record with large acquisitions; see the Citi wealth management acquisition from a decade ago. 

With E-Trade, Morgan Stanley will acquire a digital platform to communicate with and understand millions of customers. This could be a good way to stay ahead of big techs like Amazon, Apple or Google, who are also looking to enter the finance and wealth field.

To sum up, there are three clear reasons why Morgan Stanley is buying E-Trade: it is a capital-light business line, it helps to serve the affluent segment, and it captures digitalization know-how. These three reasons are clear and some analysts have already explained them in part. However, there are two other analyst narratives that we disagree with. One is that the acquisition is because of Robinhood, and the second is that E-Trade is a big bet. Before we dive into these points, let's take a deeper look at the brokerage industry and E-Trade in particular.

Morgan Stanley acquires E-Trade
The online brokerage industry is a diverse field

Online brokers serving self-directed traders have been regarded as a niche within the financial industry. Before 2016 and the rise of Robinhood, they were rarely featured in the news. So what is the industry landscape now?

 

The US broker market is very saturated

 

In the US, there are a couple of electronic trading platforms, which grew with the expansion of the internet. TD Ameritrade, E-Trade, Fidelity, Charles Schwab, and Vanguard are some examples. Some, most notably Charles Schwab and Vanguard, have a large network of financial advisors. Others, like E-Trade, mostly build on their electronic platform. 

Interactive Brokers has been broadly used by dedicated day-traders because of its very low trading fees. Professional traders also use NinjaTrader. 

Recently, some fintech startups started to offer zero-commission brokerage services. Most notable among them is Robinhood, but WeBull is also popular.

There are also niche players specialized by the asset class you can trade with. One good example is Tastyworks, which specializes in options trading. 

But this is not all. There are other players on the saturated market as well, such as Ally Invest, Firstrade, or SoFi Invest.  

 

A lot of European and Asian brokers offer forex and CFDs

 

Contrary to the US, in Europe, a lot of speculative clients trade with forex and CFDs, which are special derivates for retail clients. This market is even more saturated.

An interesting aspect of the brokerage industry is that even though its digital nature would allow global service models, most brokers operate on a mono-country model and only some serve clients from all over the world.

 

Are super apps a trend in the US?

 

In the US, most of the conversation is around Robinhood, its strong customer growth and its new business model.

In Europe, and especially in China, the discussion is around another phenomenon, the so-called "super-apps". Chinese investors trade on Wechat and Alipay, but these apps are far more than just trading apps. They are much more a tool through which you can live your entire digital life. In Europe, Revolut, a daily banking app with very strong growth, has also expanded its services to include stock trading. 

Morgan Stanley acquires E-Trade
E-Trade, TD Ameritrade and Robinhood

Let's take a closer look at how E-Trade compares to its US peers. 

E-Trade is very similar to TD Ameritrade and Charles Schwab

If we compare E-Trade with its two closest competitors, TD Ameritrade and Charles Schwab, we can see that the services they provide are very similar. All these major players offer commission-free stock and ETF trades. They also generally have different trading platforms for traders and investors. Lastly, their product range covers only the US markets and their added services, such as research tools and customer support, are high-quality.

E-Trade vs TD Ameritrade and Charles Schwab
  E-Trade TD Ameritrade Charles Schwab
Fees overview

Stock and ETF fees

$0

$0

$0

Mutual fund fees

$20 per trade

4,500 free mutual fund

$50 per trade

4,000 free mutual fund

$24.8 per trade

4,000 free mutual fund

Treasury bond fee

$0

$0

$0

Stock options fees

$0.65 per contract

$0.65 per contract

$0.65 per contract

Account opening and trading platforms

Time to open account (based on our test)

3+ days

1-3 days

1 day

Minimum to open an account

$500

$0

$0 for US clients

$25,000 for non-US clients

Platform for investors

Yes (E-Trade)

Yes (TD’s web platform)

Yes (Schwab.com)

Platform for traders

Yes (Power E-Trade)

Yes (Thinkorswim)

Yes (StreetSmart Edge)

Product portfolio

Provided asset classes

Stock, ETF, bond, mutual fund, options, futures

Stock, ETF, forex, bond, mutual fund, options, futures

Stock, ETF, bond, mutual fund, options, futures

# of portfolio services (like robo-advisory or managed portfolios) 

5

3

1

Quality of support services

Customer service rating (/5)

5

5

5

Research tools rating (/5)

5

5

5

Educational tools rating (/5)

4

5

3

Robinhood is better at targeting millennial investors than E-Trade

If we compare E-Trade with newcomer, mobile-first brokers such as Robinhood, we can see more differences: newcomers' main focus is on investors, account opening is easy and quick, but the quality of support services is low. Customer service is poor, and research and education services are basic.

E-Trade vs Robinhood
  E-Trade Robinhood

Targeted customers

Investors and traders

Only investors

Fee structure

Stock, ETF, and treasury bonds are commission-free

 

Other assets have a fee

All assets are commission-free

Time to open account & minimum deposit

3+ days

$500 minimum deposit

1 day

$0 minimum deposit

Provided asset classes

Stock, ETF, bond, mutual fund, options, futures

Stock, ETF, options, crypto

Managed portfolio / robo-advisory service available

Yes

No

Quality of support services

Great customer service

Great research tools 

Great educational tools

Poor customer service

OK research tools 

Poor educational tools

Morgan Stanley acquires E-Trade
The E-Trade acquisition is not a big bet and was not driven by Robinhood

As we discussed earlier, Morgan Stanley acquired E-Trade because it is a capital-light business line helping MS to serve affluents better and to capture more digital know-how. Beyond these reasons, analysts are pointing at Robinhood and the effect of its commission-free trading model on the market. Another theme is that the E-Trade acquisition is a big bet on the part of MS. We think both of these explanations are misleading. Commission-free trading is not the main reason behind the E-Trade deal and it is not a big bet, but an experimentation by MS.

Commission-free trading was not the main reason for the deal

A lot of commentary after Morgan Stanley’s E-Trade purchase has focused on Robinhood and the effects of its commission-free trading model on the market. This was an important factor in the current deal, but not the main reason why Morgan Stanley swooped in to buy E-Trade.

For sure, commissions have been a source of revenue for brokers, and any loss in revenues is a hit. But if you look at their revenue breakdowns, you see that commissions are just one factor, and not necessarily the most defining one within the top-line of brokers. 

Online brokers have three other revenue streams:

  1. Net interest income on client money.
  2. Selling order flow.
  3. Additional services, like premium accounts or paid research.

Brokers usually do not report the details of income from selling order flow and additional services. But, you do clearly see net interest income in their income statements. Looking at E-Trade's income statement it is clear that commissions are not its biggest source of revenue.

Morgan Stanley acquires E-Trade - Commission is not the main revenue

Source: E-Trade annual reports

In November 2019 E-Trade lowered its commissions to 0. So did TD Ameritrade and other a handful of other brokers. The question is, does this put a squeeze on online brokers? Based on a back-of-the-envelope calculation, it is clear that E-Trade will remain profitable in 2020 even if all commission income disappears. There is more to it. Net interest income means that brokers can earn interest on their clients' uninvested money. According to Bill Parker from Motley Fool Asset Management, E-Trade invests clients' idle cash into mortgage-backed securities. Morgan Stanley can opt to lend these funds to clients, which is a higher-margin business. Brokerchooser's top-down calculation shows that E-Trade can remain profitable on the same level even without commissions, if it manages to increase NII margins.

Morgan Stanley acquires E-Trade - Net interest income can offset impact of zero commission

Source: E-Trade annual report and BrokerChooser calculation

The E-Trade deal is not a big bet

The E-Trade acquisition is often interpreted by analysts in the media as a big bet on the part of Morgan Stanley. It is quite often compared to the 2012 Smith Barney deal. If you look at the current deal size, $13 billion, it is almost the same as the Smith Barney valuation, which was $13.5 billion. In that sense the two deals are similar. But the thing is, a 2012 valuation was done in a completely different business climate than the bullish valuation environment of 2020.

With the acquisition of Smith Barney, Morgan Stanley had the largest financial advisory business. Today, E-Trade is not the top player, and Morgan Stanley does not have a self-directed brokerage business E-Trade can be merged into.

In fact, E-Trade is a smaller deal than TD Ameritrade's acquisition by Charles Schwab in November 2019.

Morgan Stanley acquires E-Trade - E-Trade is smaller than TD Ameritrade

Source: E-Trade and TD Ameritrade annual reports

Charles Schwab did not just buy a larger online broker than Morgan Stanley, but there is also another aspect to it, the economies of scale. When Morgan Stanley acquired Citi's Smith Barney, a wealth management business, Morgan Stanley already had its own wealth management business. When Charles Schwab acquired TD Ameritrade, Charles Schwab had an online brokerage business. Morgan Stanley does not have an online brokerage business, hence merging the two companies cannot build on economies of scale. Instead, Morgan Stanley hopes to unleash synergies by cross-selling across client segments. This is of course harder.

The E-Trade acquisition is also interesting because E-Trade has not been growing organically over the last couple of years. Yes, customer numbers were growing, but mainly on the back of acquisitions, as E-Trade bought Capital One and TCA. If Morgan Stanley wanted a customer growth champion, Robinhood would have been the target.

Morgan Stanley acquires E-Trade - E-Trade customer growth mainly by acquisition

Source: E-Trade, BrokerChooser

Morgan Stanley did not buy the fastest-growing broker. Morgan Stanley did not buy the largest online broker and Morgan Stanley did not buy an online broker to build on the economies of scale. This is not a big bet, not a doubling down which Morgan Stanley already did before, but much more an experimentation. But experimentation for what? We think it might be international expansion. 

Morgan Stanley acquires E-Trade
E-Trade acquisition sets the stage for international expansion

If you read The Next Strategic Step in Our Transformation, Morgan Stanley’s press release of the E-Trade deal, carefully you will see that MS highlights 7 strategic rationales why they bought E-Trade. They provide details on all points, except one: let's see, which one might that be?

“Provides Opportunity for International Digital Wealth Platform” — is the lack of an explanation an oversight or is there more to it? If you are #1 in financial advisory in the US, how do you grow further? Could it be that Morgan Stanley regards E-Trade as a digital platform it can use to expand its business on an international level? In fact, even Morgan Stanley Chief Executive James Gorman said that he sees an opportunity in taking the newly acquired brokerage firm international again. Can this be done?

It’s safe to say that E-Trade’s business is US-focused. The company was founded in California, its current headquarters are in New York and it has 30 branches all over the US. E-Trade’s international business has only ever spread to the United Kingdom. Accounts for British residents used to be available until 2012 when the firm decided to focus on its core US operations. This move was made after its main competitors, TD Ameritrade and Charles Schwab did the same thing a few months before. Richard Repetto, a Sandler O’Neill + Partners analyst said that it was also a decision made to save money, as only a very small part of E-Trade’s revenue was coming from the UK branch. That was of course 2012.

The current champion of international expansion is Interactive Brokers. It is also a US-based online broker but has a much larger international presence than E-Trade. In fact, IB could be regarded as the most international business. It accommodates international clients and also covers multiple international markets. E-Trade allows account opening for US residents and for some international clients through a complicated paper-based process, while IB caters to customers on every continent. Trading through E-Trade is only possible on the US market, on exchanges like the NYSE and the NASDAQ. This is very limited coverage compared to Interactive Brokers, which covers 78 markets.

Can E-Trade, a very much US-focused digital platform be used to expand internationally? We think the answer is yes, this is the Interactive Brokers way. Can this digital platform be used to build a more international advisory service too? Only time will tell.

Author of this article

Tibor Bedő

Author of this article

Tibor believes having a good stockbroker is everybody's privilege. He worked extensively in the financial industry, including at Morgan Stanley and at The Boston Consulting Group (BCG). He advised leading European banks on strategy, finance and risk management.

Tibor Bedő

Co-founder, CEO

Tibor believes having a good stockbroker is everybody's privilege. He worked extensively in the financial industry, including at Morgan Stanley and at The Boston Consulting Group (BCG). He advised leading European banks on strategy, finance and risk management.

Everything you find on BrokerChooser is based on reliable data and unbiased information. We combine our 10+ years finance experience with readers feedback. Read more about our methodology

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