US online brokers bounce back

OF ALL the dotcom players, America's major online brokers have displayed a keen survival instinct in the face of extreme environmental stress.

In the past 18 months, online brokers have faced a stunning loss of market capital, shrunken trading volume, skittish retail investors, industry concentration and competition from the bulge-bracket investment houses.

Yet the top five online traders have managed to survive to the point where, rather than adding to the pile of dotbomb wreckage, they have become takeover targets themselves.

Datek Online Holdings, the fifth largest pure online trading company, was auctioned off this week and the bidding was so brisk that the eventual winner is expected to pay upwards of $1.4bn (£975m), 50% more than analysts thought Datek would fetch just a few months ago. Datek's customers are the committed online types, individuals who trade actively and are looking for fast execution at inexpensive prices.

The bidding included most of Datek's major rivals, anxious to add its 850,000-plus customer accounts to their own client bases. Details will not be known for several days because the bids are under seal, but E*Trade, Ameritrade and Toronto-Dominion Bank were involved in the bidding, analysts believe. There was even early interest from Bank of America and Wells Fargo.

Datek's auction comes when the environment for online traders is hardly hospitable. Trading volume industry-wide has plunged by more than 50% from its peak. During the first quarter of 2000, number one Charles Schwab's average online account traded 2.87 times but dropped to 1.21 by the last quarter of 2001. Ameritrade fell from 10.8 average trades per account in the heyday to three during the final period last year.

Datek is averaging about 83,000 trades a day, 55% fewer than during the peak years when retail investors went wild riding the bull market on Wall Street. Bear Stearns reckons online trading volume declined to 32% of retail trades during the fourth quarter of 2001, down from 35% a year earlier as the bricks-and-mortar brokers garnered back a slice of the retail trading pie they lost during the market peak in 1999 and 2000.

The online brokers' survival tactic in tough times is simple: improve technology to cut costs and provide better customer service while going after new customers through acquisition and internal growth, so that everything is in place once the market turns back up.

'There is a huge focus on account growth,' says Merrill Lynch analyst Sean Chin. 'The trick is to acquire accounts in an economically attractive way.' At $1.2bn, Datek's suitor would be paying a pricey $1400 per account. Schwab's market value is higher, about $2500 per account, but it caters to higher-end customers, has a full service discount broker and the largest online account base.

The willingness to bid up Datek is a big vote of confidence that Wall Street is expecting better days ahead.

One encouraging sign is that even as volume stays low, the number of investors signing up for online accounts grew to 19m at the end of last year, a gain of 1.6m.

The bigger online brokers have managed the difficult balance of cutting costs while improving customer service. Many, like Schwab, snapped up small, niche rivals at inexpensive prices when the market was at its weakest. A recent survey by Barron's Magazine found many have improved service and delivery techniques.

'The online brokers who have survived the latest round of consolidation are offering more and better services to investors,' said Barron's, which gave eight of the 22 services a high four-star rating.

Forget back to the future. America's big online brokers are looking forward to the past.