Why Morgan Stanley Is Buying E*Trade (And How to Profit From Online Brokerage Buyouts)

Generally, when one large financial institution eats another one in a sudden takeover deal it’s a sign that things are going south economically. 

After all, when most people think of big financial mergers, they think of the chaotic series of Wall Street bankruptcies, mergers, and takeovers that heralded the 2008 financial crisis. 

But last week, one of the world’s largest banks, Morgan Stanley (NYSE: MS), announced a plan to take over one of the world’s largest online brokerages, E*Trade (NASDAQ: ETFC), for $13 billion. And this time, the reason for the mega-merger is a very good thing for investors. 

Morgan Stanley is buying E*Trade in the latest sweeping change to the brokerage industry. The deal comes just months after Charles Schwab (NYSE: SCHW) announced plans to merge with TD Ameritrade (NASDAQ: AMTD) in a $26 billion deal. 

Let’s take a look at why large online brokerages are merging or getting snapped up by banks — and how you can profit from this growing trend. 

Why Morgan Stanley Is Buying E*Trade for $13 Billion

These rapid changes in the online brokerage space are just one part of a larger trend in the financial services industry, a turn toward services that cater to smaller customers like individual retail investors. 

This trend has given rise to new innovations like the fractional share purchase programs offered by Fidelity, Robinhood, and Charles Schwab. 

Now one of Wall Street’s biggest investment banks is making its own effort to diversify beyond its underperforming advisory business for affluent and institutional clients — and into retail investing services for average Joe’s. 

Its purchase of E*Trade provides a perfect vehicle for this diversification, as 48% of the online brokerage’s customers are small, self-directed investors like you and me. 

CEO James Gorman spelled out Morgan Stanley’s thinking in a press release announcing the deal. “This [purchase of E*Trade] continues the decade-long transition of our firm to a more balance sheet light business mix, emphasizing more durable sources of revenue,” he said. 

Morgan Stanley’s push for smaller customers is a big part of the reason why this deal happened, but it’s also worth considering E*Trade’s motivations. After all, there’s another large trend in the financial services industry that is encouraging brokerages to find buyers… 

Online Brokerages Are Ditching Trading Commissions

Last October, I wrote about how Charles Schwab’s decision to get rid of online trading commissions would lead to similar moves throughout the online brokerage industry. 

The discount online brokerage, which is the oldest and largest firm of its kind, has transitioned to a business model based on revenues from mutual fund expense ratios and short-term lending. Thus, it doesn’t need to charge its customers a fee for each trade anymore.

But when it ditched the trading commission business model, it rendered its rivals (brokerages that do rely on commissions as primary sources of revenue) uncompetitive. 

In the wake of Schwab’s announcement, E*Trade, TD Ameritrade, and Interactive Brokers (NASDAQ: IBKR) all announced their own plans to cut commissions to zero in order to keep up. 

However, this business model was clearly unsustainable for these firms. Each one drew at least a third of its revenues from commissions at the time. 

In order to survive this major shift in the financial services world, brokerages like E*Trade need to find buyers with more robust business models — for example, a large investment bank like Morgan Stanley.

In summary, Morgan Stanley’s purchase of E*Trade is a win-win for the two firms, and it’s unlikely to be the last online brokerage buyout.  

The Next Online Brokerage Buyout? 

E*Trade shares shot up by about 24% on the merger announcement, while Morgan Stanley shares slumped by about 4%. This is par for the course when one publicly traded company buys another; the acquirer sees a dip in its share price while the target sees a boost. 

But the announcement had a dramatic effect on one other firm that isn’t involved in the deal: E*Trade rival Interactive Brokers. It saw shares rise 3% in the wake of Morgan Stanley’s announcement. 

That’s because, in the wake of the Schwab-TD merger and the Morgan Stanley-E*Trade buyout, Interactive Brokers is the last of its kind. It’s the last freestanding online brokerage firm, and it’s still facing the same zero-commission dilemma as the rest of the industry. 

With that in mind, it’s likely to receive its own acquisition bid in the coming months, and Wall Street is already pricing a takeover premium into its share price. 

All in all, investors are getting a sweet deal from the changes affecting the brokerage industry. Not only are we in the process of saying goodbye to trading commissions, we also have an opportunity to make a quick and easy gain on the next online brokerage buyout. 

Until next time,

Samuel Taube

Samuel Taube brings years of experience researching ETFs, cryptocurrencies, muni bonds, value stocks, and more to Wealth Daily. He has been writing for investment newsletters since 2013 and has penned articles accurately predicting financial market reactions to Brexit, the election of Donald Trump, and more. Samuel holds a degree in economics from the University of Maryland, and his investment approach focuses on finding undervalued assets at every point in the business cycle and then reaping big returns when they recover. To learn more about Samuel, click here.