Brokerage industry is evolving as it awaits return of the bull market


Stuart, a puckish young man, was once the unlikely symbol of stock investing in America.

His Ameritrade TV commercials of several years ago included one in which he photocopied his face for a party invitation, showed his boss how to trade online and then invited the boss to a party.

Stuart explained to an older generation that online trading was easy and loads of fun. But that fun part of buying stocks is missing in 2005, a year of lackluster returns and aftershocks from regulatory investigations, settlements and fines.

The full-service brokerage industry is busily repositioning for an eventual return of a bull market that will revive deal-making and trading in earnest. Meanwhile, low-commission online brokers with less business diversity are stymied by weak trading volume and looking to merge.

The industry structure is evolving, so expect change.

In a trend begun by Citigroup Inc., companies loaded with stockbrokers might spin off proprietary investments such as mutual funds to avoid possible conflicts that draw regulatory attention.

Sentimentality matters little. The venerable 70-year-old First Boston name on the investment banking unit of Credit Suisse Group was discarded in order to "unify" the company's identity.

Change affects not only how individuals buy investments, but investment firms themselves:

Ameritrade Holding Corp. is becoming TD Ameritrade by buying rival online trader TD Waterhouse from Toronto-Dominion Bank. It moves upscale, takes on a branch network and, with 239,000 daily trades, will lead in online volume.

Upscale? Looks like Stuart will never reappear.

Citigroup Inc., in a $3.7 billion transaction, is swapping its asset management businesses for the brokerage network of Legg Mason Inc. and stock.

Besides unloading its mutual funds, Citigroup draws closer to Merrill Lynch & Co. for having the most stockbrokers. That depends, of course, on how many Legg Mason brokers actually join Citigroup's Smith Barney brokerage unit.

Morgan Stanley, an investment banking superpower in turmoil since merging with retail brokerage Dean Witter, Discover & Co. in 1997, booted out divisive Chairman and Chief Executive Officer Philip J. Purcell.

The board rehired Purcell's rival, the charismatic John J. Mack, to stem employee defections and chart a new course for deal-making and brokerage services.

"Brokerage companies are some of the most exciting companies in the world and best investments, but the market too often views them solely as trading vehicles reacting to shifts in value of the Dow Jones industrial average," said Richard Bove, brokerage analyst with New York's Punk, Ziegel & Co. "Their product is money, and no economy in the world grows as rapidly as the money supply."

The drawback is the feast-or- famine nature of markets.

"You really have to look at investing in these companies with a long-term focus because it has been a long-term growth industry for decades," advised Jeffery Harte, brokerage analyst with Sandler O'Neill & Partners of New York. "The ride for the shareholder can be bumpy, but buy-and-hold works with brokerage industry stocks."

Bove and Harte recommend the stock of Morgan Stanley, a diversified firm that should benefit from improved leadership. It will fix problems in retail sales and credit-card operations, they believe, while going full speed ahead in securities underwriting and advice on mergers and acquisitions.

The discount-priced stock of Merrill Lynch, a firm rebounding from prior leadership's mistake of overexpanding into unfamiliar businesses and geographic locations, also is a Bove and Harte recommendation. This company, with a broad line of financial services such as mutual funds and insurance, should also excel in traditional investment banking and brokerage.

Bove likes familiar investment banking names Goldman Sachs Group Inc., Lehman Brothers Holdings Inc. and Bear, Stearns & Co. because they're quality, well-positioned companies with many product lines and services. Bear Stearns' price is particularly attractive, he said.

In the online industry, about 17.2 million U.S. households had online brokerage accounts at the end of 2004, an 11 percent gain over 2003, according to Jupiter Research. That's a lot, but trading volume is low.

"No one would be shocked to see another combination of online brokers down the road, giving some of the players breathing room and ensuring their stability and survival," said David Schatsky, senior vice president of research for New York-based Jupiter. "This is a highly competitive environment that will be offering more innovative planning and analysis tools."

According to Watchfire Inc., the top-ranked discount/online brokers in terms of function, ease of use, privacy and quality are: 1. Fidelity Investments; 2. Charles Schwab & Co. Inc.; 3. E*Trade Financial Corp. and Harrisdirect (tied); 5. Ameritrade Inc.; 6. WellsTrade (part of Wells Fargo Investments); 7. The Vanguard Group Inc.; 8. Cititrade (part of Citibank Investment Services), optionsXpress Inc., and TD Waterhouse (tied); 11. T. Rowe Price Investment Services; and 12. Merrill Lynch Direct.

E*Trade, whose offer to buy Ameritrade was rejected, will likely seek a partner in the next six months, predicted Tim Carpenter, senior analyst with the Watchfire consulting firm in Waltham, Mass. Discount broker Charles Schwab also might consider some type of consolidation, he said.

"The TD Waterhouse acquisition is significant because Ameritrade is taking on a large branch network that changes the entire business model of the merged companies," Carpenter said. "While Ameritrade for the past seven years had acquired large and small companies, including Datek, this represents a fundamental shift."

Andrew Leckey is a Tribune Media Services columnist.

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