Australia Markets open in 7 hrs 41 mins

Getting to unimaginable scale: Morning Brief

Myles Udland
Markets Reporter

Friday, November 22, 2019

Get the Morning Brief sent directly to your inbox every Monday to Friday by 6:30 a.m. ET. Subscribe

Trillions

Consolidation is coming to the discount brokerage industry.

On Thursday, reports indicated that Charles Schwab (SCHW) is in talks to acquire TD Ameritrade (AMTD) in a deal that would create a combined entity with $5 trillion in assets under management.

This would put the Schwab-Ameritrade NewCo's assets on par with Vanguard, about $2 trillion behind BlackRock, and ahead of rivals like Fidelity and State Street (STT).

Earlier this year, the brokerage industry gained renewed investor attention as just about every major player in the space cut fees on trades to $0. Previously, companies had charged nominal fees ranging from $4.95 to $9.95 to execute trades.

But as the race to $0 made obvious, these companies don't make money on the trades. They make money by having money.

At Schwab, for instance, 66% of net revenues in 2018 came from net interest expense. And while the Fed's four rate increases last year were a modest tailwind to this part of the business, the company was able to make more money by having more money. Average client assets at the end of last year totaled $3.4 trillion, up from a mere $2.6 trillion at the end of 2016. Buying TD Ameritrade and its $1.5 trillion in client assets means NewCo can generate more revenue from net interest. And net interest is most of the business.

And in a world where more assets are flowing to passively-managed (read:low-cost) investments and the non-professional investor class has shown limited interest in "playing the market," financial services firms are basically left to simply fight for assets.

Now, these companies do make money in other ways — fees charged by in-house investment products like ETFs and mutual funds and fees for offering advice are chief among them. TD Ameritade also did make about one-third of its revenue from trading. And as Bloomberg's Matt Levine noted Thursday, this reliance on trading have left TD shares in a rut and essentially allows Schwab to buy the company without having to pay the customary premium. Instead Schwab just has to pay what TD was worth a few months ago.

But the future of this business clearly seems to favor cash management. And why wouldn't it? The business is basically: you have money, you lend it out, you charge a small fee.

And the reason why cash management is likely the favored way forward for discount brokerages is because it is how these companies best leverage one of the decade’s biggest business themes — which is the advent of previously unimaginable scale.

The discount brokerage business is consolidating. (AP)

In a recent interview on the Invest Like The Best podcast, Spotify (SPOT) CEO Daniel Ek said digital, automation, and globalization trends have created a world where existing as a "scale" player means operating at "a much larger scale than most people would've ever imagined was even possible."

Social networks measure their users by the billions.

Asset mangers measure their assets by the trillions.

And while the economic environment, the interest rate environment, the regulatory environment, and investor preferences are just some of the factors challenging the brokerage business (and financial services broadly), the digitization of the asset management business offers opportunity through scale.

There's no reason to hire a salesforce that tries to sell dentists shares in a specific company when you can simply earn 10 or 15 basis points lending some of the dentist's money out without caring what investment decisions the dentist makes elsewhere.

And this new ability to execute against trillions of dollars worth of scale efficiently makes old approaches like upselling customers or pitching them on specific investments obsolete.

By Myles Udland, reporter and co-anchor of The Final Round. Follow him @MylesUdland

What to watch today

Economy

  • 9:45 a.m. ET: Markit US Services PMI, November preliminary (51.5 expected, 51.0 prior)

  • 9:45 a.m. ET: Markit US Manufacturing PMI, November preliminary (51.5 expected, 51.3 prior)

  • 9:45 a.m. ET: Markit US Composite PMI, November preliminary (50.9 prior);

  • 10 a.m. ET: University of Michigan Sentiment, November final (95.7 expected, 95.7 prior)

Earnings

Pre-market

  • 6:45 a.m. ET: Foot Locker (FL) is expected to report earnings of $1.07 per share on $1.94 billion in revenue

Read more

From Yahoo Finance

  • Correspondent Melody Hahm will be reporting live from the LA Auto Show. Watch our coverage throughout the day from 9 a.m. ET to 5 p.m. ET.

Top News

People take pictures of the newly unveiled all-electric battery-powered Tesla's Cybertruck at Tesla Design Center in Hawthorne, California on November 21, 2019. (Photo by FREDERIC J. BROWN / AFP) (Photo by FREDERIC J. BROWN/AFP via Getty Images)

Tesla reveals Cybertruck, its electric pickup [Yahoo Finance]

China's Xi says he wants to work out initial trade deal with U.S. [Reuters]

UK businesses slip into deepest downturn since 2016 [Reuters]

YAHOO FINANCE HIGHLIGHTS

Marijuana stocks see their best day of the year amid pro-legalization moves

Obamacare is working

Why you may get fewer emails after ordering on Amazon

Follow Yahoo Finance on Twitter, Facebook, Instagram, Flipboard, SmartNews, LinkedIn, YouTube, and reddit.