Charles Schwab's $26 billion deal for TD Ameritrade is an aggressive play for size that was set in motion before brokers started slashing commissions

REUTERS/Elijah Nouvelage

Walt Bettinger, the chief executive of Charles Schwab.

• Charles Schwab said on Monday it plans to buy smaller rival TD Ameritrade in an all-stock deal valued at about $26 billion, ending days of speculation over a transaction that would remake the US discount brokerage landscape.
• We spoke with insiders and analysts about the factors that drove the firms together and how a combination could shake out.
• One Schwab employee told us they were suprised by media reports of deal talks late last week. Analysts had noted that smaller rival E-Trade was also seen as a logical takeover target.
• In a joint statement, Schwab and TD Ameritrade touted there would be some $2 billion in cost savings post merger. That would include cutting overlapping roles, as well as reducing real estate, administrative, and other spending.
• The deal was in the works before the two firms announced plans to eliminate online trading commissions last month, and scaling up business was a main driver, one source familiar with the matter told us.
• Visit BI Prime for more wealth management stories.

Charles Schwab ended days of speculation on Monday by announcing plans to buy smaller rival TD Ameritrade in an all-stock deal valued at around $26 billion.

That sets the stage for a mega-merger that would remake the US discount brokerage landscape, and comes after rapid-fire moves to slash commissions rocked the industry and fueled chatter that consolidation and cost-cutting would follow.

San Francisco-based Charles Schwab and Omaha-based TD Ameritrade, the two largest publicly-traded US discount brokerages and registered investment adviser (RIA) custodians, would together oversee some $5 trillion in assets. The firms plan to move headquarters to Schwab's campus in Westlake, Texas.

Business Insider spoke with insiders and analysts about the forces that pushed the companies together, and what to expect next.

Deal talks were underway before the two discount brokerages announced they would eliminated online trading commissions for US stocks and ETFs in October, a source familiar with the matter said, and scaling up amid the industry's fee pressure was a main driver.

Schwab looked to TD Ameritrade for its size relative to other players in the marketplace, that source said, adding the two firms would aim to be "client-friendly" as far as product pricing goes.

Schwab had been the first of the two to announce it was axing commissions, and TD Ameritrade quickly followed suit.

Charles Schwab, the founder of the eponymous firm who now serves as its chairman, had told Business Insider in an interview soon after the commission announcement that he had contemplated the move "for years." He said he had long been a "great fan" of Google, referring to the practice of offering one service for free and finding other ways to make revenue.

The growing popularity of commission-free stock-trading apps like Robinhood, which launched in 2013, have added to fierce competitive pressures in the industry. Other ways brokerages can bring in revenue include spreads on client cash accounts and margin loans, as well as selling customers' buy-and-sell orders to sophisticated high-frequency traders, a practice known as payment for order flow.

After media reports of deal talks on Thursday, analysts noted that E-Trade had been another firm investors viewed as a logical takeover target, given the takeout premium that was baked into its stock price.

Deal follows retail shakeup and layoffs at Schwab

Schwab has already had an eventful several months. Two key execs left its retail arm as part of a restructuring over the summer, and the firm in September said it would lay off some 600 people, blaming lower interest rates that created a "more challenging" operating environment. It's also moved to shutter its offices in Singapore and Australia.

Some Schwab employees that we talked to were uneasy about what might come of the merger since the two firms overlap in areas like technology systems, RIA offerings, and retail brokerage tools. Schwab also has to work through a planned acquisition of USAA's investment management assets announced in July, a $1.8 billion deal expected to close next year.

One employee, who was spared when Schwab announced layoffs and asked for anonymity because he was not authorized to speak to the press, said on Monday that he now has fresh concerns about his job security.

Another Schwab employee told us he and the rest of his colleagues found out about the deal on Monday when it was officially announced, and that the earlier deal talk reports that trickled out last week from CNBC and Fox Business came as a shock.

The Schwab-TD Ameritrade deal is expected to close during the second half of 2020, the companies said in a statement.

TD Ameritrade has meanwhile called off a chief executive search to replace CEO Tim Hockey, who said in July he would step down early next year. TD Ameritrade's CFO, Stephen Boyle, will serve as the firm's interim CEO and president.

Charles Schwab and TD Ameritrade representatives declined to comment for this story.

'On the offense'

Execs from Schwab and TD Ameritrade held a Q&A call after Monday's announcement, where analysts pressed for details on the timing of the decision, how combining the operations of the two firms would work, and what cost-cutting would look like in practice.

"We're on the offense," Charles Schwab's CEO Walt Bettinger told analysts. He added that Schwab is "an aggressive firm looking to continue to grow and serve more people."

The firms project potential cost savings of $1.8 billion to $2 billion, noting in a statement part of that would come from "elimination of overlapping and duplicative roles," and estimate they would also spend $1.6 billion in the three years after the deal closes on integration.

"There are some elements like branch consolidation and real estate decisions that we expect will be decided and achieved relatively quickly," Peter Crawford, Charles Schwab's chief financial officer, said on the call. "Other areas like systems and technology platforms will require work that will span longer timeframes."

Analysts also asked about how existing RIA relationships would be handled, but did not get much in the way of detail.

"I think all that remains to be determined. There may be some re-papering required," Bettinger said on the call, referring to RIAs moving clients onto different platforms and going through the associated paperwork. He added that it was "too early to have that level of detail."

The two firms also cater to slightly different groups of clients, which analysts said could further complicate an integration.

TD Ameritrade's RIA clientele caters to smaller books of business than Charles Schwab or Fidelity, noted Jennifer Butler, the director of brokerage research at industry intelligence firm Corporate Insight. Some choose to do business with TD Ameritrade because their account minimums are lower than that of other firms.

"Smaller RIAs may be concerned with the level of support they receive on Schwab's platform, or may even fear getting removed from the platform entirely," Butler told Business Insider in an email on Monday.

With fewer sources in the marketplace for RIAs to choose from, smaller firms in the custodian business like Apex and the start-up Altruist will now be competing on pricing, Butler said.

Thinkorswim, a tool TD Ameritrade offers active traders, is one advantage that TD Ameritrade brings to the table in the proposed merger, said Greg O'Gara, a senior research analyst with Aite Group, a research and consulting firm. He and other analysts noted the trading platform, which TD Ameritrade acquired a decade ago, has been popular with customers and proved a boon for the firm.

Credit Suisse served as a financial adviser to Charles Schwab, while PJT Partners and Sandler O'Neill + Partners served as financial advisers to TD Ameritrade, according to a joint statement from the companies.