The Wall Street Journal-20080130-E-Trade Tries a Super Bowl II
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E*Trade Tries a Super Bowl II
Full Text (962 words)E*Trade Financial Corp. has had its share of problems lately. You wouldn't know it from the online broker's plans to spend as much as $4 million for two ads airing during this weekend's Super Bowl.
The New York company is keeping the ads a closely guarded secret, but they are part of a push to restore E*Trade's image and stock price, both battered by the mortgage downturn. The Super Bowl distraction couldn't come at a better time.
Despite an 18% rally by the shares since E*Trade reported a $1.71 billion fourth-quarter loss last week, the stock has fallen 83% in the past 12 months. Many analysts and investors remain concerned about E*Trade's home-equity loans -- and the steep cost of dividends owed to Citadel Investment Group following a much-needed capital infusion from the hedge fund late last year.
"E*Trade is far from being out of the woods," wrote Goldman Sachs Group Inc. analyst William Tanona, who predicts the firm still may need additional capital. Prashant Bhatia, a Citigroup Inc. analyst known for his bearish stance on E*Trade, doesn't expect the company to return to profitability until 2010.
Most analysts are forecasting a return to profitability in 2009, and Bank of Montreal analyst Michael Vinciquerra believes management's steps to date are a "positive." E*Trade Chief Executive Officer Jarrett Lilien says the company should be back in the black this year and he doesn't believe E*Trade will have to raise more capital.
When Citadel injected $1.75 billion into E*Trade in November, giving the hedge fund nearly a 20% stake, optimists saw the move as a signal that the market might be bottoming. Since then, though, the investment looks like yet another losing bet by supposedly smart money in recent months.
E*Trade shares are down about 20% since the Citadel deal was announced. Billionaire Joseph Lewis amassed a 9.6% stake in Bear Stearns Cos. but has since seen the value of his holdings shrink by more than $100 million. Private-equity firm Warburg Pincus agreed in December to purchase $500 million of bond insurer MBIA Inc. stock at $31 a share. The stock is now trading at about $16.
The Citadel lifeline has been a drag on E*Trade's stock. E*Trade's agreement to pay a 12.5% return on senior debt issued to Citadel as part of the deal costs E*Trade about $200 million a year. In a recent report, DBRS Ltd. concluded that the deal adds "significant stress" to E*Trade. Standard & Poor's has denounced it as "unfavorable to existing shareholders."
Mr. Lilien staunchly defends the infusion from Citadel. "In November, we were dealing with a confidence crisis that led to a disruption of our customer base and loss of customer assets. We needed to do a deal to restore customer confidence," he said in an interview.
"The Citadel deal was the best one offered, and it did restore customer confidence and halted outflows. In that context, it was a good deal," Mr. Lilien said.
Todd Gjervold, a Citadel portfolio manager who oversees the E*Trade investment, said: "This is a turnaround story. The customer base is stable, the balance sheet is fortified, restructuring and the executive search are under way. These steps were immediate priorities, proactively addressed. As the company returns its focus to growing the core business, we remain bullish on E*Trade's prospects."
E*Trade's turnaround plan, announced in pieces during the past few months, also includes cost cuts of about $360 million out of an annual expense base estimated at $1.7 billion by Richard Repetto, an analyst with Sandler O'Neill & Partners. The brokerage firm recently canceled an off-site meeting for senior managers and is scrutinizing various operations for possible closure or sale.
At the same time, E*Trade will spend $85 million on growth initiatives, such as this weekend's Super Bowl ads. E*Trade hopes to end 2008 with close to $1 billion in excess bank capital.
E*Trade's trading franchise is healthy. In the fourth quarter, that business posted record profit of $789 million on record revenue of $1.8 billion, with a daily average of 214,000 revenue-generating trades -- another record high.
With its Super Bowl ads, E*Trade already has shown that it is a survivor. In 2001, E*Trade's chimp shed a tear for the Pets.com sock puppet -- a casualty of the post-dot-com wreckage.
But E*Trade is haunted by its decision in 2000 to plow deposits into making and buying mortgage loans. Under former CEO Mitch Caplan, E*Trade also began snapping up mortgage-backed securities. The move fueled years of strong revenue growth. But when cracks appeared in the mortgage market early last year, E*Trade suddenly found itself in trouble.
About 60% of E*Trade's $11.6 billion home-equity-loan portfolio is loans made in 2006 or 2007, when the housing boom was fading. In many cases, the value of homes connected to these loans has fallen below what the consumer purchased them for, leaving both the primary lender and E*Trade in a tough spot should the borrower default.
E*Trade expects to write down an additional $1.5 billion over the next three years on its mortgage holdings, with most of the damage coming from the home-equity portfolio. Overall, 4.3% of its home- equity loans are at least 30 days delinquent, up from 1.1% a year earlier.
E*Trade's fourth-quarter loss was worse than analysts expected. Mr. Repetto says the firm's woes have made it a takeover target, but any potential buyer would have to wrestle with the fate of E*Trade's banking unit, which houses the mortgage assets.
"If you separate the bank from the brokerage, you run the risk that the bank collapses," Mr. Repetto says.
Still, the rebound in E*Trade's share price since last week's earnings release suggests that the worst-case scenarios swirling around E*Trade are overdone so far.
"There is a good part to this story," says Mr. Lilien.
