Schwab to Buy Asset Manager U.S. Trust
Leading online brokerage Charles Schwab Corp. said Thursday that it would shell out $2.9 billion in stock to buy U.S. Trust Corp., a money management firm catering to affluent clients, in a deal that underscores Schwab’s strategy of taking direct aim at full-service brokerage rivals.
Amid a vibrant U.S. economy and 9-year-old bull market in stocks that have sharply boosted the ranks of wealthy Americans, the acquisition would bring Schwab a new stable of high-net-worth clients.
Just as important, the deal could help Schwab retain customers who were drawn to discount stock trading in their 30s and 40s but who have increasingly defected to other brokerages later in life because Schwab has lacked high-end financial services such as extensive trust and estate planning.
But the deal also appears to put Schwab in potential competition with some of the financial planners to whom it now refers many upscale clients.
U.S. Trust, with $86 billion in assets and 24 offices nationwide, isn’t coming cheap: Schwab agreed to swap 3.427 of its shares for each share of U.S. Trust, a 76% premium over U.S. Trust’s closing price Wednesday.
That premium reflects that U.S. Trust has been unwilling, until now, to entertain any takeover bids. The initial advances last summer by Schwab President David Pottruck--who has been a client of U.S. Trust for two years--were rejected.
But U.S. Trust Chairman H. Marshall Schwarz said he came to see the “complementary strengths” of the two companies.
Wall Street initially reacted negatively: Schwab stock fell 10% when the deal was announced early Thursday. But it closed up $2.88, or 8%, at $40.50 on the New York Stock Exchange.
U.S. Trust shares soared $54.13, or 69%, to $133.
The deal marks another step in Schwab’s transformation from a low-cost discount broker to one offering an amalgam of financial services that increasingly resembles what’s available at full-service firms such as Merrill Lynch and Morgan Stanley Dean Witter.
Schwab now faces threats from both cut-rate online-trading firms such as E-Trade Group and from Merrill and other full-service giants that have recently rolled out low-cost online trading.
Schwab has countered by boosting investment advisory services that once were anathema to discounters but that now are in high demand among aging baby boomers whose net worths have ballooned with U.S. prosperity.
“The way we lose clients more than any other is when clients need a level of service that is above what we can provide,” said Pottruck.
Schwab does not recommend individual stocks and lacks the research and investment banking arms of full-service rivals. But the firm is tiptoeing into those areas. It now gives customers access to investment research from two outside brokerages and has teamed with two other discounters to form an online investment bank.
The U.S. Trust deal “gives Schwab the capability to touch investors at every stage of their life [and] level of wealth, from first-time investors up to households with millions and millions of dollars,” said Greg Smith, an analyst at Hambrecht & Quist.
The number of U.S. households with $5 million or more in net worth is growing 25% a year, Pottruck said. The number with net worth of $1 million to $5 million is exploding at a 40% annual rate, he said.
Those households are the typical targets for U.S. Trust, whose services include individual investment management, trust and estate planning, private banking and family-business succession planning.
Four of U.S. Trust’s offices are in California: Los Angeles, Costa Mesa, San Francisco and Larkspur. The firm plans to open a Palo Alto office in spring.
Like this week’s proposed merger of America Online and Time Warner, the deal in some ways also highlights the convergence of new-economy and old-line companies.
New York-based U.S. Trust was founded in 1853 and is the quintessential blue-blood Wall Street firm catering to the wealthy.
San Francisco-based Schwab, by contrast, was born in 1971 and has ridden the do-it-yourself investing ethos of the ‘80s and ‘90s to become the dominant discount broker.
Including investment assets managed by financial planners and housed at Schwab, the firm’s assets top $725 billion.
Those planners, however, may now be fearful that Schwab is aiming directly at them. However, Schwab has insisted in the past that any additional services it offers to high-end clients are meant to complement what independent financial advisors offer, or aren’t in competition at all with them.
Like the AOL-Time Warner deal, the blending of the two financial firms also raises questions about stock valuation.
Schwab’s stock is significantly off the highs that it and other online brokers hit in April amid investor enthusiasm over Internet-related stocks.
Nevertheless, Schwab is far more richly valued than its full-service brethren. Its stock price-to-earnings ratio is 50 based on estimated 2000 earnings, far above Merrill Lynch’s P/E of 14.
U.S. Trust’s 2000 P/E before the deal was announced was 19.
Also as in the case of AOL-Time Warner, Schwab “runs the risk of doing the right thing for the long-term future of the company, but risks from a valuation perspective some of the Internet valuation that’s embedded in their stock price,” said Richard Repetto, a Lehman Bros. analyst.
One big difference between the two deals however, is that U.S. Trust is far smaller than Schwab, whereas Time Warner is three times larger than AOL.
Schwab earned $418 million in the nine months ended Sept. 30, on revenue of $2.8 billion. U.S. Trust earned $57.4 million on revenue of $395 million in the same period.
Despite the stock dilution involved in the deal, Schwab said it expects the merger to add to its net earnings in the first year.
The Schwab-U.S. Trust deal is the first major merger announced since the repeal of Depression-era banking laws that largely barred the union of companies in differing fields of financial services. The merger would have been allowed under the old laws but is made easier by the repeal, a Schwab spokesman said.
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Aiming for the Affluent
Brokerage Charles Schwab Corp.’s planned purchase of U.S. Trust Corp., which caters specifically to upscale clients, marks another major move by Schwab to go after the well-heeled customers of such brokerage rivals as Merrill Lynch and Salomon Smith Barney. The affluent-family market is growing at a brisk pace, thanks in part to the long bull market in stocks.
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Sources: Salomon Smith Barney, Charles Schwab, Bloomberg News
