Schwab Rebounds After CEO Retakes Helm
When Charles Schwab took the stage at his company’s annual shareholder meeting last year, he acknowledged that the firm he founded had “lost touch with our heritage” as the nation’s pioneer in discount stock trading.
No such statements were needed when he addressed shareholders at the gathering this month. The company’s stock Friday was trading at $16.85 up 49% from where it stood the year before. Its first-quarter earnings report showed a 68% jump from a year earlier.
“I firmly believe that Schwab is back on the right path,” Charles Schwab told the crowd at San Francisco’s Argus Hotel on May 18. “Our turnaround clearly signals the beginning of a second act for us.”
The reversal of fortune hasn’t been sudden, or painless. Charles Schwab Corp. was forced to revamp its business model and cut thousands of employees -- including David S. Pottruck, its chief executive who was Charles Schwab’s handpicked successor.
The payoff: a streamlined company that is better positioned to take advantage of renewed public interest in stock trading and investing.
“The growth prospects for Schwab are actually quite good,” said Michael Hecht, an analyst at Banc of America Securities in New York.
In an interview, Charles Schwab, 68, credited the turnaround to the company’s decision to reconnect with individual investors, where it initially made its mark.
“Schwab is back in a very competitive way in the individual investing world,” he said.
The company flourished in the 1990s bull market, as Americans poured money into stocks. And Schwab’s future appeared brighter than any other online broker as it began offering financial advice to affluent investors, a service with high profit margins.
But the 2000 bear market laid bare a variety of problems at Schwab, including its overreliance on stock trading. In addition, the company began offering a bewildering array of services and trading packages, ultimately confusing its longtime customers.
A key mistake was keeping trading commissions too high. While competitors were chopping prices to $10 or less, Schwab’s basic rate remained $29.95. That contributed to an exodus of customers, as Schwab lost 900,000 accounts from mid-2002 to November 2005.
“We lost our way a bit,” Schwab’s chief financial officer, Chris Dodds, said in an interview. “We had created an environment of over-complexity.”
Pottruck was pushed out in 2004, leading to Charles Schwab’s return as chief executive. He dumped business lines, slashed trading commissions and shed jobs. The workforce was cut from 26,300 in 2000 to 13,600 by mid-2005, and annual expenses were shaved by $1.2 billion.
Schwab kept the focus on financial advice, but simplified the offerings and refashioned the marketing efforts. A pricey new “Talk to Chuck” ad campaign emphasized the company’s rededication to small investors. The stock remains far off its 1999 peak of $51.67, but is up from $6.25 in early 2003. It closed Friday at $16.85, up 14.9% this year.
Its fortunes, of course, remain tethered to the market. Its recovery has been abetted by the current bull market and individuals’ return to stocks.
Many analysts believe that Schwab’s shares have become fully priced after their run-up, and say that the company must live up to its potential.
“While [Schwab] has gotten its house in order,” said Robert Hansen, an analyst at Standard & Poor’s Corp., its competitors “have grown larger and become more formidable.”
Competitors such as E-Trade Financial Corp. and TD Ameritrade Holding Corp. have bulked up through acquisitions and are pursuing similar strategies of trying to gather assets and serve the so-called mass affluent. E-Trade shares are up 16.7% on the year, closing Friday at $24.35. Ameritrade shares are down 25% on the year, closing Friday at $17.99.
Under its revamped structure, Schwab has accomplished its goal of reducing its reliance on stock trading. About 18% of Schwab’s revenue now comes from trading, down from two-thirds in 2000. Because of lower commissions, trading revenue climbed only 10% in the first quarter even though average daily trading jumped 44%.
Far more important to Schwab’s bottom line are asset management and other fees -- most from its huge mutual fund business -- which supply 48% of revenue. Although they fluctuate with the market, asset-based fees are steadier than trading commissions.
Thirty-one percent of revenue comes from customer interest payments for margin loans or mortgages taken out from Schwab’s bank.
Like other online brokers, some of Schwab’s gains are coming at the expense of customers.
A major trend in the online brokerage industry is to transfer customer cash holdings from “sweep” money-market funds into lower-yielding bank savings accounts. Customers earn lower interest rates while brokerages make bigger profits.
Throughout its troubles, Schwab has had a few factors going its way. One has been its ability to attract assets, which now total $1.3 trillion. Another is the strong performance of its institutional business, which provides services to independent financial planners.
Moving forward, analysts say, Schwab must begin by improving the performance of U.S. Trust, the money manager for the uber-wealthy that was acquired in 2000 but has been beset by weak growth rates and anemic profit margins. The unit’s first-quarter pretax operating margin was 17.2%, trailing the 45.6% margin for Schwab’s institutional unit and the 30.7% showing from its retail operation.
U.S. Trust has a new chief and is rolling out hedge funds and other alternative-investment products that are in high demand.
Beyond that, strong growth could come by deepening relationships with customers through higher-margin advice offerings.
The company has focused thus far on its wealthiest clients. Financial consultants offering individualized advice are automatically assigned to customers whose assets exceed $250,000. The attrition rate for that group has shriveled to 4%, compared with 15% for those without consultants.
Finally, the company is considering modified versions of personalized services for customers with less than $250,000, a huge portion of its customer base.
Schwab is testing a program that gives customers with growing assets telephone access to financial consultants. Also in testing is a “concierge” service in which Schwab employees would be assigned to help new customers understand product offerings and navigate the website.
“Our future is all about relationships,” Charles Schwab said at a meeting with analysts this month.
