As legal and regulatory concerns stay front and center for those leading the planned $26 billion merger of Charles Schwab and TD Ameritrade, one analyst says the deal should move forward.
“We believe the merger is more likely than not to occur and currently incorporate a 75% probability of its going through in our valuation model,” said Michael Wong, Morningstar’s director of equity research for financial services, in a recent report.
A big hurdle could be removed Thursday when TD Ameritrade shareholders vote to support or reject the deal. If two-thirds vote in favor, it would supersede a lawsuit against the transaction that argues Schwab became an “interested stockholder,” as defined by a Delaware law, in its merger target before its board approved and went public with the news of the deal.
Schwab disagrees with this argument but says if a court in Delaware rules against it, TD Ameritrade cannot merge with it for three years since the time it “became an interested shareholder.”
This legal challenge, though, can be superseded if “the business combination is approved by the TD Ameritrade board of directors and authorized by the TD Ameritrade stockholders by the affirmative vote of at least 66 2/3% of the outstanding TD Ameritrade common stock,” Schwab said in a recent filing.
Separately, Schwab said it updated and amended a prospectus and proxy statement in order to put to rest eight other lawsuits concerning an “incomplete and misleading registration statement.”
“TD Ameritrade and Schwab believe that no further disclosure is required to supplement the definitive joint proxy statement/prospectus under applicable law,” the two firms said.
“However, to avoid the risk that the lawsuits may delay or otherwise affect the consummation of the merger and to minimize the expense and distraction of defending such actions, TD Ameritrade wishes to voluntarily make the supplemental disclosures related to the merger,” the amended proxy stated.
Morningstar’s Wong says he doesn’t have great antitrust concerns when it comes to uniting the two retail online brokerage businesses, since “there are many online brokerage companies and the space is very competitive.”
When it comes to the RIA business, though, the combined firm might have more than a 40% market share by assets, he points out.
Still, Wong adds, given the variety of wealth management firms today, the research firm estimates the combined companies’ market share of these assets “is probably only a mid- to high-single-digit percentage.”
More Competitive Issues
With the 10-year U.S. Treasury yield below 1%, Schwab’s net interest income is “likely to remain constrained … for a couple of years,” Wong points out.
In addition, about 30% of its net revenue is tied to asset management and administration fees. While Schwab has been adding more products and services, “these offerings have experienced pressures on pricing” throughout the industry, the researcher adds.
But, Wong said: “Given its massive scale and industry-leading cost efficiency, we believe Schwab can sustain severe competitive pressures, such as trading revenue dropping to $0, and still earn above its cost of capital.”
The firm’s “low costs and large client base also give it the flexibility to create products offering a value proposition that is comparable or superior to that of peers and that can ramp quickly,” he added.
Morningstar estimates that a “double-digit percentage of the company’s client assets are in a Schwab-branded proprietary product or advice solution.”
Overall, the research firm doesn’t have significant concerns about Schwab’s financial health and is generally upbeat on the merger, viewing the firm as having a “wide moat,” or sustainable competitive advantage over its rivals.
“Not only does it create an industry leader in retail brokerage, but it creates a leader in the overall financial sector,” Wong said, by cementing Schwab’s position as a key industry player “as the lines between industries such as traditional banks, wealth management, and retail brokerages are blurring.”
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