Since I published my last post about AMTD, I have received an earful from many Ameritrade’s clients who have been burnt by auction rate securites (ARS). Let me be clear from the start : I am embarrassed that I have committed a factual error in my last post. Ameritrade did indeed actively solicit ARS investments from its clients. As a result, Ameritrade, along with all other major brokerage firms including Charles Schwab, E-Trade, Fidelity and Oppenheimer, are all in settlement talks with the SEC regarding the ARS issue. For this omission, I apologize.
Nonetheless, I stand by the conclusion of my original post, which is that AMTD will gain in market share and absolute client base through this recession, and will emerge an even stronger player in the brokerage industry. I believe that aggrieved clients will soon discover that all major brokerages were involved in this scandal, and unless they decide never again to invest in financial products beyond cash deposits and CDs, they will find it difficult to find a big outfit which is not tainted. The other alternative is to place your money with a small outfit, such as Zecco or TradeStation. Speaking personally, I would not feel safe placing $100k to $1 million with these smaller outfits; I would much rather rely on the financial strength of a name-brand broker. I think that if my cash balances were swept into the Reserve Fund in a small brokerage with razor thin profit margins, then I probably wouldn’t be made whole by the brokerage, the way Ameritrade has offered to compensate its clients affected by the Reserve Fund issue. (This is a hypothetical situation. Although I have an Ameritrade account, my cash balances were not swept into the Reserve Fund.)
I think the proper lesson to draw from this fiasco is not that certain brokerages are not reliable, but rather that one should understand the financial products one buys and not rely on finance professionals, since they have a blatant conflict of interest. In other words, the legal principle of caveat emptor applies. This financial crisis has seen retail investors being sold a large variety of far more toxic securities compared to the ARS, including Lehman bonds and Madoff securities. In contrast to these securities, the ARS securities involves problems of liquidity and not solvency, and therefore is reasonably easy to solve. Many of the ARS are issued by safe creditors like municipals, and are backed by assets covering 200% of their face value. Furthermore, many of these creditors incurred punitive interest rate hikes when the auctions failed, and therefore are just as eager as the investors to find a solution to this problem. The most probable solution is that the Fed will contribute debt capital to a fund the acquisition of ARS securities at par, with the brokerages contributing some equity capital in proportion to their exposure. In fact, Ameritrade is about to reach an agreement with the SEC regarding the ARS issue, and does not expect any settlement to be material to earnings. I think that ARS investors are close to the end of this particular tunnel, and should see their money soon.
While management has predicted EPS of $0.90 to $1.15 in 2009, my own calculations suggest that there is a reasonable chance that EPS will end up at $1.25, assuming flat or rising stock trading volumes. Given the clean balance sheet of AMTD, and evidence that it is gaining market share, as well as recent credit upgrades by both S&P and Moody’s to reflect improved operations, it is remarkable that the stock is still selling at a PE of 10-11. I think a more realistic PE should be at least 15, and I give AMTD a target price of $15 to $19.
