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Friday, October 06, 2006

Zecco Launching ZERO COMMISSION Stock Trading


Are online brokerage firms going to see their margins at risk? OK now before you go throw all your brokerage firm stocks out the window, you need to give this some thought.

Zecco, a commission-free online brokerage firm, is launching live on Monday, October 9, 2006. They have been in beta-mode, and they go live and open to the public Monday. Their business model could threaten some of the already-squeezed margins of online trading firms. You should know that many analysts and observers will treat this new model with skepticism, and it will be some time before the verdict is known. But it won't take a rocket scientist to figure out that if this new firm stays as the only one of its kind for a period of time it should get a flood of new accounts for online brokerage.

Here is what Zecco says on its site:

At the heart of our market-busting change lies our promise of zero dollar trade commissions. That’s right. The price war is over. You won. Unless you’re a day trader, you won’t spend a penny on commissions ever again. Day traders – you’re in luck, too. You only have to pay a paltry $3.50 per stock trade after 40 trades a month, up to 10 trades a day.

STATS
$2,500.00 minimum to open an account.
40 trades FREE per month
$3.50 per trade after 40 trades/month
Quotes are powered by Interactive Data
Options: Simple Internet $3.50 + $.60 per contract
Options: Simple Broker Assisted $19.99 + $.75 per contract
Options: Exercise/ Assignment Fee $3.50

Zecco Trading is a division of Equinox Securities, a fully disclosed broker/dealer and member of the NASD, MSRB and SIPC.

MY REFERENCE TO THE PAST

E*Trade (ET) was a name that back in 1996 when I was the head of an event-driven trading team in Denmark, I told my then analyst to look into its recent IPO when it was trading under the "EGRP" ticker. I was on vacation when it went public, and it really didn't get a lot of coverage for a while. On an equivalent basis it was trading at $2.60-ish in today's terms (stock splits), but it was around $10 then. I had looked into it on my own and started running some numbers and she came up with the same math: We estimated that they could have 1 million accounts by the year 2000. The company beat that time-frame by April 1999. We also determined that even with all the stock brokers we personally knew claiming that "electronic investing" would never catch on mainstream, that they were just either stupidly wrong or that they were just trying to can any development that it would obviously put them out of business or change the way they do business drastically. I told my clients that E*Trade was a name that should double or triple if my projections were anywhere in the ballpark and if none of the huge public brokerage companies jumped into offering a full suite of online investing on a mass basis. Well, it went Main Street and it turned out that all these guys were doing was trying to hang on to their jobs and their commissions. We didn't even call it "online trading" then, because so few people were actively "trading" at the time. The investor climate still mostly bought stocks and held, but 1996 was the year that Internet names started going big and it seems like the public started going to a quasi-trader mentality in the 1997 to 1999 period.

Did online trading destroy the traditional brick and mortar office and live person brokerage business? No, it did not; but it changed that business hand over fist and made brokers at the time change to an "assets under management" model. I can recall many people actually saying that companies like Merrill Lynch (MER) and Bear Stearns (BSC) could get killed after 1998 because they were pure-play traditional brokerage business and neither was exactly going out in force to make online trading the norm for their customers. It was like the doomsayers forgot all about trading, investment banking, asset management, and trust operations being major winners for the firms. At the end of 1998 Bear Stearns (BSC) was trading at an adjusted price of about $31.00, and now sits at $147.00. Merrill Lynch (MER) was $around $30.00 at the end of 1998 on and adjusted basis, and now sits around $81.00.

At the end of 1998, E*Trade (ET) was around $11.50 adjusted to today's money, and that was after having doubled. In 1999 the stock went parabolic because we were full on into the online trading boom and they were signing up accounts left and right. ET shares now sit around $25.00. E*Trade did help change and participate in the changing of the way investors and traders approached the markets, but the traditional brokerages still grew.

CURRENT IMPLICATIONS

We can speculate all day if the company will make enough money to cover costs, but neither Zecco nor its parent Equinox is a public company. This "free" online brokerage is going to be watched closely by competitors as a model before anyone else comes running too fast, although the public needs to know that there are and have been some quasi-free pitches out there. This isn't truly free if you look over the math if you are a diverse investor, but it can and may have an influence on the online discount brokers.

I used the E*Trade (ET) example because it was one that I personally saw and the company I worked for ended up being acquired by a larger company and that in turn ended up becoming part of E*Trade.

Please keep in mind that the commission schedule from other firms is done at the “base rate” level. It is not applicable to active traders or investors with substantial assets. These fees may also change or be in the process of changing as brokerage firms do this routinely. The outside fees are as follows:

On the equity side E-Trade (ET) starts its trades for an under $50,000.00 balance and 0-29 trades per quarter at $12.99 and $12.99 + $1.25 per contract.

Scottrade starts their commissions at $7.00.

Ameritrade (AMTD) has a flat $9.99 plan per trade.

Schwab (SCHW) starts their basic fees at $12.95 per trade.

On the options side Options Express (OXPS) only charges $1.50 per contract, but it has a $14.95 minimum.

This move to a free trading platform will get a flood of accounts. It has enough of an intrigue factor that they may not even have to do more than issue press releases and hit chat rooms. The question is how many accounts they get in a short period of time. If they sign up 1 million accounts before year-end, then you know for certain that the other online trading firms are going to have to adapt and will have to lower fees. If Zecco signs up only a few thousand here and there, then there will be no impact to them.

You can expect some of the analysts that follow the online brokers to at least acknowledge this free model of Zecco as a threat in the coming weeks.

LONGER TERM IMPLICATIONS

This could change the landscape quite a bit if Zecco gets a flood of accounts. Unfortunately there is very little known about their infrastructure, back office, support, execution, and many other issues. Without knowing any of that it is hard to crunch the math. Realistically this could appeal to a broad base of customers. It is a simple model that is easy to understand.

Let’s pretend that this works and that Zecco does really well. If they take 1 million accounts, even if it takes 1 year or 2 years, it can have an impact on the forward revenues and earnings of online firms. If Ameritrade lost even 1% of its business over the next year that could trim off $21,000,000+ of the $2.15 to $2.2 Billion estimated revenues that the street thinks it will do in fiscal 2007. If you use the same 1% on E*Trade (ET) and its projected $2.7 Billion in revenues expected for 2007, then you could see $27,000,000.00 get trimmed off of its revenue expectations. On the surface 1% isn't much, but it is enough that Wall Street analysts could trim their estimates on online brokers. That probably wouldn't merit anywhere enough for waves of downgrades from analysts, but that is assuming the pricing structure stays static. If Zecco takes on a major flood of accounts and customers at all of the other online firms start to complain about higher fees and threaten to bail, then that could create another wave of commission wars among the online brokerages. If there is another round of commission wars then analysts would more aggressively trim estimates and many would cut their ratings on the stocks.

The long and short of the matter is that customers do hate switching accounts to another brokerage firm. They will have to see a noticeable savings AND they will have to have high confidence in the new firm. It will also depend on what sort of additional services that Zecco offers. Most online brokerage firms now offer a myriad of other non-trading services and many offer in depth research, and we just do not know what Zecco will truly offer yet.

It is likely that the company will go out aggressively on its PR. From some chat sessions I have monitored and from message boards I have seen I am pretty sure that the company won't open on Monday and just wonder where customers are. The $2,500.00 minimum account balance is only a deterrent to the brokerage accounts that most firms don't want anyway, so Zecco hasn't put a huge barrier on the number of accounts they can expect. Some firms have no such minimums to open an account, but if people don't have $2,500.00 to open a brokerage account then you have to wonder how many trading firms really want them anyway.

POTENTIAL SILVER LINING FOR OTHER BROKERS

If this turns out to be an experiment and doesn't work very well, and if the company cannot get to profitability after a reasonable time then there could actually be a silver lining in this for online brokers. It would show that commissions at the current levels won't really need to come down and the online trading commission wars would essentially be over. The others have already established themselves and their relative positions, so they would love nothing more than to know that the days of them having to cut commission prices every quarter would be at or close to an end.

Whether Zecco wins or even if it flops, this is going to make a great case study for university business students down the road.

It is certainly going to be interesting to watch.

Jon C. Ogg
October 6, 2006
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