Old economy meets new economy -- investors have seen this storyline before. But the media has recently taken to covering this affair with the kind of close attention usually reserved for the ongoing Brad Pitt-Jennifer Aniston lovefest, especially since America Online fell hard for Time Warner earlier this week.
Today, the Cupid of Wall Street struck again as online and offline discount broker Charles Schwab(NYSE: SCH) agreed to acquire old school wealth manager U.S. Trust Corp.(NYSE: UTC) for about $2.7 billion in stock. As happened when AOL publicly professed its desire for Time Warner, the pursuer's stock fell this morning while the pursued saw its shares climb to new heights, like a smitten heart soaring toward the heavens.
While it probably won't inspire a made-for-TV movie on Lifetime anytime soon, the combination of Schwab and U.S. Trust is a heartwarming story in its own way. By dishing out a tad more than 3.4 shares of its own stock for each U.S. Trust share, Schwab is acquiring a direct link to the wallet of wealthy America. All told, U.S. Trust manages a total of $86 billion in assets, which is segmented among three general types of clients. About half of the firm's managed assets and accounts come from clients with between $2 million and $50 million in investable assets, according to Merrill Lynch. The super rich (> $50 million) and the newly rich (<$2 million) make up the rest of the asset and client base.
Catering to the country's wealthy is big business, as U.S. Trust booked total revenues of $541 million in the just-reported 1999 fiscal year. Net earnings came in at $77 million, leading to a return on equity of 27% and a return on average assets of 1.78%. That's second-class to the 40%+ ROE and 2.00%+ ROA regularly posted by fee income machine Mellon Financial. However, U.S. Trust's overall profitability still tops the returns generated by other financial institutions such as the regional banks, which are far more reliant on lower margin interest revenues from their traditional banking business lines.
What separates U.S. Trust from other asset managers such as Mellon is the company's focus on the affluent customer. Thanks to rapid stock market gains, this segment of the population is growing at a very fast rate. According to market research firm PSI Global, 3 million U.S. households currently sport more than $1 million in investable assets. By 2005, that figure is expected to hit 9.2 million households -- a growth rate that is roughly ten times the overall growth rate of the general population. That's a fertile area for Schwab to tap into with its brokerage services.
U.S. Trust's traditional power center has been the New York area and currently only about a third of the company's total wealth management revenues come from other parts of the country. With its 340 branch offices, Schwab will help U.S. Trust roll-out its services to emerging wealth centers such as Seattle and Atlanta and develop a true nationwide presence for the asset manager. U.S. Trust's Internet presence will also get a boost from Schwab, but anyone who thinks the wealth management business is heading completely online is fooling themselves.
U.S. Trust's business requires a commitment to customer service above and beyond that offered by your run-of-the-mill discount or even full-service broker. Building relationships is the key when you are dealing with the kind of jumbo accounts that are the bread and butter of U.S. Trust's business, many of which are the size of entire university endowments. Giving the client some S&P stock guides and an online account with real-time quotes isn't going to cut it.
For current Schwab investors, the addition of U.S. Trust changes things, but the merger is not an out-and-out model-buster. The main business drivers for Schwab -- the old brokerage standbys of account growth, commission rates, and client trading activity -- will indeed become less important as the company picks up new revenue streams, but they will still make up the bulk of the business.
Schwab has always been somewhat diversified, with about a quarter of its annual revenues coming from asset management and other areas not related to trading and margin lending. With U.S. Trust on board, non-brokerage revenues will jump from 25% to about 35% of the total. As with any large merger, Schwab investors should take some time to examine the ramifications of today's deal and factor in how the addition of U.S. Trust changes their assumptions for the future.
