Trading M&A: Schwab & Ameritrade
Market participants who love to trade mergers and acquisitions, as well as other corporate actions, have had a cornucopia of opportunities to choose from in 2019.
And the list of companies involved in M&A deals got a little longer last week, with LVMH (owner of Louis Vuitton) buying U.S.-based Tiffany (TIF), and Charles Schwab (SCHW) announcing its intention to acquire TD Ameritrade (AMTD).
The latter deal, involving two of the biggest discount brokerage firms in the United States, was of particular interest to the investment community. The combination of Charles Schwab and TD Ameritrade is expected to produce an entity boasting $5 trillion in client assets.
While Charles Schwab was already the third-largest financial entity in the U.S. ranked by total retail client assets (after Fidelity and Vanguard), this strategic move further cements its position and allows for additional breathing room between it and number four on the list, J.P. Morgan (JPM).
Another interesting wrinkle in this narrative is the fact that Charles Schwab recently shook up the discount brokerage business landscape when it announced it was eliminating trading commissions back in October. That decision triggered a dramatic selloff in the stock of Schwab and its primary competitors, including TD Ameritrade, which lost roughly 30% of its market value in the days after Schwab cut commissions to zero.
Given that hindsight illustrates Schwab’s announcement essentially worked to provide a discount on the price it would theoretically need to pay for Ameritrade, it’s guaranteed that regulators in the United States will take a closer look at the proposed deal (and lead-up to the deal) before offering their blessing.
Other regulatory questions may be raised about the deal due to the fact that both Schwab and Ameritrade possess deep service relationships with independent registered investment advisers (RIAs). Schwab is already the largest custodian of RIA accounts, and Ameritrade is estimated to be number three, meaning the combined entity could house more than 13,000 such accounts.
Complicating matters is the fact that many RIAs had specifically chosen either Charles Schwab or TD Ameritrade based on the different philosophies and cultures propagated by each. Consolidation in the space means that RIAs may be looking elsewhere in the future to ensure that their clients still have a choice when selecting a custodian.
Owners of the estimated 24 million retail accounts that will involuntarily be inducted into the combined entity will also have to decide if they want to remain with Schwab, or if another financial institution focusing on retail accounts—such as tastyworks, E-Trade or Robinhood–might be more suitable.
In terms of the actual deal, the agreement calls for Ameritrade stockholders to receive 1.0837 Schwab shares for every Ameritrade share held. The deal is expected to close in the second half of 2020, and it is forecasted to take another 18 to 36 months beyond that for the two companies to complete their integration.
Options traders should be aware that because the deal between Charles Schwab and TD Ameritrade is an “all-stock offer,” the number of shares covered by Ameritrade options will ultimately be changed to adjust for the value of the buyout. In practice, that means the options of the bought-out company (AMTD in this case) will change to options on the buying company’s stock at the same strike price, but for an adjusted number of shares.
Adjustments are not made to listed options until a given deal actually closes. And traders can still elect to close or exercise open options positions at any time—including prior to the proposed closing date.
Mergers and acquisitions, like the proposed buyout of TD Ameritrade by Charles Schwab, do also carry an unknown degree of “deal risk,” or the possibility that the marriage between the two isn’t ultimately consummated.
While the probability of this outcome is nearly impossible to accurately quantify, traders can look at the failed acquisition of NXP Semiconductors (NXPI) by Qualcomm (QCOM) as a case study on the potential risks and rewards associated with trading the stock and options of companies involved in these types of corporate actions. In the case of QCOM and NXPI, it was essentially regulatory hurdles that derailed the closing of the pact.
To learn more, traders can review a past installment of Best Practices presented by the tastytrade financial network when scheduling allows. This episode focuses specifically on trading considerations related to corporate actions, such as mergers and acquisitions.
Sage Anderson is a pseudonym. The contributor has an extensive background in trading equity derivatives and managing volatility-based portfolios as a former prop trading firm employee. The contributor is not an employee of Luckbox, tastytrade or any affiliated companies. Readers can direct questions about topics covered in this blog post, or any other trading-related subject, to support@luckboxmagazine.com.
