Image source: TD Ameritrade .
Online brokerage TD Ameritrade (NASDAQ: AMTD) announced declining earnings in its fiscal fourth quarter of 2016, driven by a decline in trading activity and increased operating expenses. But its financial results weren't the highlight of its earnings report, which detailed a $2.7 billion acquisition of Scottrade 's brokerage unit that would increase its client accounts by 45% to roughly 10 million accounts.
The fourth quarter by the numbers
|Metric/Quarter||Q4 2016||Q4 2015||YOY Change|
|Client assets||$774 billion||$667 billion||16%|
|Trades per day||444,000||479,000||(7%)|
|Net income||$185 million||$216 million||(14%)|
|Diluted earnings per share||$0.35||$0.40||(13%)|
Data source: Company investor relations. YOY = year over year.
Some notable expense items shaved $0.05 from diluted EPS this quarter, offset by $0.03 of tax items. When combined, these items negatively affected earnings by about $0.02 per share.
What happened this quarter
There were some important developments during TD Ameritrade's fiscal fourth quarter.
- TD Ameritrade couldn't escape an industrywide trading slump in its fiscal fourth quarter. Notably, trades per day decreased 7% from the year-ago period despite a 5% year-over-year increase in funded accounts.
- Transaction-based revenue (commissions) declined 8% year over year. Asset-based revenue (management fees and revenue from margin and stock lending) grew 5%, papering over the decline in commission revenue. Total revenue declined marginally by $2 million, or less than 0.25% year over year.
- Increased operating expenses (up 16%) were a meaningful factor in the decline in net income and diluted earnings per share. Pre-tax margin fell to 33% in the fiscal fourth quarter of 2016 from 42% in the year-ago period due primarily to elevated expenses and flat revenue year over year.
"A scale play"
TD Ameritrade moved up its earnings report in order to share news that it reached a deal to acquire Scottrade for $4 billion. TD Ameritrade will put up $2.7 billion in total consideration to buy its brokerage unit. Toronto-Dominion Bank (NYSE: TD) will put up the remaining $1.3 billion to buy Scottrade's banking assets.
According to TD Ameritrade, the combined company can benefit from economies of scale and ultimately eliminate as much as 60% of Scottrade's $750 million expense base. Advertising (about $100 million per year) and duplicated back-office functions were specifically mentioned as areas for cost savings. Some costs will be hard to cut. It expects to operate 450 brick-and-mortar branches as a combined company. TD currently operates about 100 branches in larger cities; Scottrade has about 500 branches scattered across the United States, many in less populated areas.
The broker also sees opportunities for increased revenue by expanding the products available to Scottrade customers, which the company estimates could generate $50 million to $100 million in additional annual revenue in years two and three after the deal closes. Executives cited the similarities in customer profiles between the two companies and its ability to squeeze more revenue from Scottrade's customers with asset-based revenue streams. When asked by an analyst, management opted not to discuss how it might change its pricing, given the current differences in trading commissions between the two brokers.
The broker's guidance for fiscal 2017 calls for earnings in the range of $1.50 to $1.80 per share, excluding any impact of the Scottrade acquisition, which is expected to close at or near the end of its fiscal year 2017 and thus have minimal impact on its 2017 earnings.
At the midpoint of its outlook, TD Ameritrade is guiding for earnings-per-share growth of about 4% in 2017 to $1.65. Of course, brokerage earnings are inherently volatile, as key revenue drivers -- commissions, management fees, interest rates, asset prices, and trading activity -- are largely outside the control of the company over shorter periods of time. Interest rates alone are an important factor, as each quarter-point increase in rates would add $0.08 to $0.10 to annual earnings, according to conference call commentary.
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Jordan Wathen has no position in any stocks mentioned. The Motley Fool owns shares of and recommends TD Ameritrade. Try any of our Foolish newsletter services free for 30 days . We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy .