Joe Ricketts was supposed to be in Sturgis, South Dakota. It was the second week of August, time for America’s biggest annual motorcycle rally, where Ricketts likes to rub elbows with fellow leather-clad, chain rattling bike aficionados from police touring clubs and outlaw packs.
He never got there. On Monday, August 7, the rally’s opening day, the billionaire founder and chairman of online brokerage Ameritrade Holding Corp. was holed up in the company’s Omaha, Nebraska, headquarters, preparing to make a startling announcement after the close of New York Stock Exchange trading: Chief executive officer Thomas Lewis had resigned.
Only three months earlier the 47-year-old had become the sole CEO after sharing the title with Ricketts for 14 months. Ricketts, 59, was cruising toward semiretirement on a sprawling bison ranch near Jackson Hole, Wyoming. The succession seemed seamless, the interpersonal chemistry confirmed by the fact that Lewis, Ricketts and two companions had spent two weeks in July riding top-of-the-line BMW motorcycles on a 4,000-mile bonding trip from Helena, Montana, through the Canadian province of Alberta and down to Jackson Hole. A picture of the foursome clad in riding leathers and boots, toasting the end of their journey with raised wine goblets, was beamed from Ricketts’s ranch to Ameritrade employees over the company intranet.
Now Lewis was out of the picture, and Ricketts was out of retirement, trying to reassure analysts, journalists, employees and anyone else who would listen that the CEO’s resignation was truly for personal reasons and not a sign of deeper conflicts at the firm, which faces growing pressure to keep pace with the rapidly changing and fiercely competitive online financial services market. Lewis, who sat for extensive interviews with this magazine during the week before the announcement, could not be reached for comment afterward.
“Without Tom we would have had to have sold this firm. Without Tom we would not be a major player today,” declares Ricketts of Lewis, a technology guru who rescued Ameritrade from a near meltdown in its back office last year. “Tom is a friend of mine. I love him. An unexpected personal situation came up in his life. And he made the right decision.”
At Ameritrade Lewis had what he viewed as a dream job. But the strain of being separated from his family, which remained in Baltimore, proved too much, say sources familiar with his decision. Lewis essentially gave up Internet fame and fortune for the sake of home life.
Whether Ameritrade can retain its elite status among the majors in online financial services is a topic of some debate that would still be raging even if Lewis had stayed on. The market is more competitive and less susceptible to bold breakthroughs than it was four years ago, when this small discount brokerage came out of nowhere to break into the top tier. With an average 112,000 trades per day, or 10.6 percent of the market, the2,700-employee Ameritrade is the fifth-largest online brokerage, according to second-quarter data from U.S. Bancorp Piper Jaffray. (Including orders received through its voice response system and other non-Internet channels, Ameritrade’s daily average is 124,000.) In online share Ameritrade trails Fidelity Investments (11.1 percent), TD Waterhouse Group (12.5 percent), E*Trade Group (15.5 percent) and Charles Schwab & Co. (22 percent).
But online finance businesses are not what they were when the dot-com investment wave was at its peak. The general decline in technology stocks and trading volumes over the past six months, the collapse of the dot-com sector and the burden of competing against some 200 other online brokerages have taken a heavy toll and exposed weaknesses in one e-model after another. Ameritrade has watched its stock price drop 76 percent from its 1999 high of $63, cutting its market cap from a peak of $11 billion to #3.1 billion. Total daily customer activity is off about 15 percent from the high of 149,000 trades in Ameritrade’s second fiscal quarter, which ended March 31. Average trades per account declined from 11.2 percent in that quarter to 7.6 percent in the next. “If assets are the endgame,” says Morgan Stanley Dean Witter financial services analyst Henry McVey, “then we think Charles Schwab and TD Waterhouse are pulling ahead.”
Many analysts also are alarmed by Ameritrade’s dogmatic focus on online brokerage and on the U.S. at a time when competitors are broadening their product lines and going global. That’s quite a reversal from Ricketts’s maverick and revolutionary image. Bill Doyle, the lead consumer e-commerce analyst at Forrester Research in Cambridge, Massachusetts, who once ran E.F. Hutton’s pioneering Huttonline electronic brokerage service, says that Ricketts and Ameritrade “changed perceptions” with their heavily advertised $8-a-trade commissions. “Joe Ricketts is a poster child for how the Internet changes finance,” Doyle says.
“Ameritrade has a very focused business strategy,” explains J. Peter Ricketts, Joe’s 36-year-old son, who runs strategy and business development. “We want to really nail the discount brokerage business. We answer the phones really well. We process the trades really well. If we got into another business, we’d just add another layer of costs.”
In presentations to securities analysts, Ameritrade describes its strategy as “focused and deep.” Piper Jaffray analyst Stephen Franco praises the firm’s recent performance but worries about its long-term growth prospects “in a market where I think we’re going to see a sea change.” Says Franco: “The next generation of online investors is going to be interested in planning and other services. Ameritrade is not moving very quickly in that direction.”
In contrast, E*Trade, the No. 2 online brokerage, this year spent $1.8 billion to buy Telebanc Financial Corp., which it calls a “pure-play Internet bank,” and paid an undisclosed amount to acquire Card Capture Services and its network of 8,500 automated teller machines, giving customers easier access to cash. Last month, E*Trade said it would acquire PrivateAccounts.com, which offers personalized asset management services to the high-net-worth crowd. In January online brokerage leader Charles Schwab, with an already established mutual fund supermarket, bought the old-line private bank U.S. Trust Corp. for $2.7 billion to balance its booming Internet business. DLJdirect struck a deal with several companies led by Sumitomo Bank to enter the nascent Japanese online brokerage market. And almost all of the major brokerages—with the exception of Ameritrade—have bought stakes in at least one of the new electronic stock trading systems that are jockeying to replace the traditional exchanges.
When Ameritrade does diversify, it keeps a close eye on costs. It has made a foray into investment banking, but through a joint venture with competitors. It also started, and plans eventually to spin off, OnMoney, a financial aggregation service that offers customers a single, consolidated view of their assets and accounts at all institutions that hold them.
Otherwise, Amerirrade is partial to alliance agreements with other financial services providers. It will, for example, do joint marketing with the MBNA America Bank credit card organization and with the Internet bank NetBank. Ameritrade officials pointedly state that establishing such arrangements is a lot more efficient than issuing credit cards on their own or buying a bank outright as E*Trade did with Teleblanc. They are planning a succession of these alliances with one feature in common: The partnerships won’t cost Ameritrade any money.
Cost consciousness has also been a hallmark in the conventional administrative sense, and this is where chairman Ricketts says Lewis left his mark. An insurance industry veteran who collaborated with Louis Gerstner on a technological overhaul of American Express Co. (before Gerstner took the top job at IBM Corp.), Lewis presided over a $100 million investment program that last year shored up Ameritrade’s back office and dramatically raised its level of automation. As a result, its clearing and transaction costs are the lowest in the business. Now 68 percent of incoming calls are handled without human intervention; this has cut the percentage of transactions handled by registered representatives from 14 percent to almost none in the last quarter and reduced the cost of processing a trade by about one quarter in the last year.
Operating out of Omaha doesn’t hurt this cause. The company built its main call center in a nondescript shopping mall where it pays $3.35 per square foot for space formerly occupied by a Younkers department store. The frugality extended to an Ameritrade company picnic last month—employees had to pay $5 to attend.
With all these building blocks in place, Ameritrade has become one of the few brokerage firms with more than a million electronic accounts, and its tight business focus is looking pretty smart in the wake of the early Internet euphoria. None of the online-only banks—not Bank One Corp.'s WingspanBank.com, NetBank or E*Trade Bank, which was formerly Telebanc—have crossed into seven figures. Like the banks, online insurance and consumer loan companies have fallen far short of earlier growth expectations. And none of the alternative electronic stock exchanges, which grabbed 30 percent of all Nasdaq trading after just a few years, has gone public or proven that it can generate significant profits. Apart from brokerage, where transactions are relatively straightforward and uncomplicated, consumers of financial services still seem to prefer to deal with traditional providers.
“The American consumer wants a bank in their backyard; with insurance they want a deal; with a mortgage they want a good rate,” Lewis said in his preresignation interview. “Ameritrade does not have this misguided belief in world domination of online financial services. We’re here to be profitable quarter after quarter.”
As trading volume slumped in the June quarter—the third quarter of Ameritrade’s fiscal year—analysts were warning that undiversified Ameritrade would almost certainly lose money. It didn’t. The company earned $4.6 million, or 3 cents per share, even after spending a hefty $41 million on the ubiquitous advertising that includes commercials with trader-hipster Stuart and his multihued hair. That helped attract a healthy 173,000 net new accounts during the quarter. “The story of Ameritrade’s fiscal third quarter was its ability to grow profits in a depressed market while maintaining its position as the low-cost leader,” wrote Chase H&Q online finance analyst Gregory Smith. The performance has turned Donaldson, Lufkin & Jenrette electronic financial services analyst Richard Zandi into an “Ameritrade bull,” he says. “Even as their stock has gone straight down for a year and half, they’ve stuck to their knitting: providing low-cost trading.”
IT TOOK MIDWESTERN FORTITUDE, NOT TO mention out-of-the-box thinking, to build a brokerage empire in Nebraska. The sparsely populated state can’t support too many full-service brokerage offices. The Omaha World-Herald’s business page is just as likely to feature crop reports as stock commentary. The state’s largest city—Warren Buffett and Mutual of Omaha Insurance Co. notwithstanding—hardly conjures up thoughts of big money or big business. Ameritrade’s two-story headquarters building sits opposite a fertilizer wholesaler and next door to a Kellogg’s breakfast cereal plant.
Joe Ricketts was born in 1941 in rural Nebraska City, Nebraska. His father, Donovan, a carpenter, built houses and additions, and urged his son to do the same. After earning a BA in economics at Creighton University in Omaha in 1969, Ricketts suffered through the bear market of the early 1970s as a broker at Dean Witter Reynolds. In 1975, the year of the May Day revolution that did away with mandatory fixed commissions on stock trades, Ricketts began to see the potential of negotiated commissions. On a visit to the Chicago Board Options Exchange, he met up with a former classmate who was running one of the early discount brokerages and decided to follow him into that business. Returning to Omaha, Ricketts and four other investors put up $12,500 each to form First Omaha Securities, which soon became First National Brokerage.
By 1988 Ricketts had begun experimenting with technology. His was the first brokerage firm to handle trades via TouchTone phone. The price was what even now is a remarkably low 3 cents per share. Business picked up, and the firm, renamed TransTerra, made money, but the brokerage was tiny by national standards, averaging an underwhelming 353 trades per day. Ricketts, however, was ready for the Internet. In 1995 he spent $8 million to acquire New York-based K. Aufhauser, which one year earlier had become one of the first brokerages to take orders via the Net. Charles Schwab went online in 1996, and Ricketts was determined not to be left behind. The next year he introduced the $8 price for market orders and spent $14 million on the first big online brokerage advertising campaign using the slogan “Eight bucks per trade.” Business boomed; the firm, renamed Ameritrade, went public in March 1997, and Ricketts poured the proceeds back into an even bigger ad blitz. In 15 months Ameritrade’s 100,000 accounts more than quadrupled.
Behind the scenes, however, things had become, well, rickety. Computer servers were crashing, customer service was slow, and the idea of adding capacity seemed incredibly daunting. “It was a small regional [technology] shop providing service to a company that had become an overnight success,” says chief information officer James Ditmore, who joined Ameritrade in 1999. “They were pretty much outmanned.”
Ricketts began searching for an outsider who could solve the technology problems. New York headhunter Jay Gaines introduced him to Lewis.Lewis had fixed difficult situations before. He was head of technology for the White House during the Reagan administration and had been a key player in revamping the technology infrastructure of Credit Suisse First Boston Corp. in the mid-1980s. After his stint with Gerstner at American Express, he worked on another technological overhaul, at the troubled insurance company USF&G, now pan of St. Paul Cos. “Tom is a technology visionary,” says Vivek Wadhwa, CEO of software consulting firm Relativity Technologies, who worked for Lewis at CSFB. “First Boston, like other investment banks, had systems built in the 1970s. They had to be massively rebuilt. Tom pushed to use client-server technology. Back in 1985 that was like talking about Star Wars.”
Ricketts and Lewis hit it off, but Lewis, at that time president of TenFold Insurance Systems Group and considering his own start-up, wasn’t interested in yet another rebuilding job. “I said, ‘I don’t want to run technology now,’” recalled Lewis. “And I’m not interested in moving to Omaha.” But he had another proposition for Ricketts. “I said, ‘You could give me your job.’” Ricketts soon agreed, with a few conditions. He and Lewis would be co-CEOs for a year, after which Ricketts would become chairman and concentrate on strategic issues. The deal was spelled out in a detailed employment contract that guaranteed that Lewis’s stock options would vest if he was not given the top job or was assigned non-CEO responsibilities.
Lewis joined in March 1999 and dived into fixing the tech problems. He recruited former USF&G colleague Ditmore and scores of others from previous postings to establish an advanced technology center in Annapolis Junction, Maryland, an easier place than Omaha to hire technical people. Ditmore essentially began reengineering on the fly. Some nights it wasn’t clear if a new system would be ready when it was needed the next morning. “Those were anxious times,” says Ditmore.
The $100 million was well spent. Ameritrade climbed from nearly last to a first-place tie with Fidelity in Money magazine’s survey of overall online performance. Keynote Systems, an assessor of online systems performance, cited Ameritrade’s as one of the fastest-loading of all Internet home pages for the first quarter of this year, with the average transaction time dropping to between 7 and 8 seconds, from 35 to 38 seconds a year ago. “We’ve written the check for technology,” says Ameritrade chief financial officer J. Randy MacDonald. “We now have infinite scalability. Our competition still has to write a check for that.”
Ricketts, who views technology as the key to the firm’s competitive advantage, gives Lewis all the credit. “Reliability, speed and low cost provide the foundation for this company,” he says. “We would not be in that position without Tom.”
And now Ricketts, serving as temporary CEO pending a search by Heidrick & Struggles, has a serious void to fill. It won’t be easy to find someone who approaches Lewis’s combination of management skills and technological understanding—and who can be persuaded to spend most of his time in Omaha.
Ricketts plainly favors his son for CEO—assuming that Pete, who has spent seven years with the company, wants the job. “Oh yes, I would back him, definitely,” says Ricketts, who with his wife and various family trusts controls about 60 percent of Ameritrade stock, now worth about $1.9 billion. Pete, a down-to-earth executive who plays in the company paintball league, controls another 8.7 million shares, worth about $139 million.
Some observers don’t appreciate this succession idea, even though Pete Ricketts has a solid reputation in the industry. “The market would not look favorably on it,” says one analyst, who asked not to be named. “It’s nothing against Pete, but they need to bring in a world-class manager like Tom.”
Ameritrade must also find a way to retain the Marylandbased advanced technology team, which has been working on innovations such as Web site customization and digital signatures. Seventy-five senior technologists worked for Lewis in the past.
RICKETTS MAY BE LOOKING FOR A NEW CEO, BUT he is not shopping for a new strategy. His long-term goal remains making Ameritrade the largest agency brokerage in the world.
That flies in the face of conventional wisdom. Brokerage firms all want to be asset gatherers these days, and online financial firms aspire to be portals. Pure trade execution is supposed to be the ultimate commodity business, and diversification has been the mantra for years. Ricketts, who assiduously courts analysts, has heard their calls to expand and says: “I think it’s idiocy. It’s really not their money. It’s our job to maximize cash flow for shareholders.”
In Omaha pure execution is still profitable. With a commission mix of $8 for a market order and $13 for a limit order, Ameritrade made an average of $12 to $13 per trade in the third fiscal quarter. Add $5 to $6 per trade for $2.8 billion of outstanding customer margin loans and a little more than $1 for payments for order flow from market makers, and revenue per trade comes to about $20.
In the second calendar quarter of this year, Ameritrade spent about half that amount—$10.27—to process and clear the average trade. Because of declining volume, that figure was up from $8.54 in the previous quarter, but it was down from about $13.44 in the third quarter of 1999.
“We are the lowest-cost provider of executing and processing a trade,” says Ricketts. “That’s the most important position. No one can take us out.” Though it is hard to make valid statistical comparisons among firms, Piper Jaffray’s Franco says Ameritrade does appear to have the lowest-cost infrastructure.
With competitive pressures holding down commissions and existing customers trading at the already frenetic pace of seven times per quarter, Ameritrade’s future growth depends on adding new accounts. So far it’s been able to keep doing that at a pace that has surpassed analyst expectations and beaten the competition. In a March research report, FleetBoston Robertson Stephens estimated that Ameritrade would increase accounts this year by 92 percent, about double the rate of the rest of the industry. Why? In part because hundreds of millions of dollars of Stuart ads have turned Ameritrade into a brand more powerful than some of its larger rivals. “I think the brand is considerably better known than TD Waterhouse,” which has used celebrities in its advertising, says Robertson Stephens analyst Scott Appleby.
Ameritrade believes it can keep opening accounts at this torrid pace. The firm has just wrapped production of a fall advertising campaign, part of a $200 million ad budget for the next 12 months, that will debut during the Olympic Games. (More scripts have been written for Stuart ads, but the ongoing Screen Actors Guild strike may keep the firm from shooting them anytime soon.) In its third quarter Ameritrade’s cost of acquiring new accounts was $240, up from $179 the previous quarter. TD Waterhouse, by contrast, brings new accounts in at an industry-low average of $127, thanks in part to the banking franchise of its former parent company. Ameritrade expects to average $200 to $300 over the next few quarters.
Ameritrade is also counting on a shakeout that will thin the ranks of smaller competitors. In the past year Ameritrade itself has been approached about four or five potential purchases, and inquiries from motivated sellers have picked up recently. Ameritrade believes that a massive consolidation is inevitable and imminent. “It takes a fair amount of scale to make money in this business,” says Ameritrade brokerage president Jack McDonnell. Ricketts plans to start buying firms when the price per account drops below the cost of opening new accounts through marketing and advertising.
While any such acquisitions would bolster the core business, Ameritrade is just beginning to go down the alliance road with MBNA and NetBank, and it is busy sorting through other possible arrangements that would promote diversification on the cheap. Ricketts won’t put numbers on the revenue he hopes to generate from these alliances, but Lewis indicated that the firm is hoping to double its revenue per customer without increasing core brokerage costs. “We’re going to have banking through NetBank, but we didn’t pay $1.8 billion for it,” said Lewis, aiming a verbal dagger at E*Trade and its Telebanc acquisition. “Banking is a zeromargin business with no brand.”
As long as customers don’t object, and some other company handles the up-front and processing costs, Ameritrade seems eager to experiment with a range of products. A financial education certification program is being considered, and before his departure, Lewis, citing the merchandising success of American Express, was even examining the possibility of selling nonfinancial products—from Palm personal organizers to luggage. The executives who have been cautious about expanding overseas may soon test those waters, too. They hint that they are actively seeking a partner to help Ameritrade break into the Asian marker.
In contrast to the low-cost-alliance approach, Ricketts and Ameritrade are making bolder bets in investment banking with Epoch Partners and in aggregation with OnMoney.
Epoch is an effort by co-owners Ameritrade, Charles Schwab and TD Waterhouse to increase their customers’ access to initial public offerings. The discount brokerages were joined in the enterprise by major venture capital firms, including Kleiner Perkins Caufield & Byers and Benchmark Capital. After eight months of planning and hiring, the firm has just participated in its first two deals as a comanager.
Ricketts dreamed up OnMoney, a relatively expensive and somewhat controversial e-finance project. Launched with a high-profile Super Bowl ad in January, OnMoney is designed to give financial consumers personalized, portal-like access to all of their financial data, regardless of where their accounts reside. Traditional financial institutions fear losing their primary relationships with customers who turn to this new breed of data consolidator.
OnMoney is surpassing projections, with more than 400,000 registered users, says Ricketts. “The company is well on its way to achieving a positive cash flow,” he adds.
A behind-the-scenes skirmish with E*Trade has delayed OnMoney’s expected spin-off from Ameritrade. Earlier this year OnMoney retained Robertson Stephens to sell a piece of the company in a private placement. After three months of preparation, and weeks before a road show was scheduled to begin, E*Trade, an important Robertson client, objected to its investment bank working for an archrival. Robertson had told OnMoney months earlier that the E*Trade relationship was not a problem, and Ricketts contends that “Robbie Stephens pulled out of the deal on direction from E*Trade. They fell all over themselves apologizing, but that threw a real wrench into our plans.” Ricketts says OnMoney is now close to signing up a handful of strategic partners and investors. E*Trade declined to comment.
Lewis was a harsh and vocal E*Trade critic, asserting that his competitor’s rhetoric didn’t march its accomplishments. “I hope I am around to dance on their grave,” he said before his resignation. Ricketts is more conciliatory: “I know [E*Trade chairman] Christos Cotsakos. I enjoy his competition. I enjoy his company.”
Of course, Ricketts could take care of all his strategic headaches by just selling off the firm he’s spent the last 25 years building. Earlier this year he set off speculation that he was planning to do just that, when a Financial Times article reported that he was open to an acquisition. The company vehemently claimed he was misquoted.
Lewis’s resignation has set off more talk about a possible sale. Rumors surfaced that American Express, which held merger talks with E*Trade, might be in talks to buy Ameritrade. In an interview the week of Lewis’s resignation, however, Ricketts insisted that he had not been approached by any serious buyers and that he wouldn’t sell at anything close to the current $3.1 billion market cap.
He remains adamant on one more count: He is going back into retirement on that ranch, and, presumably, to next year’s Sturgis rally. “I did not want to come back,” says Ricketts. “I am not going to be here.”
