Friday, March 25, 2011

Schwab Buys optionsXpress In Bid For Discount Investors

Sometimes it pays to pay even when you're used to chasing discounts.  Charles Schwab, one of America's leading discount brokerages, is offering $1B in stock for optionsXpress.  Thumbnail sketches are in order. 

This is an all-stock deal, with 60mm new SCHW shares going to OXPS holders.  SCHW shareholders will experience dilution of about 5%, which isn't bad considering they're getting a huge options brokerage's market position.  OXPS's ROE of 25% is unbelievably healthy, although its three straight years of declining net income is a cause for concern.  OXPS's accounts payable and long-term debt are manageable loads for SCHW's balance sheet to bear. 

Writing puts under OXPS would be tempting if this were a cash deal, but the all-stock characteristic would make such a move very vulnerable to market volatility.  That is a huge risk to take with OXPS's P/E over 20 and SCHW's over 47. 

Schwab is probably making the right long-term move here, but the risk factors above take the joy out of any short-term special situation strategy for investors. 

Full disclosure:  No position in SCHW or OXPS.