E*TRADE’s Secondary Drop Is Actually Good For Holders (ETFC, SCHW, AMTD, MS, GS)

E*TRADE Financial Corporation (NASDAQ: ETFC) is getting hit hard today on news that Ken Griffin’s Citadel Investment Group has sold shares in the stock in a registered offering.  Don’t be fooled by this initial reaction to the stock offering.  This is “good dilution” if there can be such a thing with a $3.5 billion market cap.

We just did a full review of E*TRADE’s Annual Report to find the hidden gems that investors overlook.  After going back over this finding and looking at today’s offering, this stock sale is actually good for E*TRADE and its holders even if the shares have fallen over 5% today to $15.80.  Citadel, E*TRADE’s largest shareholder, sold 23.9 million shares and this took the implied ownership down substantially.

The company still has ties to Citadel.  For that long-expected buyout to come it has to be clear to a buyer that E*TRADE will stay independent for a while.  As far as who will buy E*TRADE down the road, the most likely suitors are Charles Schwab Corp. (NYSE: SCHW) with its $22 billion in market cap or TD AMERITRADE Holding Corporation (NASDAQ: AMTD) with its near-$12 billion market cap.  Who could ultimately be larger strategic acquirers could even end up being those “bank holding companies” which are not banks at all.  That means Morgan Staley (NYSE: MS) or even Goldman Sachs Group Inc. (NYSE: GS), although neither would be as solid integrations as a Schwab or Ameritrade and they would be strategic moves in a new direction rather than discount and online broker market share-driven acquisitions.

E*TRADE had noted in its annual report just this week that Citadel held about 9.9% of the common stock or approximately 27% of the common stock assuming conversion of convertible debentures it holds.  Kenneth Griffin, President and CEO of Citadel, joined the E*TRADE board of directors on June 8, 2009.  The reason that this is good for E*TRADE shareholders is that E*TRADE was without strong management of its own for quite some time during the recovery and it was Citadel’s investment that was one of the key events which effectively rescued E*TRADE during the financial meltdown.  This also gave Citadel a hold on much of E*TRADE.

While this is the lowest share price in about a month, Citadel had already started to unload shares and it controlled nearly half of the company at the peak of its holdings.  Investors should consider this a win-win.  Griffin’s Citadel gets to take some money off the table here and E*TRADE gets to be one more step closer to being less dominated by an outsider.

The most recent monthly trading data from last night showed a 2% increase in trading from last month and the loan losses look better as well: total special mention delinquencies of 30 to 89 days delinquent fell by 6% from December 31, 2010 to January 31, 2011 and total at-risk delinquencies of 30 to 179 days delinquent were down 4% during the same period.

With shares down over 5% at $15.80, just because this is good dilution does not mean that the shares will instantly recover.  Shares were above $18.00 as recently as February 16 before the Libya and Bahrain market-hit from the Middle East and North Africa.  This is the lowest level going back to January 27, 2011 and shares closed out 2010 at $16.00.

JON C. OGG