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E*Trade Financial (Nasdaq: ETFC): Why This Company’s Takeover Prospects Keep Improving

 October 29, 2009 10:59 AM

(by Louis Basenese) Just over a month ago, I pegged E*Trade Financial (Nasdaq: ETFC) as a takeover target.

However, after reviewing the company's most recent results, you might consider my prediction laughable…

On Tuesday, E*Trade reported its ninth straight quarterly loss. And this one was a doozie. Over $830 million in red ink flooded the bottom line. Keep in mind that E*Trade's market cap checks in at a mere $1.75 billion.

Again, I get that it's not obvious why anyone would want to buy a company chalking up quarterly losses equivalent to roughly half its market value. But we can't rely exclusively on headline numbers to guide our investment decisions – because they never tell the whole story.

[Related -E TRADE Financial Corporation (ETFC) Earnings Preview About to Be Bid Lower?]

And ironically, in this case, the whopping loss actually underscores E*Trade's takeover appeal. Here's why…

E*Trade Pays Now in Order to Set Up Profits Later

Dig into E*Trade's results and you'll find a one-time, pre-tax charge of $968 million, related to "refinancing."

Strip it out, and E*Trade only lost $59 million, or five cents per share. And that's a dramatic improvement from last quarter's loss of 22 cents per share.

Essentially what E*Trade did was swap $1.75 billion in bonds due in 2011 and 2017 for new loans that can eventually be converted into common stock.

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Sounds complex, I know. But don't worry about all the details. Here are the most important takeaways:

  • The debt exchange slashes E*Trade's annual interest expenses by more than 50%.
  • It pushes out any significant debt maturities until 2013.

And when we add in recent asset sales and a stock offering that netted the company a total of $765 million in cash, E*Trade now possesses all the financial breathing room it needs to weather its ill-advised foray into real estate lending and return to profitability.

And that's not just my opinion.

As management proclaims, "(We are) confident that we have adequate cushion against any reasonably foreseeable losses in our own portfolio."

But if you'd rather get an unbiased opinion, look no further than federal banking agency regulations. With a Tier 1 Capital Ratio of 6.72%, E*Trade now ranks as "well-capitalized."

In short, E*Trade's big loss is a symptom of making a necessary change in order to ward off bankruptcy once and for all. It had nothing to do with poor execution or rapidly deteriorating fundamentals.

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