By Tiernan Ray
With just over a week to go before the lock-up expires on the U.S. Treasury’s 7.7 billion shares of Citigroup (C) common stock, the stock is up 24 cents, or 7%, at $3.80 on volume of 690 million, more than double the average.
Clearly, investors are excited at the prospect the U.S. government will soon be exiting Citi. (Oh, there’s also the prospect that short sales of the stock could be banned, but I wouldn’t put too much stock in that.)
So, should you buy?
First of all, let’s be clear: “The enthusiasm is not about the exit of Treasury but the recognition the company has turned the corner,” says Rochedale Securities analyst Dick Bove. “In a couple of years, they should start to show some significant profits,” Bove told me in a phone call this afternoon, with “normalized” earnings of perhaps 65 cents to 75 cents per share per year.
But he’s not buying at the moment. The expiration of the lock-up is “not the other shoe, it’s an iron boot,” remarks Bove, meaning it’s going to take a couple of tranches for the government to unload its supply of shares without completely obliterating demand.
“If the stock can demonstrate a price around $4 per share, Treasury will get out,” figures Bove.
Indeed, how to exit is a sore matter for the Treasury given that Citi’s common stock offering in mid-December was seen as a debacle, with shares pricing at just $3.15 given the overhang of the government’s involvement.
“The process didn’t work as intended in December,” observes Credit-Suisse’s Moshe Orenbuch. “This has to be done in a thoughtful manner,” with respect to stock sales.
“My expectation is they do this in two, maybe three blocks” of stock sales, says Chris Kotowski with Oppenheimer & Co., referring to Treasury’s sale of the shares. That means that although Treasury has expressed its urgency to get out of Citi, the overhang could hang a little longer.
One rumor making the rounds is that Treasury would actually structure its exit through something called a “reverse-DRIP,” akin to a dividend reinvestment plan, wherein the government sells off its stake in blocks of 30 million to 50 million shares per day. The process is relatively anonymous, and it would allow Treasury to slam on the breaks should the supply appear to be denting the stock price.
The risk, says Kotowski, who has a “Neutral” rating on the stock, is that government’s involvement lags for some time, creating a situation like Continental Illinois bank in the mid-80s: Regulators took over and the company became extremely risk averse. Return on equity dropped to 5% to 7%, and the thing was sold around 1993 for 1.1 times book value.
Kotowski hopes that’s not what’s in store for Citi, but, “The longer they’re under some form of government control, the harder it becomes to attract good people and maintain the franchise.”
Looking beyond Treasury’s exit, there’s reason for enthusiasm and for caution.
The stock is relatively under-owned by large long-only mutual funds, observes analyst James Mitchell with Buckingham Research, considering it’s a big part of stock indices. The stock trades at 0.9 times his estimate for this year’s tangible book value, when Goldman Sachs (GS), Bank of America (BAC) and others trade at 1.3 times or more.
As for the business, he advises looking at the operations of Citicorp. — “the good bank.”
Citicorp is “Almost 70% non-U.S. business,” notes Mitchell. “And if emerging markets are a faster growth opportunity, that should be a good area for them.”
As for the rest, “It’s still more challenged than others, given they have to shrink their balance sheet by a third, but they are not immune from a cyclical recovery, and the economy is stabilizing.”
Mitchell has a “Buy” rating on Citi and a $6 price target.
Bove points out that Citi’s dramatic restructuring has left it a dramatically different bank:
“Citi has solved its problems,” Bove points out, “They’ve sold their casualty business, their life insurance business, their money management, Smith Barney operations, most of their operations in Japan, including what was the third largest brokerage, what was the largest consumer finance in Japan, their credit card operations in Brazil, their various joint ventures in india and Saudi Arabia.”
Not to mention all the things Citi is planning or working on selling, including the biggest chunk of their mortgage operations, Bove adds.
Still, “The first 10% to 15% rise in the stock was relatively easy,” observes Credit-Suisse’s Orenbuch, who has a “Neutral” rating on the stock, because Citi has been “the only stock trading below book value.”
From here on out, however, it’s easier for other banks such as JP Morgan Chase (JPM) or Bank of America to see higher returns on book value than Citi, he believes.
One issue in particular gives him concern: about $1.80 or so of book value may be attributable to a deferred tax asset. That’s fine, but Orenbuch worries that the result is a lower-quality book value for the firm.
At the end of the day, though, you may be able to just chuck book value out the window, says Bove, since it’s really a measure of a company’s liquidation value, and Citi’s not going away.
Better to look at earnings, he believes: “As the economy improves, that will result in substantial decline in loan losses and lead to a surge in earnings; It’s merely a matter of time to before they are back in a profitable position that will attract investors.”
Bove estimates 3 cents per share in earnings this year, a penny less than the Street consensus. |
