By Ryan Barnes. Edited By Douglas A. McIntyre
Citigroup (C ); Price $54.75; Break-up Value $65
Much has been written, suggested, and clamored for in regards to a break-up at Citi.
Whatever the original intentions were in gobbling up revenue at any cost, Citi hasn’t been to execute on it in terms of shareholder value. They still lag behind Goldman in the investment banking business, despite their plethora of financial resources. The U.S. consumer bank lags in market share as well, losing out to smaller regional units and the “up-on-their-heels” Bank of America and JPMorgan Chase. There are bright spots – Citi is growing solidly abroad and the Card Services & Alternative Investment groups are doing well, but shareholders haven’t profited because of the bloated and complicated nature of Citigroup as a whole.
The biggest argument in favor of splitting the company up at this point is this – what will cause multiple expansion at this point? They would have to show outsize earnings growth compare to their peers, and given their sheer size, this feat seems nearly impossible. There just aren’t hidden pockets of multi-billion dollar profit out there to be found year in, year out. And as for “operational efficiency”, there are obvious signs that the company cannot effectively manage the scope of their business lines, such as the fact that operating expenses grew 23% in 2006, twice the rate EPS growth and 50% higher than top-line growth.
The “Great Amasser” of Citigroup, Sandy Weill, is gone, so there shouldn’t be huge opposition from within the company in terms of culture or ego. And yet management has been vocal and adamant against a full-scale breakup thus far. At some point, a critical mass for splitting the company will be reached, and after four years of stagnant share appreciation, that point may be very near unless the company can punish earnings estimates in the coming quarters.
Insurance has been sold off (Travelers unit sold to MetLife), and the mutual fund group was swapped with Legg Mason in exchange for their brokerage business – so some things have been done. But it seems that the markets will not give Citi any type of premium valuation as long as they remain consolidated. Regardless of how the pie ends up being sliced in a breakup, the parts will likely arrive at a higher net shareholder value than the 10x forward P/E the company currently sports due to the reasons above. Investors will be better able to understand the financials of the company and evaluate future earnings prospects, and management will be more accountable for their operating performance. So without further ado, here’s our stab at a three piece break-up, along with their respective values in current shareholder dollars:
U.S. Operations – This unit would comprise the U.S. retail banking, credit cards, and commercial lending segments. This is currently the slowest-growing area of Citigroup, but margins are strong (27% operating), and credit card financials have improved greatly in the past two years. In order to pique investor interest in this group as a stand-alone company, we’ve added the Alternative Investment segment of Citi, which manages over $40b in hedge fund and private equity assets, which have the potential for huge growth. The combined unit should fetch the low end of industry multiples, or about 12x earnings, for a total value of nearly $116b.
Global Operations – This segment as a stand-alone company is where shareholders would get the greatest benefit of multiple expansion, as the performance could be seen outside of the stagnant growth in the U.S. banking segment. Internationally, the company can not only grow market share but also make acquisitions that actually affect the top line. By any account Citi has the strongest world presence of any U.S. bank, and this split would allow the unit to shine. Except for a gaffe in Japan operations last year, the unit showed nearly 25% revenue growth, and Citi has been operating in many foreign countries for decades now. This company would be able to command a premium multiple, in the range of 15-17x earnings. Using the midpoint, we arrive at a value of roughly $64b.
Global Investment Banking/Asset Management – This unit would combine the two present company segments, including the brokerage services acquired from Legg Mason and the old Smith Barney. Revenue growth is strong across the board at these groups, and the volatility inherent in investment banking would be balanced out by the steady cash flow of the asset management group, which is mostly fee-based. Valuing the group at 16x earnings (or a PEG of 1), we arrive at a value of $137b.
The total shareholder value under this scenario comes to just shy of $65/share using the low or mid-point of industry valuations across the board. Citigroup will likely become a mandatory case-study for MBA students for many years to come as an example of when a whole lot is simply too much.
Ryan Barnes
Ryan Barnes has over 10 years’ experience in portfolio management and investment research, covering equities, fixed income, and derivative products. Ryan spent the past 5 years working as an institutional trader & manager for high-net worth investors, working with Merrill Lynch, Charles Schwab, Morgan Stanley, and many others. Ryan is currently working as a writer and financial modeling consultant on hedging and capital appreciation strategies, and does not own securities in the companies being covered.
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