By William Patalon III
Money Morning/The Money Map Report
Citi was America’s biggest bank. And it looked like it was going to fail.
The outlook was so very clear, most investors believed. You see, under its former chairman, the money-center bank had developed a reputation for excellence – and for risk-taking. But that risk-taking always paid off.
Then that legendary chairman stepped down, and his hand-picked successor took over the top spot. Over time, however, it became very clear that the successor lacked the “magic touch” of his mentor. The risks the successor took turned into losses – massive losses, in fact – and now the once-proud bank’s balance sheet looked like a sailing ship that washed up on the rocks during a winter gale.
Only one thing saved Cit: A big bailout by a Middle East investor.
Look to the Future With an Eye on the Past
And I think Citi will be fixed. Indeed, I’m going on the record right now as saying that Citi will be turned around, and will prove to be a shrewd investment –and a very nice payday – for those who buy into the big bank now, but who are also able to ignore the bad news and volatility that’s surely still to come before the turnaround is complete.
If you think that short preceding narrative sounds like a prediction of how the current Citigroup Inc. (C) saga will play out, you may well be correct. As we saw last week, Citigroup did indeed receive a $7.5 billion cash infusion from a Middle East investor.
And I think Citi will be fixed this time around. Indeed, I’m going on the record right now as saying that Citi will be turned around. For those who buy into the big bank now, Citi will prove to be a shrewd investment, and will generate a very nice payday – but only for investors who patient enough to absorb and even ignore the bad news and volatility that’s certain still to come before this turnaround is completed and “in the books.”
But when I initially wrote the narrative above, it wasn’t a prediction.
It was actually a look back on the successful early 1990s turnaround of Citicorp Inc., as it was called back then. I’d used it as a case study of a well-executed corporate turnaround – and a profitable stock play – for my book, “Contrarian Investing: How to Buy and Sell When Others Won’t and Make Money Doing it.”
In that case study, I pointed out that investors who’d bet on Citicorp back then had snapped up shares that traded as low as $8.63 in 1991, and then rode them until the stock peaked at $140 a share in 1997, when my co-author and I were putting the finishing touches on our manuscript [these prices have not been adjusted to correlate with the merger with Travelers Group, or with today’s Citi share prices].
Walter Wriston was the legendary chairman I’d referred to back then. And John Reed was the hand-picked successor. Before he’d turned Citi’s reins over to Reed in 1984, Wriston had maintained a stated goal of 15% annual profit growth, an aggressive target for a big bank, and one that periodically led to missteps in his never-ending push for growth. But at the end of the day, Wriston always got results. So it’s no surprise that, at first, Wall Street figured the younger Reed would find it tough to escape Winston’s imposing shadow.
But Reed did make his mark as CEO. In fact, by the late 1980s, one Wall Streeter said of Reed: “He is Citicorp.” But unlike Wriston, who was feisty and tough, Reed was known for accommodation. He got high marks from shareholders for his more-conservative- approach to running the bank. But those marks were more for style than for substance.
Indeed, Reed’s demeanor was so different from the combative Wriston that, in 1987, when Citicorp was clobbered for making ill-advised loans to Third World countries, Reed was actually lavished with worshipful praise when he opted to come clean and write off the bad loans. [Of course, Wall Street said almost nothing about how stupid the loans had been to make in the first place.]
But Reed and Citi were on a collision course with major trouble. As the 1990s began, it still had bad debts on its books, and needed extra income to overcome the losses on those loans. Its solution: Move heavily into lending for commercial and residential real estate [now I understand what baseball great Yogi Berra meant when he said it was “déjà vu all over again.”]. Citi also became a major financier of the Gordon Gekko-esque financial fad du jour: The leveraged buyout, or LBO.
Citi had earned $1.9 billion in 1988. But, by 1991, it was in big trouble. The Iraqi invasion of Kuwait caused energy prices to spike and helped tip the U.S. economy into a recession. Investors watched as the junk-bond market that had fueled the LBO boom imploded. So all those companies that had been buyout plays were suddenly collapsing under the high interest rate debt loads they now shouldered. The loans went bad. Bank finances were decimated. Citi posted a loss of $885 million in the third quarter alone.
Most investors were writing epitaphs for Citicorp. But one saw the profit potential, and was taking action. His name was Alwaleed bin Talal, and he was a Saudi prince. He invested $590 million in Citicorp, becoming its biggest shareholder, a role he maintains even today [although the recent $7.5 billion infusion from Abu Dhabi may change that].
Prince Alwaleed – today considered one of the world’s greatest investors [For our Money Morning investment research report on the prince, please click here] – saw what should have been obvious to everyone. Citi had many valuable businesses. It was a global force. It had a terrific and trusted brand name. And it was probably too big to fail.
He was right on all counts.
Even today, with Citi shares down by about 50% from their 52-week high, that $590 investment is worth more than $6 billion – meaning Prince Alwaleed still has the proverbial “ten-bagger” in hand. And if the stock returns to its previous high – as we expect that it will – his $590 million stake will be worth $12 billion.
But why will it bounce back? Let’s take a look …
Citigroup Turnaround Redux
Citi’s fall from grace this time around followed the same old script. Only the names were changed. Citicorp is now Citigroup. This time around, Sanford I. "Sandy" Weill, the famed financier who in April 1998 announced a $76 billion merger between his company, insurance giant Travelers Group, and Citicorp, assumed the role of the legendary predecessor played the last time around by ace chairman Walter Wriston. Weill completed his masterpiece Travelers/Citicorp merger in October 1998.
Weill was the same visionary risk-taker as Wriston, and always got the job done. This time around, the successor who was the focus of Wall Street’s skepticism was CEO Charles O. “Chuck” Prince III. Like Reed, the successor in the last turnaround saga, Prince won’t have much of a legacy at Citi.
This time around, after suffering losses from the subprime-mortgage disaster, Citigroup found that its share price had been halved and that it was starved for capital. Most recently, Citigroup announced that its fourth-quarter profits would be reduced by as much as $7 billion, leading to the ouster of Prince, the CEO.
Then, just last week, the Citi saga came full circle, as it received another bailout from a savvy Middle East investor. Citi gets a $7.5 billion cash infusion from the Abu Dhabi Investment Authority, or ADIA, an investment arm of Abu Dhabi’s government. The investment will enable the largest U.S. bank to keep paying its $2.16 a share dividend – a promise made by Chairman Robert Rubin – but at a price [more on the dividend in a minute].
Citi will be paying an 11% interest rate on the convertible shares it issued to the ADIA – a "junk bond" rate that’s nearly double the payout rate it offers its other bondholders, Bloomberg News reported.
Under the terms of the deal, ADIA will buy equity units that convert into Citigroup shares at strike prices ranging from $31.83 to $37.24 a share. Each equity unit will pay Abu Dhabi an 11% annual payment rate and will convert to Citigroup common shares from March 15, 2010 to Sept. 15, 2011.
ADIA ownership of shares won’t breach 4.9% of the company’s outstanding shares, and the company won’t have voting rights in Citigroup management, and won’t be able to designate board members.
I have to tell you that I really like the looks of this deal.
The Benefits of a Bounce Back
Even more than the last time it went through this financial tornado, Citigroup is a global company with a great brand identity. It’s the one U.S. bank that plays in all portions of the global financial services market.
Indeed, the Abu Dhabi investment makes me believe that it’s the closet thing to a sure bet I’ve seen in a long time. In short, you’ve got a savvy outside investor who’s willing to bet $7.5 billion that Citi isn’t done. The Abu Dhabi royal family may not have voting rights, but they already have the equivalent of a "bat-phone" hotline right into Rubin’s office.
If Abu Dhabi can visualize a total corporate turnaround, and are putting money at risk to capitalize on it, it seems like a safe bet for individual investors with a three to five year time horizon – minimum – to do the same.
In our Contrarian book, my co-author and I said that whenever you have a brand-name company whose shares are down 50% or more from their 52-week highs – and where there’s either substantial buying by insiders, or big purchases by “knowledgeable outside investors,” that’s a stock you almost have to buy and play for the turnaround.
Turnarounds are great stock plays. You get the conventional growth of the company as its market grows. But that’s magnified by the cost cutting, asset sales and refocusing that are part-and-parcel of a turnaround. The profit gains that emanate from a successful corporate turnaround are huge. And so are the share-price gains.
Then there’s the dividend. At Wednesday’s closing price of $32.29, the dividend yield on Citi’s stock was a hefty 6.69%. It had been more than 7% at Tuesday’s close [Citigroup’s shares rallied 6.5% Wednesday, as I was writing this]. And Rubin, the former Clinton Administration treasury secretary who is now Citigroup’s chairman, insists the dividend must be protected. That’s one reason they solicited the investment from Abu Dhabi.
If Citi achieves that goal and maintains the dividend, even as your Citi shares appreciate, you’ll still have a big yield on your original investment outlay.
And I believe it’s highly likely you’ll end up with the same kind of long-term returns that the investors who went into Citi the last time around ended up with.
We’ll revisit this stock from time to time.
About the Author
Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning. With his latest project, Private Briefing, Bill takes you "behind the scenes" of his established investment news website for a closer look at the action. Members get all the expert analysis and exclusive scoops he can't publish... and some of the most valuable picks that turn up in Bill's closed-door sessions with editors and experts.