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Citigroup's shift will pay off
The big banking company is streamlining itself in an effort to focus on high-return businesses. Investors will reward its efforts by pushing the stock higher.
By Robert Walberg
For the past five years, Citigroup's (C, news, msgs) stock has gone nowhere. That's about to change.
The primary reason for the stock's lackluster performance is that management keeps changing the company's strategic vision. In the go-go '90s, Citigroup roared higher as then-CEO Sandy Weill built the company into a one-stop financial shop, offering everything from basic banking to insurance to investment banking. Over the past several months the company, now under the watchful leadership of Charles Prince, has been busy divesting itself of underperforming businesses and streamlining operations.
Just last week, Citigroup ended its foray into the insurance world by completing the sale of its Travelers Life & Annuity unit to Metropolitan Life (MET, news, msgs) in a deal expected to net the company gains of about $2 billion. Citigroup already had shed its property and casualty insurance business a few years back.
Last month, Citigroup raised some eyebrows on the Street when it sold its profitable asset management unit to Legg Mason (LG, news, msgs) for $3.7 billion. The group had over $430 billion in assets and generated after-tax income of roughly $200 million annually. But what was most interesting about this deal is what Citigroup received in return. In addition to a 14% ownership interest in Legg Mason and $550 million in cash, Citigroup took control of Legg Mason's broker-dealer and capital markets businesses, worth about $1.7 billion.
More to it
While most analysts point to tougher regulatory standards, a scandalous past and potential conflicts of interest as reasons why Citigroup basically swapped its asset management division for Legg Mason's brokerage business, there was more to it than that. Under Prince's leadership Citigroup is attempting to focus on businesses with the highest return on capital, and the company's brokerage group has historically generated a return on capital nearly five time that of the asset management unit. Many of the assets in the latter group were parked in money-market funds yielding relatively low returns to Citigroup.
Having all but gutted what had been known as its global investment management division, which was responsible for about 7% to 8% of total earnings, Citigroup now is much closer to reflecting the image of its current CEO who wants a leaner, more efficient and less risky global financial services company.
Interestingly, Citigroup's efforts to divest certain businesses and streamline operations comes at a time when one of its competitors, Bank of America (BAC, news, msgs), agreed to buy credit-card provider MBNA (KRB, news, msgs) in an effort to keep up with the likes of Citigroup and J.P. Morgan Chase (JPM, news, msgs).
Pieces come together
Over the past few years, Bank of America's stock has handily outperformed Citigroup's. With the two companies now going in different directions, will the stocks continue to do the same, and which will be the winner? Street Patrol readers know that I think Bank of America paid too steep a price for MBNA, a decision that's apt to weigh on its stock for months, if not quarters, to come.
On the flip side, how can you argue with a company that's reorganizing its operations by focusing on only those businesses with the highest rates of return. The confusing and occasionally painful process of Citigroup's realignment is almost complete. Though it may take some time for the pieces of the puzzle to come together as planned, Citigroup has positioned itself for better-than-industry growth. And now, with the confusion created by some of its moves, the stock is trading at a discount to its peers.
But as Citigroup begins to reap the benefits of its streamlining efforts over the next six to 12 months, look for investors to reward the stock with a higher multiple. At 14 times estimated 2006 earnings, a multiple consistent with its historical norms, Citigroup has upside to the $65 area, or nearly 40% above current levels. That's not bad, especially when you toss in the 3.6% dividend yield.
At the time of publication, Robert Walberg neither owned nor controlled shares in any equities mentioned in this column.
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