Commentary: Associates: Will The Purchase Make Sense For Citi?

Other highfliers have stumbled after buying outfits like Associates

With the purchase of Associates First Capital Corp., Citigroup expands its customer base by 20 million borrowers and more than doubles its commercial lending portfolio. It also gains global reach: Associates ranks as Japan's No. 5 lender and has a growing presence in Europe. But is that worth $31.1 billion--the fourth-biggest financial-services price tag in the past decade?

After all, the Dallas company, which makes loans to consumers and companies with poor credit, faces a host of potential problems. Changes in Japan's regulatory climate, a downturn for the U.S. trucking industry (where it's a major lender), a Federal Trade Commission review, and a jump in credit-card losses could all signal lower profits for Associates.

Associates, which Ford Motor Co. spun off two years ago, makes high-interest-rate loans to predominantly low- and middle-income consumers through nearly 2,800 branches in the U.S. and 13 other countries. Additionally, about 40% of its $100 billion portfolio consists of loans to small and midsize companies. Citigroup is paying a 50% premium on Associates' share price at the market's close on Sept. 5. That works out to 16 times the Dallas company's 2001 earnings estimate. And because it's a share swap, Associates shareholders will wind up with about 10% of Citigroup's equity.

"DOABLE." More than one highflier has stumbled in recent years after buying a company such as Associates that lends to borrowers who can't qualify for bank loans. First Union and Conseco paid hefty premiums for Money Store Inc. and Green Tree Financial Inc., respectively, and then suffered when their new acquisitions' profits fell.

Associates lends mainly to the same kind of consumers as Money Store and Green Tree Financial. But analysts are quick to point out that Associates' accounting is much more conservative--and its profits more predictable. Citigroup figures that the deal will add 10 cents per share to the parent's earnings by 2001, a number that CIBC Oppenheimer analyst Vincent Daniel calls "doable."

Another positive for Citigroup, though, is that with this purchase, Citigroup Chairman and Chief Executive Sanford I. Weill isn't venturing into new territory. His insurance and investment banking behemoth, Travelers, which merged with Citibank to form Citigroup two years ago, was built around Commercial Credit, a consumer-finance company he bought in 1986.

Nonetheless, Citigroup is buying the company at a time when Associates is dogged by a host of questions. Associates' business in Japan accounted for nearly 30% of its earnings last quarter. Before Citigroup entered the picture, investors were braced for Japan earnings to drop. The reason: In June, the Japanese government cut the maximum interest rate on the kind of short-term loans that Associates makes from 40% to 29%. Associates told analysts (before the merger was announced) that its profit margins in Japan were likely to be squeezed.

Citigroup, as a bank, can obtain funds at a much lower cost than the credit company. With Citigroup's deep pockets, officials at Associates now say they will benefit from the regulatory change. Roy A. Gutherie, Associates' chief financial officer, said in a conference call that he anticipates scooping up new business as smaller lenders get shoved out.

ADAPTABLE? Perhaps. But where Associates' profits are likely to suffer is in trucking. It has made some $20 billion in loans to trucking companies--whose profits fell last quarter as gasoline prices rose. Some may be defaulting on their loans.

Perhaps the tie with Citi can give Associates an image boost. Speculation about the fallout from an ongoing FTC review has long haunted Associates. The scuttlebutt: The company has been targeted because some brokers it does business with charge minorities higher interest rates for loans. Associates has not been charged with any wrongdoing, nor has it been formally approached by the FTC. In a June 22 statement, Asociates said it disagreed with the FTC's conclusion. Nonetheless, regulators nationwide have promised in recent months to keep a closer eye on nonbank lenders who make loans at notably high interest rates.

Weill says he isn't worried. He likes to think of Citigroup as an adaptable company, one that can "walk and chew gum at the same time." Sure, but maybe one finance company is enough, even for Sandy.

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