Citicorp: Cleaned Up But Falling Behind

Investors are carping about Citicorp's slow recovery. Can Chuck Prince pick up the pace?

Citigroup (C ) investors aren't the only ones who are impatient with a stock that's going nowhere fast and a new investment strategy that has yet to pay off. "Get in line," quipped CEO Charles "Chuck" Prince, in an interview with BusinessWeek on Oct. 4. "It's not as good as I want it to be either."

Prince has faced one crisis after another during his three-year reign, from run-ins with regulators on three continents to shareholder lawsuits over Enron and WorldCom. And the Federal Reserve tied his hands, forbidding all acquisitions until he cleaned house. That's all behind him now. But he's not home free. And Prince is facing his biggest crisis ever -- one of confidence in his leadership and his ability to steer a trillion-dollar empire toward desperately needed new growth. Profits have fallen short of analysts' estimates in four out of the last five quarters, and the stock has been stagnant for about three years.

Citi's U.S. consumer business, which has suffered after years of neglect, is behind much of the bank's woes. As some shareholders grumble that it may be time for him to go, the 57-year-old chief executive acknowledges the discontent: "The concerns are perfectly legitimate," says Prince. "People are saying 'Do something!' They want to know how long is this guy going to take?"

An ethics cop was exactly what Citigroup needed when Prince took over in 2003. Citigroup founder Sanford I. "Sandy" Weill's voracious drive to create a financial powerhouse through rapid-fire acquisitions was spectacularly successful (page 128). But the effort to build revenues at all costs created a cowboy culture lacking in controls. Prince, a corporate lawyer for most of his career, starting at U.S. Steel in the 1970s, clamped down hard on rogue behavior and worked closely with regulators to get Citi back in their good graces.

With the ethics issues resolved, some people are wondering whether Prince's focus on rules and regulations is stifling the vitality of the company. "There are too many layers of bureaucracy, and he has a problem with generating momentum," says one former senior executive who declined to be named.

As a global financial services company, Citicorp is unrivaled in reach, yet it has dropped to No. 3 from No. 1 in the credit-card business, and smaller retail banks are eating its lunch. In many cases, Citigroup lags behind in both revenue and profit percentage growth when measured against either retail bank rivals, such as Bank of America (BAC ) and JPMorgan Chase (JPM ), or investment banks like Morgan Stanley (MS ) or Goldman Sachs (GS ).

Some crave the return of a rainmaker as leader. "Maybe it's time for a management change to get this horse running again," says Carl Salvato, portfolio manager of money management firm Great Companies in Tampa, Fla., which has $350 million in assets and holds 150,000 shares of Citi. "We've waited too long for results; it's extreme frustration."

TIME TO CUT COSTS

Investors such as Salvato will be happy to hear that Prince is dropping hints that he's revving up the deal engine again. He laments that for the past three years he had to stay out of the market and focus exclusively on making existing operations more profitable. "We're getting ourselves back on the playing field," he said, noting that most of the acquisitions will be in foreign markets. There's already chatter in London that he's eyeing Lloyds Bank PLC or BNP Paribas. Prince insists he's not interested in a big U.S. retail bank or mortgage company unless it's at a fire-sale price.

But deals alone aren't enough, and Prince concedes that. By all accounts, Citigroup is still a profit powerhouse. Earnings surged to $24.6 billion last year, a 37.7% jump since December, 2003, the year he took over. But almost half of the company's businesses are under pressure to find new sources of growth, and recent investments have yet to pay off. Moreover, despite $16.8 billion in stock buybacks and $14 billion in dividend payouts in the last 18 months, the stock has hovered at around $50 a share. Since Prince's appointment in October, 2003, shares are up just 8.6%, vs. 35% for the S&P 500 Financials Index. Bank of America Corp., with $248 billion in total market value, is quickly closing in on No. 1 Citi, whose stock is worth $252 billion.

One of the biggest complaints by investors and analysts alike is that Citi's expenses are growing faster than its revenues. In the second quarter, for example, revenues were up 9%, but expenses rose 15%. And only 2% of the cost increase was due to new investments, such as building up retail branches. Because the gap between expenses and revenues has been widening, shareholders -- among them the bank's largest individual shareholder, Saudi Prince Alwaleed bin Talal -- are up in arms. In an April interview with BusinessWeek columnist Maria Bartiromo, Prince Alwaleed said: "The grace period is over."

Citi's Prince says he got the message. In an internal memo sent to employees on July 22, he announced that he has asked business heads to evaluate every line item and squeeze out "business-as-usual" costs for items as small as newspaper subscriptions or travel. But he's vehement about not cutting investments to shortchange the future.

Revamping the consumer business is absorbing most of Prince's focus now. The bank lags behind competitors in deposits by a mile (3% of the U.S. market, vs. 10% for BofA and 7% for JPMorgan). "If we don't grow consumer, the whole place has modest growth," he says. Prince is planning big branch expansions in locations where many customers of the company's Smith Barney brokerage business live, hoping to sell them bank products. In Boston, for instance, Citi is planning to build 30 branches next year as a service to 30,000 Smith Barney clients. If it's successful, Citi will roll out new branches in Philadelphia and a half-dozen other cities. If not, it's back to the drawing board, says Prince.

One well-regarded financial analyst says Citi's retail expansion is misguided. Building the consumer bank from scratch is "controversial, late in the cycle, and in markets that are over-banked," says Merrill Lynch (MER ) senior bank analyst Guy Moszkowski. "It's not convincing."

The man who put him in the job is not exactly effusive when asked if he regrets handing over the reins to Prince. "I think Chuck is the best person I could have recommended to the board at that point in time.... I'm very hopeful that Chuck will end up being a great CEO," Weill told Bartiromo on Oct. 4. He says shareholders should be patient with Prince a bit longer. "I think it's been a pretty short time so far."

For now, the board is backing Prince, too. Says Alain J. P. Belda, CEO of Alcoa Inc. (AA ) and a Citigroup board member: "Remember, this is a cultural shift of great magnitude...300,000 people transforming their thinking is not an easy endeavor." Adds Robert E. Rubin, former Treasury Secretary and chairman of Citigroup's executive committee: "The period during which he had to deal with these regulatory issues probably did have a somewhat dampening effect. [But] it's behind us. I get a sense of people who are moving forward in their mindsets and very energetic. Chuck certainly has the fire."

Some shareholders are willing to give Prince more time. "Investors are too impatient. This is not an instant gratification story," says Yvonne M. Bishop, fund manager of the Summit Everest Fund. Citigroup shares make up slightly more than 2% of the $83 million fund.

Nevertheless, Wall Street analysts are frustrated by the lack of results. "They have made promises to investors... that look very challenging for them to deliver," says bank analyst Joe Dickerson of Atlantic Equities in London, who on July 27 cut his 2006 earnings estimate to $4.32 a share from $4.60. Michael L. Mayo of Prudential Equity Group downgraded the stock in July to neutral, partly because he thinks "Citigroup seems to lack a catalyst [for growth]."

Prince's strongest critics think the best way to spur growth is to break up the financial behemoth. Prince is dead set against it, but money manager William B. Smith of SAM Advisors in New York proposes splitting the bank into three parts: retail, investment banking, and global operations. He figures a breakup could push the stock to 66 immediately, from 51 today, and to 90 in two years. "Why does Prince think breaking up the company is 'the dumbest thing he's ever heard?"' asks Smith. "Tyco (TYC ) did it, Altria (MO ) did it."

All eyes will be on Citi's third-quarter numbers, due out on Oct. 19, to see if there has been any progress since the end of June. Prince also plans to address investors in a special conference call on Oct. 27 to explain the bank's investment strategy. Given the Street's reaction in recent quarters, Moszkowski thinks Citi is trying to do damage control: "It would certainly make you think that they are concerned that the numbers won't be well received, and they'll want to spend some time explaining the investments."

In defense of his record, Prince says investments he made three years ago in Citi's capital markets business are now paying off nicely. In the second quarter of 2006, the investment banking arm earned $1.7 billion, up from $1.37 billion in the same quarter last year. The investment bank marked its 19th consecutive quarter as the No. 1 underwriter of combined debt and equity offerings. "The pendulum had swung pretty far to the conservative side," says Tom Maheras, CEO of Citi's Global Capital Markets group. "The balance between risk management and innovation is back."

Prince's biggest challenge is to project himself as a leader with a vision. According to one senior manager at Citi: "Chuck's big weakness is that he hasn't been able to make his case to the world outside."Meanwhile, talented people who are frustrated by the pace of growth are heading for the exits. A number of high-level executives, from advertising to investment banking, have left for such companies as Macy's (FD ), Barclays (BCS ), andJPMorgan, taking underlings with them. "We are increasingly concerned about the people who are leaving throughout the ranks, and we're wondering if Prince is the right guy to make this thing go," says Great Companies President Jim Huguet. Prince responds: "When you are making a lot of changes, you are by definition making someone unhappy." The bank says it has recruited many talented people to fill holes.

Of course, not everyone is pessimistic about Citigroup's prospects under Prince. Steve Neimeth, a senior portfolio manager at AIG SunAmerica Asset Management Corp., who manages more than $800 million in assets, says the stock is a good buy. It has a 4% dividend yield and trades at roughly 11 times 2007 expected earnings, with an annual earnings-per-share growth rate of 8% to 10%. With help from a surge in the Dow 30 stocks, Citi hit a 52-week high of 51.03 on Oct. 4. Neimeth likens the recent underperformance of Citi's shares to that of Merrill Lynch or Morgan Stanley when those firms were undergoing management upheavals: "You need to buy them when they are out of favor."

By Mara Der Hovanesian, with Maria Bartiromo in New York

— With assistance by Maria Bartiromo

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