Citi's Nikko Bid Faces Investor Hurdle

Citigroup's planned takeover of the brokerageit would be Japan's largest by a foreignermay require a larger offer to appease other shareholders

If Citigroup's (C) planned acquisition of Nikko Cordial (NIKOY) goes through as planned, it would become Japan's largest-ever foreign takeover. But Citi, which announced the deal on Mar. 6, might have to cough up more than the $10.8 billion that Chief Executive Officer Charles Prince had bargained for.

At least one of Nikko Cordial's investors, Chicago-based Harris Associates, has come forward and complained that Citi's offer of 1350 yen ($11.60) per share isn't nearly high enough. "We welcome Citigroup's involvement but certainly not at that price," David Herro, chief investment officer of international equities at Harris, told Bloomberg News. Herro reckons Japan's third-largest brokerage is worth at least 2,000 yen ($17.20) a share.

It's unlikely that Harris is the only shareholder Citi will have to appease. Nikko's four largest shareholders are based overseas. In recent weeks, some of those shareholders—who own over half of Nikko's shares—have been increasing their stakes in Nikko amid speculation it would be bought out by Citi or Mizuho Financial Group (MFG), Japan's No. 2 banking group, among others.

Chance of Failure

While it is the largest shareholder in Nikko, Harris's 7.23% stake on its own isn't huge, and it's unclear whether others, such as Southeastern Asset Management, Mackenzie Financial of Canada, or Bermuda-based Orbis Investment Management, will chime in. But if they decide to band together they would account for more than a quarter of Nikko's stock and their opposition could prove a stumbling block for the deal.

What is clear is that Citi's terms aren't particularly generous. Citi's offer price for Nikko Cordial shares gives investors a premium of just 0.75% over the closing price on the day the deal was revealed. It's also nearly 10% less than the value Nikko's stock traded at in December. "Without raising the takeover bid price, there will be a great chance Citi will fail," says Yasuhiro Matsumoto, an analyst at Shinsei Securities in Tokyo. "The mark-up may need to be around 20%."

Citi and Nikko said that Citi would seek to raise its current 4.92% to at least 51%, and both sides expressed confidence that the deal would be approved (see, 3/6/07, "Tokyo Comeback: Citi Buys Nikko"). Many analysts in Tokyo agree.

Welcoming a Bailout?

But Citi and Nikko shouldn't get complacent: Last month, shareholders in Japan rejected a merger attempt between steelmakers Tokyo Kohtetsu and Osaka Steel, marking the first time that a plan approved by the board of directors of both companies got shot down by investors. Ichigo Asset Management, a fund led by a former Morgan Stanley (MS) banker, urged investors to block the transaction because the proposed share swap didn't give Kohtetsu shareholders a sufficient premium.

Even so, a few factors remain in Citi's favor. Japanese shareholders may be eager to accept the offer quickly. The Tokyo Stock Exchange is considering de-listing Nikko Cordial's shares as punishment for accounting irregularities, and a decision could come as early as Mar. 9. If that happens, many Japanese fund managers would welcome the chance to bail out at whatever price they can get because of agreements with clients to only invest in listed companies.

And if Citi's offer were to fall through, it's unclear whether another buyer would step in. Mizuho, which will become Japan's fourth-largest brokerage after it merges its business with Shinko Securities, reportedly decided against making a bid for Nikko. So far, its executives show no signs they're changing their minds.

Still, Citi would be wise to boost its bid rather than rely on the TSE to help its cause. "I don't think a de-listing will draw any concessions from the investors. They know Citi is eager to buy Nikko," says Shinsei's Matsumoto. "Citigroup should quicken the buying process to take away anxiety among Nikko's customers and employees…by raising the bid."

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