What Does Lampert Want with Citi?

Now that investor Edward Lampert has taken a stake in the financial conglomerate, analysts are wondering whether substantial changes will follow

Shares of Citi rose May 16 on news that hedge fund mogul Edward Lampert, the head of ESL Investments, had acquired a small stake in the market-lagging financial supermarket.

Lampert has about $800 million worth of shares, less than 1% of the company. RBS, which manages Lampert's ESL, revealed it had amassed a stake of about 15 million shares last fall and early this winter. Citi's shares rose about 3.8%, to $54.80, on the news.

What does Lampert want with Citi (C)? There was plenty of speculation online and off. Will the man known as an activist investor push for substantial changes at the underperformer or will he simply keep the shares as a passive investment? Maybe he'll just sit and wait for the market to have the company drawn and quartered for failing to fire people fast enough. At a time when conglomerates are out of favor, there are calls for a breakup of Citi.

Divided Bets

Citi shares have been chugging far behind its rivals. Citi stock is up 12% during the last two years, while shares of Morgan Stanley (MS) are up 50%, according to Bloggingstocks. That has infuriated investors such as Saudi Prince Alwaleed bin Talal, who have called for major cutbacks in expenses. Such calls have led to plans to shed 17,000 jobs.

Those measures haven't been enough to satisfy investors, though. Now a breakup of the company may be in the works. Citi management has fretted over that possibility for weeks, according to Financial Times' Alphaville blog. "Oh dear. Just a couple of weeks after senior Citigroup executives were revealed to have concerns that the bank could become the target of activist hedge funds, look what happens…" Alphaville noted.

Not everyone believes Lampert is betting on a breakup. As a longstanding investor in Sears (SHLD), Lambert is more of a "builder," according to The Wall Street Journal's Deal Journal blog.

Fee Floatation

The Peridot Capitalist argues that a passive investment is a possibility. "The purchase makes sense given that Lampert is a value guy (Citi trades at a 10 p-e and yields 4%) and his hedge fund is big enough that large cap stocks are the only kinds of investments that he can really take a meaningful position in without buying an entire firm," writes Chad Brand, president of investment advisory firm Peridot Capital Management.

A breakup might not be out of the question, though. Management has tried to cut costs, without much effect. Would another round of cost cuts really make enough difference to close the valuation gap with Morgan Stanley? That's a stretch. Given the current disdain for conglomerates, a breakup could be hard to resist. And that would generate enough fees to keep the investment banking sector afloat for the next century.

Before it's here, it's on the Bloomberg Terminal.