Can Citi Regroup?

Investors want a breakup, but the arguments against that are powerful

By Mara Der Hovanesian

Need further proof that investors want Citigroup (C ), the world's second-largest financial supermarket, to break itself apart? Consider the events of Nov. 5. Chairman Robert E. Rubin noted that whoever steps in permanently for newly departed CEO Charles O. Prince isn't likely to make big changes anytime soon—and Citi's lifeless stock dropped a further 5%. "Break it up," thunders William B. Smith, senior portfolio manager of Smith Asset Management and holder of 70,000 Citi shares.

Selling off assets would seem to solve many of Citi's subprime mortgage and other woes. Analysts at bond-monitoring firm CreditSights said on Nov. 6 that the bank's losses could surpass $21 billion all told. Citi itself doesn't yet have a handle on how bad the problem might get. "These are current estimates," says Chief Financial Officer Gary L. Crittenden. "It's just not possible to know the direction of the markets." Unlocking cash through asset sales would give Citi financial flexibility—and appease increasingly vocal shareholders who've long argued that the financial supermarket model isn't working.


But a breakup might not be the panacea investors think. "We value [Citi's] diversification," says Tanya S. Azarchs of Standard & Poor's (MHP ). "It's a good safeguard for what goes wrong in one area if you have others that are working." Indeed, during the subprime storm, Citi's international, wealth management, and other businesses have helped smooth out its earnings results; without them, the profit hit would be even worse. Azarchs says major earnings problems next year could prompt a downgrade of its bonds, and she says a breakup would increase that risk. "With the credit cycle deteriorating and consumer credit issues starting to mount," says Azarchs, "can we be assured that next year will be smooth sailing?"

What's more, while money manager Smith estimates that Citi's breakup value is 67 a share, nearly double its current price, the firm won't get top dollar with valuations of financial firms slumping. Eric C. Weber of Freeman & Co., a New York investment bank, notes that mergers and acquisitions in the financial services sector fell to $142 billion in the third quarter, from $250 billion in the first. "Do you want to sell, or do you want to hang on and see if the market recovers?" asks Weber.

The tax consequences of selling off particular units could limit Citi's options, too. Joseph Unger, a tax partner at Weiser, a New York accounting firm, notes that it wouldn't make sense for Citi to lop off any profitable foreign operations, which make up half its income, since overseas earnings are tax-free. And if Citi were to spin off a U.S. unit it has owned for less than five years, it could trigger double taxation for shareholders and the company, because spin-offs are treated as dividends for tax purposes. "When you talk about a breakup, corporations don't have many tax benefits, but they do have tax detriments," says Unger.

Not everyone wants a split-up. William C. Nygren, manager of the $5.4 billion Oakmark Fund, which holds 2.4 million shares, says Citi's "global footprint and strong brand give it worldwide growth opportunities that most financials don't have, and we still think those advantages are in place."

There's one thing on which virtually everyone agrees, however: Prince managed Citi poorly. The other financial supermarkets have fared much better recently. Says one former Citi business head: "I don't hear any noise about Wachovia (WB ) or JPMorgan Chase (JPM ) selling off wealth management or the brokerage unit. [Citigroup's problems were] clearly an issue of mismanagement of great assets."

Rubin seems to believe better managers are needed, not a better model. Interim CEO Win Bischoff hasn't yet weighed in. Says a New York investment banker: "If, as a board member, you really don't want to start breaking [Citi] apart by taking out pieces, then you've got to find someone capable of running this thing."

With Anthony Bianco

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