Can Citigroup Inc.’s Vikram Pandit pull off the banking equivalent of the retreat from Gallipoli in World War I?
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After a failed campaign to overthrow the Ottoman Empire, the British, French and Australasian expeditionary force replaced its commander and executed a clever retreat with minimal casualties. It’s too early to tell whether Pandit will have similar success if he breaks up the Citi behemoth.
But wedging Smith Barney into a Morgan Stanley-run joint venture is a deft start. Citigroup is merging the US and Australian operations of Smith Barney, a division of Citigroup Global Capital Markets Inc., as well as its UK outfit, Quilter, with Morgan Stanley’s wealth management unit. Morgan Stanley will initially own a 51% stake in the joint venture and pay Citigroup $2.7 billion (Rs13,149 crore). After year three, both firms will have various purchase and sale rights. For example, Morgan Stanley can buy an additional 14% stake after year three and 15% in year four.
Citigroup will register a total gain of $9.5 billion—$5.8 billion after tax—as the deal will allow the bank to write up the value at which it carries Smith Barney on its balance sheet. This will also create around $6.5 billion of tangible common equity. The joint venture will be called Morgan Stanley Smith Barney.
How does this work? After all, Citi is only getting $2.7 billion for handing control to Morgan Stanley. That’s a far cry from the $25 billion or more that Citi might have fetched if it sold Smith Barney in its entirety a year ago, or earlier. But Citi has always carried Smith Barney on its books at around $3 billion. By ceding control to Morgan Stanley, Citi creates an extra $6.5 billion in tangible common equity. As a result, the bank will register a pre-tax gain of around $9.5 billion, including the payment from Morgan Stanley.
And of course, Citi retains a 49% stake in the joint venture which, with luck, will have increased in value by the time Citi’s option to sell any more of the unit kicks in three years down the road. Moreover, the two firms reckon they can slash 15% of their combined expense base, or around $1.1 billion. Once taxed and put on a multiple of 10—a standard way of valuing cost savings from a merger—the value to Citi’s shareholders for its share comes to around $3.8 billion.
There are risks of course: even with retention packages on offer, brokers may leave; and a prolonged recession and stock market slump could stoke lurking culture clashes and management differences. But for now, at least, Pandit appears to have pulled off a good first step towards making Citi more manageable. But he has a long way to go to pull the rest of Citi out of the quagmire.