Friday, November 30th, 2007
Why Some of the World’s Savviest Investors Are Buying - Gasp! - Citigroup
By Keith Fitz-Gerald
Investment Director, Money Morning
At a time when many investors are running for the exits, a few of the world’s savviest investors are lining up to buy Citigroup (C).
Admittedly, many investors are just scratching their heads. But that’s because they can’t be bothered to look at the real picture - an opportunity to buy into one of the world’s fastest growing and best run financial companies, at a bargain basement price…
I recognize that you might be thinking that I’ve completely lost my mind calling Citi anything that even remotely resembles a credible investment - let alone one of the world’s best-run companies, but hear me out…
First, what’s causing Citi’s current angst is related to a breakdown of risk management - not the deterioration of operations.
In fact, the company remains globally diversified, and many portions of its business still reflect double-digit growth rates, particularly when it comes to China and Eastern Europe. That’s something that most investors in their rush to judgment don’t properly understand.
As a result, the markets have sold the company hard. And that brings me to my second point:
Citi is trading for a pittance.
In fact, it’s just barely seven times earnings and eight times 2008 earnings. Yet, if you add up the growth prospects and current valuations, the company reflects a value that could be as high as $60 or more a share.
Value investors will recognize this as important because history shows that the lower P/E ratios are when you make an investment, the better your overall returns tend to be. Generally, large globally diversified companies are considered bargains at a P/E of 12, which makes Citi a screaming deal at 7 or 8.
Now we get to the third point:
The list of investors beating a path to Citi’s shares right now is looking like a "who’s who" of legendary investors.
Not only is Citi’s largest shareholder, Saudi Prince Alwaleed bin Talal, keeping his shares, but he’s rumored to be angling for more. And given his history with Citi, that’s hardly unexpected.
The last time Citi stumbled was in the early 1990s, when it made a series of bad U.S. real estate bets and got overextended in Latin America. Back then, Prince Alwaleed stepped in with $600 million (at a converted share value of $2 per share) and literally turned it into billions. This time around, I can’t imagine his expectations are any different.
Then there are the value managers, like noted bargain hunter William Smith of SAM Advisors. He’s been actively buying shares. In fact, he’s pinned Citi’s "sum of all parts" value at $63 a share, according to a recent article in Barron’s.
My own calculations come in at $55, but either way, that’s nearly a double from where Citi is trading today.
Most recently, the Abu Dhabi Investment Authority entered the picture with a $7.5 billion chunk of change for a 4.9% stake in Citi’s equity. Not only is this going to provide a much need source of capital for Citi at a time when it badly needs it, but it will help raise Citi’s reserves to required levels, which will provide additional reinforcements against further credit problems.
And this brings me to my fourth point:
There’s a good chance that the credit market write downs, which have been so extreme in recent weeks, will be reduced in subsequent quarters the same way employment numbers are revised after the fact.
The reason is that collateralized bond obligations (CDOs) are valued according to proxy, which means that there’s no open market valuation mechanism. In other words, CDOs are worth what the companies who are responsible for them say they are worth.
In an era when CEO’s are acutely sensitive to accurate disclosure, it’s entirely possible that they’ve erred on the side of overly aggressive write downs, much the way banks erred with real estate write downs during the S&L crisis two decades ago.
If the valuation write downs Citi (and others) have taken do in fact prove to be overly extreme, then there’s a lot of money that will suddenly find itself back on the books in a real hurry at the first sign of an upward revision.
It all comes down to cash flow, as so many things do. And in this case, Citi’s valuations have been pummeled at a time when the underlying cash flow really hasn’t changed all that much.
One caution though, there’s a lot of conjecture that Citi may have to break itself up or cut its dividend. Certainly those are valid risks. So are possible downgrades and negative comments from gun-shy ratings agencies that were caught flatfooted by the credit crisis - just like they were in 2000 when the dot.bombs blew up.
Any of these things will take a while to work through the system, and Citi’s share price will be volatile. In fact, I’m betting on it - and so are other seasoned pros like the ones I just mentioned…
And therein lies the opportunity.
News and Related Story Links:
- Money Morning News:
Citigroup Gets a Much-Needed $7.5 Billion Boost from Abu Dhabi. - Money Morning News:
Goldman Analyst Says ‘Sell’ Citigroup, Lowers 2008 Estimates - Barron’s:
Citi Can Still Deliver On Its Unrealized Promise - Wikipedia:
Saudi Prince Alwaleed bin Talal
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