Possible Financial Spinoff In The Future - Should You Wait To Buy?
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In general, investors benefit when the companies they own break up. This is particularly true of companies that are very complex, such as huge financial companies. In contrast, management may be slighted from breaking up their companies as this makes their fiefdoms smaller.
Michael Corbat has taken over Citigroup (NYSE: C) as its new CEO, and some shareholders see this leadership as an opportunity to get parts of Citigroup spun off. Should investors buy Citigroup shares at this time, or should they wait?
Analyst Calls for Big Bank Break Ups
Renowned bank analyst Mike Mayo is making waves since he suggested that it would be in shareholders’ best interests if large banks split into smaller, low-risk units. Mayo indicated that many banks were underperforming as evidenced by their returns and stock prices. Breaking them up into simpler companies would have the stock prices increase up to double what they are now. According to Mayo, “A large majority of investors indicate that breakups — divestitures, downsizings and de-mergers — would be good for stock prices.”
Mayo insists that banks need to have low gearing levels thus low risk, and low cost of capital for stock prices to improve. According to Mayo, this can only be achieved if banks break and it is important since better stock prices add up to the achievement of shareholders’ wealth maximization goal. Mayo cited a few divestitures including JP Morgan’s Asset management unit and indicated that such are bound to reduce risk and cost of capital.
To be fair, it is odd that Mayo insists that performance of major banks is below par yet Bank of America (NYSE: BAC) had its share price double-despite its large size. It seems that his thesis anticipates even more value that could be realized by simplifying these bank businesses.
Breaking up these financial companies could have some negative consequences. Some clients could interpret split ups to mean the banks are predicting financial crisis and they may withdraw their investments as a result.
More voices are piping up in support of Mayo since large firms are associated with much higher risk.
Regulator Sues JPMorgan for WaMu Securities
And yes, there are lots of problems that arise from the big banks being too big, to complex, and too engrossed with legacy assets for even the best management teams.
Most recently, the NCUA (National Credit Union Administration) filed its third lawsuit against JPMorgan Chase (NYSE: JPM), the largest bank in the United States, concerning losses generated by mortgage-backed securities. JPMorgan, after buying the assets of Washington Mutual in 2008, is accused to have violated standards against misrepresentation in the underwriting and sale of Washington Mutual’s mortgage-backed securities. This has led to insolvency problems for Southwest Corporate, Western Corporate and U.S. Central federal credit unions, the purchasers of these securities. According to the agency’s board chairman Debbie Matz, “The damage caused by the actions of firms like Washington Mutual has been extremely expensive to contain and repair. It’s only right that the people who caused the damage be required to pick up that burden, as well.”
The case serves as an addition to the pile of pending lawsuits against JPMorgan relating to its conduct during the 2008 financial crisis. In the first case filed on June 2011, JPMorgan was similarly the underwriter and seller of around $1.4 billion worth of securities. In December 2012, the bank was again sued over $3.6 billion worth of Bear Sterns securities. None of these cases have been resolved as of present.
During the previous two years, NCUA made similar actions against Credit Suisse (CS), RBS Securities (RBS), UBS Securities (UBS), Goldman Sachs (GS), Barclays Capital (BCS), and Wachovia. Many of these cases are also pending, but settlements amounting to $170 million have been made against HSBC (HBC), Deutsche Bank Securities (DB) and Citigroup.
NCUA has been trying to remedy the losses generated during the crumble of the housing market, focusing on five financial institutions that it seized in 2009 and 2010. Wholesale credit unions have experienced larger losses compared to retail credit unions as certain restrictions were not similarly imposed on permitted investments.
Will Citigroup’s new CEO break it up?
Many large investors including Trillium Asset Management, the Benedictine Sisters of Mount St. Scholastic, and the AFSCME Employees Pension Plan filed a proposal for the Citigroup to be broken up. The vice president of Trillium Asset Management, Jonas Krons, emphasized, "If there's not an appetite for our proposal so be it. But we think there should be a discussion."
Rebuttals to the proposal suggest that it lacks specifics since it does not say what exactly is to be spun off. The plan might suffer from accounting errors. In addition, there might be some resistance to any examination of assets which might appraise them lower than the book values they are listed at today. Citi could try to sell its investment banking division although it might not be worth much because it is perceived as underperforming other investment banks. Finding a buyer may not be easy either since investment banks have generally struggled since the financial crisis
Since all of this is speculation, investors should only buy Citigroup without a breakup if it is a bargain. It is cheap based on valuation, but so are its peers:
Though Citigroup has a low price-to-sales multiple, it is not the cheapest on the basis of its discount to book value, or on its earnings multiple.
News of an activist investor-led asset disposal would be amazing news for Citigroup shareholders, but we don’t know if this will actually happen. Thus, don’t buy Citigroup yet. If you are looking to buy Citigroup, wait for a price decline based on a write-down or some other announcement which assigns bad news to the old management regime. Once the stock price sinks in response to news like this and plunges all its multiples below its peers, then Citigroup would be a conceivable speculative bet among other bank stocks.
BillEdson11 has no position in any stocks mentioned. The Motley Fool owns shares of Bank of America, Citigroup Inc , and JPMorgan Chase & Co.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!