These Investments Warrant a Closer Look Part Three: Going Very, Very, Long on Citigroup
Alexander is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Citigroup (NYSE: C) shareholders have had a rough six years. They have seen the value of their shares fall from over $500 per share, split-adjusted, to around $35 today. The darkest days were even worse, with shares trading under $10 per share, split-adjusted. Now, the company appears to be turning a corner, and it's far more stable than before. This leaves potential investors with multiple options on how to play a Citigroup recovery.
How we got them
When Citigroup was in need of capital during the financial meltdown, Uncle Sam stepped in, buying preferred stock and collecting stock warrants from the financial giant. This plugged holes in the balance sheet, ensuring that shareholders would get something, even though they'd still lose much of their stakes through dilution. Further dilution happened as the government converted its preferred stake into common stock before selling it to the public. So many shares were created that, prior to the reverse split, every person in the world could've had about four shares. During the selldown of the federal stake, the market took in billions of Citigroup common shares, along with the 10-year warrants the government collected.
These warrants, a result of the government's TARP program, also exist for other financial institutions, including Bank of America (NYSE: BAC), Wells Fargo (NYSE: WFC), and some regional banks. But Citigroup's warrants are much farther out of the money than B of A's or Wells Fargo's, and they represent an extreme bullish bet on Citigroup.
And I do mean "extreme"
Citigroup's class A warrants have a strike price of $106.10 per share; the company's shares currently trade in the $30 range. At only $0.35 per warrant, they appear underpriced, but the 1-for-10 reverse split means an investor would need 10 warrants to buy one share. In truth, that makes class A warrants a $3.50-per-share investment.
This is not the only way the reverse split has wreaked havoc on warrant holders. By reverse-splitting the stock, Citigroup has made a quick rebound more difficult, since it is easier for the market to move a stock from $3 to $10 than from $30 to $100. Citigroup will likely see gains over the next several years, but they will be slower than if a reverse split had never happened. For warrant holders, time is the enemy, and slower movement means lesser profits. In effect, the reverse split made these warrants far less attractive than they could have been had it never occurred. For this reason, they are only suitable for the strongest of Citigroup bulls.
Bullish on Citigroup
Despite not being a fan of the warrants, I am still bullish on Citigroup common stock, as both a value and recovery play. Citigroup is profitable again and has been free of government ownership for over two years now. For those who require a dividend to invest in a stock, Citigroup does pay one although it's only a penny per quarter. As the financial crisis recedes into the distance, Citigroup should feel more comfortable about increasing its dividend, a move that would also benefit the share price.
Like many other big bank stocks, Citigroup also trades at a fraction of its tangible book value. A return to historical valuations, or even just to book value, would result in a significant share price gain. Of course there are risks to this book value, like the company hiding a bombshell in its balance sheet or drastically overvaluing an asset, but as we move further away from the crisis, the risk associated with a drop in book value lessens and the removal of this risk should help the market valuation of Citigroup.
The numbers just don't provide a favorable valuation for the Citigroup warrants. However, I believe there is significant value in many of the other TARP warrants, as well as the AIG warrants which indirectly resulted from the bailout but were never issued to the government. If you are interested in a Citigroup lottery ticket, the warrants are your type of investment. But if you are interested in a buy and hold long term gain, the common stock is a better investment.
Interested in Additional Analysis?
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