Last night I was watching the futures soar on news that Citigroup agreed to sell 4.9% of the company to Abu Dhabi in return for $7.5 billion in cash. See Abu Dhabi Deal Raises Questions About Citigroup’s Health.
This morning Minyanville Professor Quint Tatro was talking about The Great Transfer of Wealth.
The problems the U.S. is facing today have come as a result of its own actions and it is now facing the consequences. This is nothing new and one can review many times in U.S. history when cycles have ebbed and flowed, resulting in booms and busts, the most recent being the technology bubble that came as a result of innovation, coupled with easy or cheap money and fueled by greed.
Now, however, it seems the U.S.’ white knight has arrived and the U.S. will gladly accept the international community’s assistance in working out its problems. Of course, this comes at a price and that is a transfer of this wealth at an incredible discount.
While I am still not sure how I feel about it all and I still need to process it quite a bit, my job as a market participant is not necessarily to over-analyze but to find a way to profit from it. I will be watching the financial stocks such as Citigroup, Washington Mutual (WM), Bank of America (BAC) to see how they handle today’s news. If they can bounce from these levels I would suspect the S&P; may start to find its footing, but if they cannot the blue light special may just have started.
Citigroup Deal Smells Of Desperation
Minyanville Professor Mark Bloudek is also talking about Citigroup in The Real Deal.
When I look at this deal it is quite interesting. First of all, it must be understood that this is effectively an equity deal because of the mandatory conversion provision. From the limited information I have been able to retrieve, it seems that Citigroup (C) is selling just under 5% of the company for approximately $5.7 bln. Why is it not the $7.5 bln that it is getting from the investors? Because Citi will have to pay interest on the $7.5 bln for just over two years, which will come out to approximately $1.8 bln. $7.5 – $1.8 = $5.7.
By my estimate, Citigroup has basically issued restricted equity (to be officially issued in two-plus years) at a price per share around the mid 20’s when you take into account the 11% interest it is paying on the $7.5 bln. Additionally, Citi does get the benefit of using $7.5 bln now instead of only getting $5.7 bln now (if it had just done a straightforward equity deal), while paying $1.8 bln over the next two-plus years in interest.
All in all, this deal is a tough deal for Citi in my opinion because it smells like desperation. But don’t be confused about the 11%. It is clear since the deal has mandatory conversion prices that the 11% interest rate is basically a discounting mechanism for the conversion price, which is why I say the equity was effectively issued in the mid 20’s. It also must be noted that doing a convertible may have certain tax advantages for Citi instead of doing a straight equity deal in the 20’s.
It should now be clear that Citigroup squandered tens of billions of dollars over the years buying back stock at inflated prices. The irony is that as petrodollars return home, foreigners get to buy in at an effective price in the mid-20’s.
This is the price the US has to pay for the our spending sprees over the last seven years financed by China, Japan, and the oil producers. And what do we have to show for that spending spree? The answer is a sinking US dollar, neglected infrastructure, and a housing boom gone bust.
Given that foreign dollar reserves eventually have to come home, this deal is just a token down payment for what’s to come.
On a side notes, I was asked this morning if foreign buying would support stock prices. The answer is that it won’t. For every buyer there is a seller so “buying” never drives up prices except on the day of an IPO. Sentiment (willingness to take on risk and speculate) drives stock prices, not “buying”. That sentiment is clearly waning.
The party is over. The US now must face the consequences.
Mike Shedlock / Mish
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