3 Ways to Fix Citigroup

It's been quite tantalizing to watch Citigroup's (NYSE: C  ) shares sink to five-year lows -- buried underneath the horrible news headlines lies an unparalleled money-making machine. I'm no financial genius, but I believe there's a simple way to unleash Citi's potential and send its shares skyrocketing.

Act 1: Capital restructure
First off, Citi needs to shore up the balance sheet, even if that means cutting the dividend or diluting current shareholders -- no short-term pain, no long-term gain. After all, a bank relies on its balance sheet to extend loans and pay depositors, so it's better to make sure the patient is fully rehabilitated before sending it back out into the business jungle.

Thus, Citi's management should place a couple of calls to the likes of Warren Buffett at Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) , Eddie Lampert at Sears Holding (Nasdaq: SHLD  ) , and Saudi Arabian Prince Alwaleed bin Alsaud (a major shareholder) to raise somewhere in the neighborhood of $25 billion to $30 billion, the amount CIBC analyst Meredith Whitney suggested Citi needs to remain healthy.

Sure, raising additional capital would dilute current shareholders by about 10%-15% (depending on the conversion premium), which is a slight negative, because current shareholders will thus own less of the company. However, I think a little dilution is a minor price to pay to fix the balance sheet and reposition Citigroup for future success.

Act 2: Instill confidence
Citi's problems are neither structural nor pervasive among its distinct collections of strong businesses. For example, the problems with structured investment vehicles (SIVs) and collateralized debt obligation (CDO) credit quality do not hinder Citi's ability to offer wealth management services at the Smith Barney division, or credit cards to consumer bankers. The problems are localized and fixable.

After raising that $25 billion, Citi could amputate the tumor by effectively getting rid of its exposure to credit-sensitive securities. Keep in mind, I am not suggesting that Citi have a fire sale of its CDOs and leveraged loans.

Rather, armed with a $25 billion war chest, Citi could resecuritize, hedge, and insure its troubled securities to get rid of the malignant credit tumor. This should help shunt exposure to its estimated $55 billion in remaining subprime exposure (for which Citi estimates it may need to take an additional $8 billion to $10 billion loss), $80 billion in SIVs (although it doesn't bear credit risk, it has some liquidity risk), and $57 billion in leveraged loan commitments as of the latest quarter.

In addition, the announcement of former Treasury Secretary Robert Rubin as interim chairman should provide a psychological boost to the credit markets. Rubin's role will be to pick a new CEO, with possible candidates including John Thain, current CEO of NYSE Euronext (NYSE: NYX  ) ; Robert Willumstad, Citi's former COO and current Chairman of AIG (NYSE: AIG  ) ; and Vikram Pandit, who heads up Citi's alternative investment businesses. Installing a CEO with a track record as a skilled operator, and more important, one with risk management skills, should help boost Citi's stock.

Act 3: Break it up!
Citigroup's shares trade at a huge conglomerate discount. Boutique investment banks like Greenhill and Lazard, wealth managers like Raymond James, and diversified consumer banks like US Bancorp (NYSE: USB  ) and Wells Fargo (NYSE: WFC  ) trade in the 20, 15, and 12 times trailing price earning multiples ranges.

Citigroup, which boasts extremely competitive positions in most of its businesses, should trade near or at a slight discount to these multiples -- shares are currently trading at less than eight times 2008 earnings estimates. If Citigroup simply split into consumer banking, capital markets, and wealth management divisions, it would almost certainly increase in value, become much more nimble, and remove layers of bureaucratic expenses.

The synergies of the financial supermarket model have never worked. Sure, it makes sense for consumer banks to offer credit cards. But it doesn't make much sense to pair an investment bank and a consumer bank. Jane or Joe Schmo won't walk into a bank, deposit $100, and then ask for merger and acquisition advice.

So there you have it. Anyone who has ever read "You Can Be a Stock Market Genius" can attest to the fact that spin-offs handily outperform the market once freed from an onerous and bureaucratic structure. It may be time for Citi to regroup, spin off into separate businesses, and finally allow its shares to beat the market.

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