Studying Citigroup

With the major stock indexes falling, the Rule Maker faces the same challenge as many investors: How to quickly review a wide range of stocks whose prices are becoming more attractive?

We've no magic answer here, just the advice to get busy and understand there are limits to the information you'll be able to gather and assimilate. Fortunately, we have a growing watch list of companies we've written about in the past that may become purchases at some point in the future, but there are still many opportunities we're exploring on the fly. 

For quick review, we picked the financial services industry because shares in this sector have taken a hit in the aftermath of the World Trade Center disaster. It feels a little small to be talking about stocks at a time like this, but that's what we do here. It's our job. And as investors we're always looking for opportunities to buy shares of solid companies at reasonable prices.

Today I'll take a look at Citigroup (NYSE: C), the world's largest financial services company. Next week, we'll write two articles on the investment banking business, focusing, most likely, on Goldman Sachs (NYSE: GS), Morgan Stanley (NYSE: MWD) (Mike Trigg had a quick take on the company in today's news), Merrill Lynch (NYSE: MER), and J.P. Morgan (NYSE: JPM).

Citigroup offers a wide range of financial services to consumers and corporations in more than 100 countries. As many investors and analysts have said in the past, it's hard to find a Citigroup peer since, more than any other bank, Citigroup has fashioned itself into the proverbial modern financial services company, offering a wide array of products: commercial and consumer banking services, credit cards, securities trading, insurance, investment research, annuities, and mutual funds.

While investment banks such as Goldman and Merrill make the bulk of their money in the corporate underwriting business, and American Express (NYSE: AXP) makes most of its money in the consumer charge and credit card business, Citigroup has a foot in both corporate and consumer camps. I like this kind of diversification.

Citibank has three main divisions: Global Consumer, Global Corporate, and Global Investment Management. The first two are the earnings winners, bringing in about 39% and 47% of 2000 net income, respectively. The big drivers in the Global Consumer unit are the company's North American credit card business, which made $2.7 billion in 2000, and the Travelers and Primerica insurance business, which made $1.6 billion. In the Global Corporate unit, the profit maker is the Salomon Smith Barney investment banking and securities business, which made $3.7 billion in 2000.

Citigroup stands where it does today as the result of mergers and acquisitions such as the November 2000 acquisition of Associates First Capital and the October 1998 merger with Travelers, which combined two companies with more than $6.4 billion in net income. By 2000, Citigroup net income had soared to $13.5 billion.

Citicorp is the world's largest issuer of credit cards, with 100 million accounts and about $118 billion in receivables at the end of last year. It's the world's largest global consumer finance company, with $5.3 billion in net income. From 1990 to 2000, Citigroup shares grew an astounding 40.6% annually as its mergers and acquisitions succeeded and the economy grew.

It has been a different story this year. Citigroup shares fell about 30% as the underwriting business dried up and fears of recession haunted shareholders. Of course, the shares fell in the aftermath of the terrorist attacks as recession fears rose, and the company reported that its Travelers unit could be exposed to as much as $700 million in losses from the attacks.

Economic downturns always have a powerful effect on the shares of financial services companies, but Citicorp's business strength is undiminished. The current climate won't last forever and Citigroup will likely thrive.

Still, I have a number of concerns about the company that keep me from getting too excited about it as a new Rule Maker. Some are related to the company and others have more to do with the Rule Maker Portfolio.

1. For Citigroup's shares to double in five years, we need to see the company's market share grow to $400 billion. Personally, I'm more interested in hunting for companies with a bit more headroom. This doesn't mean Citigroup can't keep growing and creating value, just that moving a ship this big is a monster task. I don't expect to see even the best companies receiving the kind of earnings multiples they earned in the go-go 1990s. With its current multiple in the 13 to 14 range, I'm not convinced we can't find better bargains.
   
   
2. To me, the most intriguing part of the company's consumer unit is its banking and lending business, primarily its credit card division. Yet we already own American Express in the Rule Maker Portfolio, which we chose because of its brand. Citigroup's card unit is large and efficient, but less differentiated. I'm not sure it makes sense to duplicate our investment in the card business with Citigroup, even though the company offers many other financial products and services.
   
   
3. Citigroup typically uses the pooling of interest accounting method when it merges with another company, and it has done so often. Because the balance sheets are simply combined in such a transaction, no premium for goodwill is recorded. This artificially boosts the company's return on equity because it doesn't have to earn a return on the premium it pays. In my opinion, we're a little bit in the dark determining the company's returns.
   
   
4. As successful as Citigroup's stock has been, there's a lot of work left to do on the big Travelers merger. A Bloomberg story in March detailed the difficulties the company is having cross-selling its vast array of products. This was the reason for the merger in the first place.

That's my quick take on Citigroup. It's a Rule Maker, but I'd like to fully explore other avenues first.

Post your thoughts on the Rule Maker Strategy discussion board.

Have a great day.