Since the beginning of 2021, Citigroup (C 1.87%) has been working on a multiyear plan to modernize and simplify the bank, focus on better-performing businesses, and ultimately boost returns, which management hopes will lead to a higher valuation and stock price.
A key part of this plan had been selling the consumer, small business, and middle-market banking arm in Citigroup's Mexican subsidiary, Citibanamex, which has been a high-performing business. But recently, Citigroup said that it would no longer pursue a sale of these businesses and would instead spin them off in an initial public offering (IPO).
While this had always been a possibility, most believed a sale would be the likely outcome and the quickest way to expedite the bank's multiyear transformation, which makes this news disappointing. Here's why.
Image source: Getty Images.
Why no sale?
Citigroup has been divesting most of its international consumer banking franchises that lack adequate scale. While Citibanamex has been a bright spot for the bank, it makes Citigroup more complex. I think many investors were on board with the plan because the sale would free up significant capital and likely lower Citigroup's regulatory capital requirements.
The problem is that Citibanamex is one of the largest banks in Mexico. So a sale involves working closely with the Mexican government, which had several key conditions attached to Citigroup's decision to exit the business.
For instance, Mexican President Andres Manuel Lopez Obrador said last year that Citibanamex should be sold to Mexican investors and avoid mass layoffs. That led other potential bidders to drop out and likely reduced the value of the businesses, because a big way bank acquisitions create value is through cost savings, which typically include layoffs.
Grupo Mexico had reportedly been closing in on a deal to purchase the Citibanamex units for $7 billion, but the units likely would have fetched more had some of these conditions not been attached. It is also unclear what other conditions would have been attached to the deal. In a press release, Citigroup Chief Executive Officer Jane Fraser said that management concluded that the best way to maximize shareholder value was through an IPO.
Removing a near-term catalyst
Although Fraser probably is right about maximizing value, I and many others had viewed the announcement of a sale, which had been expected this year, as a near-term catalyst that might get the stock moving from its depressed levels. The sale would enable Citigroup to clarify its capital position and, ideally, begin buying back stock while it traded below its tangible book value or net worth.
NYSE: C
Key Data Points
As part of this decision, Citigroup said it could resume a modest level of share repurchases this quarter. But now, the separation of Citibanamex's consumer, small business, and middle-market businesses from its institutional businesses isn't expected until at least next year, with an IPO not anticipated until 2025. This process will remain an uncertainty for investors, and the bank's full transformation will take longer.
Furthermore, this puts a lot of focus on the Federal Reserve's stress-test results, due in June; the tests play a significant role in determining large bank regulatory capital requirements. Citigroup has built a lot of capital recently, so if the bank's requirements don't rise, it may be able to commence a larger buyback, which investors have been waiting for. However, after several high-profile bank failures, many are uncertain how severe the stress-test results might be and, therefore, how they might affect bank regulatory capital requirements.
Is the investment thesis still in play?
I am disappointed by this news because it continues to drag out the broader transformation process. While it might result in more value for Citibanamex, I would have preferred that the bank complete this part of the transformation sooner than later.
That said, I still think the investment thesis is in play, whereby the bank modernizes its infrastructure, takes care of regulatory issues, becomes simpler, and invests more in higher-performing businesses to boost returns. A bigger share repurchase plan is also still possible, depending on what happens with stress testing.
However, the story and path likely just got longer, and I'm guessing investors' patience continues to run thin because they have been waiting a long time for Citigroup to get its act together. Time is a big part of investing, so this could make it less compelling for investors to stick around. But if you can take a longer-term view, I still think there is a good investment to be had here.
