Posted tagged ‘transaction’

Citi: Breaking Up is Long Overdue (And Hard to Do Right)

January 15, 2009

Well, the Citi is burning… or breaking apart at least. Honestly, this has all been rehashed so much, I’ll not even bother citing where I have learned these basic facts and figures. First, though, I will say that Deal Journal‘s coverage has been great as has Alphaville‘s coverage. And, as usual, Felix is translating for us. Read all the coverage there (in between catching up on your reading).

The Facts

So, as is my usual M.O., let’s start with what we know.

  • Smith Barney is going into some odd and very complicated joint venture. In an epic win for branding, it will be called “Morgan Stanley Smith Barney.”
  • Citi’s private bank (focused on people with net worth of $10 million and up) and brokers who are housed within Citibank branches will not be part of the joint venture. Morgan Stanley’s franchise focusing on high net worth individuals, analogous to the Citi Private Bank, will indeed be part of the joint venture.
  • Citi is looking to slim down it’s operations, seemingly across all product lines. Businesses rumored to be “on the block” include risky consumer finance businesses (Primerica and CitiFinancial), private label credit card business (credit cards issued by Citi, but branded by another company, like a retailer), and proprietary trading.
  • Many structures are contemplated. Seemingly what will happen is another entity will have all those businesses transferred into it until each can be sold.

The Situation

Okay, seems clear. Now, what can we deduce from this?

First, the Morgan Stanley Smith Barney transaction will be an absolute and total nightmare. I predict the level of success will be somewhere between Merrill’s acquisition of Advest (disaster) and Bank of America’s acquisition of U.S. Trust (moderate success). Why do I believe this? Well, let’s look at what the joint venture creates: a massive, co-branded entity with business lines focused on high net worth individuals and, separately, more traditional clients of full-service brokerages. Also, this behemoth is responsible for selling both Citi and Morgan Stanley products! Morgan Stanley controls the entity and is left with no business lines that overlap with the venture. Citi retains brokers housed in their retail branches and it’s private bank, both direct competitors to the joint venture. Well, that hardly seems logical… To sell a business but still keep enough fragments of it to have to maintain the same infrastructure, support staff, and organizational complexity as if it wasn’t sold–things like stock trading, account processing, compliance, client account management, and relationship management software are all required no matter how many brokers you have.

Now, Citi further complicates it’s own dismantling with respect to the Smith Barney transaction because, well, it’s not east to answer the question, “Which advisers are part of Smith Barney?” For years Smith Barney has been hiring away brokers who focus on high net worth individuals but didn’t want to be part of the private bank–these teams had a structure and style all their own. These teams also use the private bank’s platform and infrastructure. Where do these brokers go? With the joint venture or to the private bank? They need access to products and services which will not be part of the joint venture (but which might be duplicated by Morgan Stanley, although I doubt it). I don’t know where these teams go, and I’d be 97% sure Citi doesn’t know (and Morgan Stanley is, most likely, not aware of the issue).

Just to summarize, we see that Citi has created an entity it intends to compete with and which diminishes their distribution capabilities and other value of their remaining businesses, while not diminishing any of their infrastructure needs.

Next up, we have the dismantling of the mothership–everything that isn’t Smith Barney within Citi. Let’s first note that the infrastructure argument from above applies here, it seems like no business line is going to be cut, merely focused. Although, there are probably still some sort of cost savings here because these franchises rumored to be spun off have always been marred with issues due to the lack of integration. For example, it’s been reported that CitiFinancial lives on it’s own systems and isn’t integrated in any way with other consumer businesses.

Mundane details aside, though, who is going to buy these businesses? In this market, when you cherry pick the worst businesses and try to sell them who is buying these businesses for anything but rock-bottom prices? Further, if you don’t sell the businesses A.S.A.P., then you’re still at risk for the losses. I’ll say that I don’t see the value in identifying to the world the businesses you are about to neglect–totally demoralizing the employees and hitting productivity and profitability hard–before you’re ready to actually dispose of those businesses. Further, why would anyone buy the businesses Citi had that were under-performing all these years? It’ll be interesting to watch how they position these “assets” for sale. Will they admit the problems and put those in front of potential buyers as immediate ways to increase value?

Two last points to be made, both about the investment bank.

  1. Citi is spinning off the assets guaranteed by the U.S. Government. What will that do to the financial status of the government’s investment?
  2. Citi is said to be shutting down all proprietary trading businesses. Anyone who has been watching knows that those businesses are either the few remaining revenue generators or have dismantled themselves long ago. And some, like Metalmark or the hedge fund that hadn’t launched or began operating yet (but was founded by Morgan Stanley alums), were clearly acquired at top dollar.

Further, this means Citi is going to drastically scale down it’s trading operations. When one is merely an order taker, and cannot use the firm’s capital, there is a very limited upside. You have turned a white collar professional into the best paid grunt ever. While some Citi traders clearly deserve this, it’s not clear that a complete strategy change won’t kill Citi’s sales and trading operation totally.

The Elephants in the Room

After all this, Citi still has some big issues that will challenge it’s ability to operate effectively going forward. Some of these are holdovers from my earlier issues with Citi

How is Citi going to deal with the politics, infighting, legacy technology issues, and fractured culture? These, I would argue, are the real sources of the tens of billions in writedowns. No effective risk management. No sense of responsibility. No trust in management. No ability to even see all the risks on the books.

Why won’t Citi need more capital or have to deal with further catastrophic losses? Especially with these assets being de-emphasized and starved of capital.
I have yet to hear a god answer, really, about why the steps beyond the Smith Barney transaction are even newsworthy. Until something is sold or shuttered, it’s all financial engineering and corporate legal maneuvering.

I guess we’ll see…

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Dear John Thain: Think Outside the Box with T.P.G.

May 26, 2008

Dear John Thain,

I am intrigued to see you talking to T.P.G., although the media seems to only care about discussing capital infusions from the P.E. firm and hedge fund manager. With the recent Clear Channel conflict reverberating throughout the financial system it’s never been more clear the friction points that exist between investment banks and the other firms with which they interact. Building a collaborative relationship with a large private equity firm will give Merrill the ability to innovate their business model and profit where other banks are trying to mitigate losses. Would T.P.G. be in a better position with Merrill seeding their funds? Absolutely. Would Merrill have a better franchise if they were assured to be retained as an adviser for all/most of T.P.G.’s acquisitions (and likewise for portfolio companies)? Absolutely. Would financing large deals be easier if both sides (lender and borrower) have a stake in the transaction being completed and the total P&L of the deal (debt and equity)? Absolutely.

The best part is the model already exists and been proven out: Goldman Sachs. Goldman Sachs Capital Partners is one of the top fee payers amongst private equity funds, showing a clear benefit to Goldman’s advisory business. Goldman has been able to be aggressive in moving loans throughout the recent credit market turmoil–having a large P.E. operation, the fee income from their equity investments provides a positive balance to the negative marks for loans. In good times Goldman’s private equity arm generated profitable loans for itself and other banks (wow, how far those days seem) and added to their total income associated with a transaction. Clearly this dynamic is superior to the situation the Clear Channel financing consortium found themselves in, suing the financial sponsors because the sponsors are making money and the banks aren’t.

Merrill would also have an extremely valuable asset in the T.P.G. brand, proven fund raising ability, and long track record–a benefit that other investment banks have pursued but not had much success in achieving, Goldman being the closest to an exception (or perhaps Morgan Stanley in the form of M.S.R.E.F.). Clearly these considerations are extremely similar to the considerations that drove Merrill’s decision to invest in a top brand in money management (Blackrock). Oh, and let’s not forget the alternative asset management platform Merrill will gain access to with T.P.G.-Axon.

So, Mr. Thain, what is my proposal? Well, I’m hardly an expert on structuring these sorts of transactions, but some specific points worth exploring come to mind:

  • Merrill should take an equity stake in T.P.G. to align it’s interests with the performance of T.P.G.’s funds.
  • Merrill and T.P.G. could form a J.V. where Merrill’s leveraged loan business would, partially or in its entirety, reside. This unit would be responsible for financing buyouts and servicing T.P.G.’s needs. Leveraged finance professionals, leveraged loan trading, and distribution of loans would occur in this unit.
  • Merrill and either T.P.G.-Axon or T.P.G. itself (or both) could create an actively managed debt fund to opportunistically purchase corporate loans, real estate loans, etc. Merrill would provide some amount of leverage with T.P.G. using it’s deep relationships to acquire the rest. Some Merrill loans in inventory would seed this venture.
  • Merrill would become an adviser to the various T.P.G. funds. I’m not sure if it’s permissible to “lock up” future advisory business, but certainly there would need to be an understanding for a strong preference for Merrill to be included on all advisory work.
  • Merrill’s current private equity business, where allowed and not in violation of any agreement (O.M. terms, perhaps), would sell it’s private equity business to T.P.G.
  • Merrill and T.P.G. could institute a program for high net worth brokerage/private wealth clients to invest in T.P.G. funds.

Those are just some of the points that could lead to a productive and profitable relationship. This would turn other firms’ weaknesses and conflicts into an opportunity for Merrill. There are, obviously, tons of places where such an arrangement could break down (valuation of businesses, legal constraints, logistical issues, compliance and conflicts, etc.) but innovating the business model of Wall St. is going to set the stage for the next boom, in much the same way firms have failed this time around by, for example, relying on the same distribution-centric business models for new, unproven products. Just a thought.

Sincerely,

DearJohnThain