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Never underestimate the unintended consequences of a change to the number of shares outstanding and the resulting float. Citigroup (NYSE:C) finds themselves right in the middle of this phenomenon. In a financial environment that is anticipating new mark to market accounting regulations on April 2nd, the Citigroup float is a major issue to understand. Less float means more directional velocity. If the direction for financials is heading up, the 36% stake by the U.S. government in Citigroup will put additional upside pressure on the stock. Not good for shorts, very good for the long side speculators.

It is expected that in April Citi will exchange $27.5 billion in preferred shares to common stock and the U.S. government will tender up to $25 billion of its preferred holdings into common stock. This scenario would give the government a 36% stake in the company and it would increase the number of shares outstanding from the current 5.5 billion to anywhere between 13 billion and 21 billion depending on how many investors participate. (See here.) This dilution is positive for Citi because their tangible common equity will rise to approx. $81 billion, up from $30 billion at the beginning of 2009.

With all of this dilution Citi is at risk of becoming a stock that is virtually impossible to move because of the ridiculous amount of shares outstanding. However, this week the company announced they will be seeking shareholder and government approval to do a reverse split with a range anywhere from 1-for-2 to 1-for-30. This move makes a lot of sense for Citi. It’s looking like they may end up with a total number of shares outstanding below the current 5.5 billion, it could end up lower than 1 billion and the government would have a 36% stake.

Until now, most have viewed the government stake as a negative for the stock but that perception might change quickly. A float of less than 1 billion with 36% of it stable. The government won’t be selling, and most other investors who have ridden this stock down to its depths won’t be selling either. It is conceivable that 80% of the shares outstanding won’t be sold in the near term which leaves only a 20% float for investors to buy and sell. Many firms try to manipulate their stock price by restricting the percentage of tradable float. According to a research report release by Robin Greenwod of Harvard Business School, “prices rise when the float is contracted and fall when the float is released.”

For a current example just look at the price action of Sears (NASDAQ:SHLD). CEO Eddie Lampert has been buying back shares for years and has dramatically reduced the available float. As a result, Sears has been able to keep its stock up near $40 a share even though most on Wall Street feel it should be in the single digits. Citigroup appears poised to be the next stock to experience the gift of a tight float. If financials do rise, expect Citi and also AIG (government has a 79.9% stake) to be the percentage gaining leaders because of the unintended consequences of government ownership on their price velocity.

Disclosure: Author holds a long position in C

Source: Citigroup Float May Experience Dramatic Upside Velocity