Expect Some Citi Fireworks

Note to self: Citigroup (C) market cap calculation doesn’t reflect the upcoming increase in float due to the conversion of various preferreds. This means that pure indexers are way underweight in the stock, by a factor of 4. Expect some fireworks when the convert becomes effective.

At $3.77, market cap is $20.645 billion and C’s S&P500 weight is 0.26, should move up to 1.00 approximately.

Disclosure: Long C

Comments

[esotérico:]

can you give a bit more of an explanation for us non-experts. It would be greatly appreciated.
does the increase in weight mean the stock will almost quadruple? being that 1.00/.26=~4. I think a double, though wishful for us owners will happen within the next three months.
Also, has there been been any word of when the convert will happen?

do you think the conversion has been priced into the stock? or will there be an unreasonable drop of more than 20% ?

May 20 10:09 AM

[Axeman:]

Is that fireworks in a good way or a bad way? I can't tell if you mean that indexers have not priced in the preferred convertibles which would cause the price per share to fall or if you are saying that even with share dilution Citi is undervalued.

May 20 10:12 AM

[Mr. Stupid:]

Kommer, you need to explain your rationale on "FIRE WORKS." I mean is this a good or bad thing for us unsophisticated investors?

That is if you want readers to have interest in your post.

Frank

May 20 10:36 AM

[jge3:]

The price per share drops with the increase(float) in the total number of shares available to be traded.

May 20 11:26 AM

[jayswoc:]

Please elaborate on your article.
Should one invest long or short term or just stay away from this stock.

May 20 11:48 AM

[tjr:]

earnings per share, I always thought that this was based on fully deluted shares or shares after preferred was converted to common, so if that is the case would not preferred converted to common cause the stock to rise, could somebody explain

May 20 02:34 PM

[andruomail:]

I think he's saying that index funds will be forced to buy C shares to give them equal weight in their basket of the S&P500. Seems kind of backwards though to say they'll go up because there's more shares out. Wouldn't that happen every time an S&P500 company issues stock?

May 20 02:50 PM

[Fd:]

You're right, he is saying that index funds will be forced to buy C shares.I think not to make it equal weight but because the index is value weighted (by market cap). Since the conversion will make the stock increase market cap 4 times compared to currently, those matching the index (many mutual funds etc must do so) are forced into increasing their position, as close as possible to the time the market cap change occurs.
IMO, this will have an effect like short-covering - short term but strongly positive.

May 20 11:56 PM

[ETFnerd:]

Mr. Kommer is arguing that the market cap weight in indexes will quadruple with the preferred conversion. Assuming that the valuation of all other index components is constant, that would mean that the equity market cap of C would quadruple witht he preferred conversion.

Although it can be argued that not having to pay the preferred dividend may be beneficial to C, I don't see how that makes C 4x times more valuable on day one. Also the increased float will dilute the equity shares putting downward pressure on the price of the stock.

This is probably the worst analysis I have ever seen on seeking alpha. Why is this article so popular?

May 21 10:03 AM

[long roh:]

Note to self: anticipated index effect (and dilution) already priced into the market, because none of this is a secret.

May 21 12:00 PM

[homeschooled:]

Note to sef:
The writer is long c and uses code as not to later appear wrong

May 21 02:02 PM

[Poor Dude:]

The dilution is known and already priced in, but the index funds haven't yet had to adjust their holdings because the conversion hasn't yet happened. When it happens (early in June, last I heard), they will then be forced to adjust their weightings. And yes, the price of Citi could easily quadruple within a few weeks after the conversion. (And possibly go up even more, as the last shorts are forced out and that whole "momentum" thing gets started.)

It's an interesting point, and one which hadn't occurred to me. Thanks!

May 21 02:09 PM

[ETFnerd:]

I'm going to put my 401K contribution in on the 26th, but the index funds haven't yet had to adjust their holdings because my $200 contribution hasn't been sent yet. For a penny stock like C, I guess that will have at least a 300% effect on the stock price. Gotta make sure I load up on C. ;-)


On May 21 02:09 PM Poor Dude wrote:

> The dilution is known and already priced in, but the index funds
> haven't yet had to adjust their holdings because the conversion hasn't
> yet happened. When it happens (early in June, last I heard), they
> will then be forced to adjust their weightings. And yes, the price
> of Citi could easily quadruple within a few weeks after the conversion.
> (And possibly go up even more, as the last shorts are forced out
> and that whole "momentum" thing gets started.)
>
> It's an interesting point, and one which hadn't occurred to me. Thanks!

May 21 03:17 PM

[Poor Dude:]

Actually, after thinking about it, I need to correct my initial post. Just because the index-weighted funds need to increase their C holdings by a factor of 4 doesn't mean that C's price will automatically go up by a factor of 4. It depends on what percentage of the total available shares are currently held by weighted funds. If they hold only 10 percent of all C stock, then they'll only have to increase their holdings by 30 percent of the total pre-conversion float. And upon conversion, there will be a LOT of new shares issued. So the net effect could easily be a downwards correction (300 percent new shares available, with index-weighted funds only required to buy some small portion of those new shares).

Whether the price goes up or down will really depend on whether those "new" shares are available to the marketplace or not. Our government has indicated that it will take delivery of its shares in certificate form, meaning they won't be available to the marketplace. If the other convertees (is that a word?) all do the same, then the price could easily jump by a factor of 4 or more. I've been told that prices are driven primarily by marginal supply and short-term demand, since most shares are "locked up" at any given point in time and all the trading is done with a small percentage of the total shares.

But if all the new shares get immediately dumped onto the market to be sold, it could put significant downwards pressure on the stock price (although I doubt that many - if any - of those shares would be willingly sold at less than the $3.25 conversion price).

So I'm sort of thinking that $3.25 is a pretty solid floor for C stock in the near to intermediate term. And if the folks getting all those new common shares in exchange for their preferred shares are smart, they'll sit on them and let the market try to figure out how to value C stock when far less than 25 percent of the total shares are available for sale and lots of people MUST buy up to 30 percent of them or more (in addition to the growing numbers of people who already think they represent a bargain and want some but aren't "required" to buy them).

But I'm usually wrong whenever I try to guess where a stock price is going. We'll just have to wait and see what happens, I guess. But it could well get interesting. Maybe "fireworks" understates the show we're about to see!

:)

Disclosure: I've been long C since it fell below $40, digging my hole deeper and deeper as we went along.

May 21 10:33 PM

[long roh:]

Index funds deal with this phenomenon all the time (additions to the index, the annual Russell shuffling, etc.) There are games that go on with hedge funds and indexers around those events, and this will be no different. Indexers can buy early or buy late if they think it will benefit them -- a little tracking error is tolerable. There is no safe or clear way for a little guy to play it, especially with hedges and other banks pushing much bigger dollars around, not to mention the potential for massive dilution.

May 22 04:34 PM

[Dr. Rushin:]

Converting preferred into common will bailout shorts: the ratio will drop from the current 20% to 5%. If they decide to cover their short positions, it will barely affect the share price. It is ironic that the government is helping to bailout financial speculators, whom president Obama is blasting. There is a much better solution for everybody (except for shorts): check www.gameofbeads.com/Ci...

May 28 10:07 PM

[happyhat:]

it's amazing to me that blogs are always wrong......The whole thing will even itself out and the price for C will inevitably be dictated by whether or not the company can make money .... as always

Jun 01 12:49 PM