Why Is Citi Selling Phibro for Less Than One Year's Net Earnings?

Well, Citigroup (C) just did. According to a report by Tracy Alloway at ft.com (here), Citi is selling its profitable Phibro trading unit to Occidental Petroleum (OXY) for as little as $250 million. That is the amount specified in an OXY press release (here). Phibro net earnings have averaged $372 million per year over the past five years.

A report by Richard Bove, analyst for Rochdale Securities and quoted by Tracy, indicates that the official announcement by OXY may be low on price as “private sources” are saying the price will actually be $450 million. Even at that price, isn’t a pay-back before taxes in less than 15 months a pretty good deal for the buyer?

The obvious question is not why would OXY be a willing buyer, but why would Citi be a willing seller. One might speculate that Citi is selling to avoid the embarrassment caused by the high earnings of Phibro staff, mainly head trader Andrew Hall, whose contract specified $100 million in compensation in 2008, based on performance.

According to Felix Salmon at Reuters back in April (here), companies with substantial government ownership simply can not pay super large bonuses, even if they are earned. Felix said it was obvious that Phibro would have to be sold.

But couldn’t Citi have gotten more, maybe three or four times earnings? Perhaps, but one must question the timing. Maybe Citi needed to make the deal to avoid legal action by Hall for breach of contract. Perhaps the discrepancy between the $250 million and $450 million figures is simply the total of 2008 and anticipated 2009 performance based earnings of Phibro staff. Citi may have been in a legal bind, between a Washington rock and a contractual hard place. If OXY will officially pay $250 million for the asset and assume the $200 million contractual obligation, the hard place disappears.

And, of course, as pointed out in a previous article (here), Citi is in a position where they need to sell assets to raise capital to offset balance sheet losses coming through to earnings reports. For the five quarters starting with 2Q/2008 through 2Q/2009, C had operating losses of more than $22 billion after receipts for sale of operating assets were subtracted. If this sale does bring another $450 million to GAAP earnings, that is another motivator. It would take five quarters to realize that through accumulating earnings.

Comments

[lower98th:]

Do we know, generally, how those earnings have been produced, and if the possible regulatory changes will make it difficult to realize the same returns going forward?

Oct 13 08:18 AM

[tripleblack:]

I just put OXY on my potential "buy" list.

Oct 13 08:19 AM

[Formyx:]

The question is what OXY really buys. If they simply takeover a proprietary trading team then a valuation of 10% of assets is not cheap. Therefore, the crux is of whether there are any hard assets or otherwise that they buy. All the numbers sloshing in the press fail to provide this information as well as of how much capital they tied up to produce the profits. In typical Salomon fashion their trading desks always advertised profits than returns. has anyone seen the details of the assets to be transferred?

Oct 13 08:44 AM

[Angry Banker:]

Formyx has nailed the key question. While Phibro may have produced megabucks in profits, if it tied up many multiples of those amounts in capital, then the capital costs may not have been acceptable for Citigroup in the new reality of high priced capital.


On Oct 13 08:44 AM Formyx wrote:

> The question is what OXY really buys. If they simply takeover a proprietary
> trading team then a valuation of 10% of assets is not cheap. Therefore,
> the crux is of whether there are any hard assets or otherwise that
> they buy. All the numbers sloshing in the press fail to provide this
> information as well as of how much capital they tied up to produce
> the profits. In typical Salomon fashion their trading desks always
> advertised profits than returns. has anyone seen the details of the
> assets to be transferred?

Oct 13 09:18 AM

[Graham and ...:]

Phibro was the unit that contained Andrew Hall and his $100 million bonus, right? If so, Citi may really have been trying to get rid of this (and a bunch of other, related, liabilities). In that case, the "true" sales prices is the $250 million proceeds (not much), PLUS savings on other liabilities (probably, lots).

Oct 13 10:01 AM

[Alan Young:]

Another thumbs-up for Formyx. But my first question would be, what is an oil-drilling company doing trying to run a financial trading company?

Oct 13 01:18 PM

[John Lounsbury:]

Alan - - -

Phibro is an energy futures trader, so it fits in OXY's business nicely.

On Oct 13 01:18 PM Alan Young wrote:

> Another thumbs-up for Formyx. But my first question would be, what
> is an oil-drilling company doing trying to run a financial trading
> company?

Oct 13 08:40 PM