Citigroup Inc. (C) has finally arrived in the Chinese capital markets. In a statement, Citi said that it has launched a joint venture with Shanghai-based Orient Securities. The joint venture will be named Citi Orient Securities. It has a registered capital of $126 million (800 million yuan) with Citi holding a 33.3% stake in the venture. This is the regulatory ceiling for a foreign firm's stake in the investment banking business in China. Going forward, Citi has mentioned that it could increase its stake in the venture, although this will still be subject to regulatory approval.
Stephen Bird, Citi's Chief Executive in the Asia Pacific region, said that the newly launched entity will engage in mergers and acquisitions deals, as well as underwriting transactions. The entity will focus on industries such as energy, automobile and entertainment. I believe that these are sunrise industries for the Chinese capital markets. Although most deals are in the property sector, the relatively under-served niche consumer markets like automobile and entertainment should drive the deal flows in the coming years.
This also appears to be a strategic move for Citi to enter into the deeply regulated Chinese capital market. Orient Securities is a long-time player in the industry, having been established in 1998. It operates around 60 securities branches. Its business includes securities underwriting, brokerage services, securities trading, asset management and commodities future across China. Given the Chinese bureaucratic style of management, the joint venture is well positioned to win government bids in various sectors. On the other hand, this is also good for Orient Securities to move into global finance. It seems like a give-and-take situation. The venture will capitalize on Orient's deep local network and Citi's global network, expertise and client base.
Joining the Chinese Bandwagon
Citi's move keeps it in line with rivals UBS (UBS), Goldman Sachs (GS), and Morgan Stanley (MS). These companies have set up a similar investment banking ventures in China in the past few years. In fact, there are reports that China will initiate reforms to spur smaller brokerages into future global investment banks to compete with the likes of Goldman Sachs and Morgan Stanley. Based on the article, China Securities Regulatory Commission will allow domestic brokerages to expand their business from trading stocks and underwriting securities to asset management, private banking and equity. At present, the smaller Chinese players have yet to compete head on with these US investment banking firms. This means that Citi's foray into the Chinese capital market is very timely. I also view this as an admission from the Chinese regulators that it is indeed difficult to compete with American investment banking giants with strong financial muscle and deep networks.
Even with the recent bullish comments from industry pundits, the Chinese capital is still not fully developed. Given the uncertainties surrounding the global markets and China's tight monetary policy, the dollar value of initial public offerings have declined last year. In 2011, 282 companies went public in China and raised $45.3 billion in new equity funds. In contrast, 347 companies raised $76.3 billion in 2010. The silver lining is that private equity is seen as emerging key driver to the capital market of China. Private equity fund raising reached a record high in 2011 - at $44.1 billion in investments. Pundits are comparing China's capital markets as the 1970s US capital markets where sources of capital raising were scarce. We all know what happened in the 1980s US markets. China is going through a similar phase at this point in time.
Citi divides its businesses based on its clients: Global Consumer Banking, Institutional Clients Group and Citi Holdings. Given that most of its clients will be corporations, the entity will be under Institutional Client Groups. From 2009, the segment revenue for the group declined from $36 billion to $31 billion. This also resulted in lower operating income of the segment at $12.9 billion in 2009 to $14 billion in 2011. The reason for the decline has been lower transactions due to the uncertainties surrounding the global economy. The segment is an important driver of the bank's growth, as it accounts for 40% of its total revenue.
The bank's topline growth has been anemic for the last 5 years, declining to 0.21% a year. However, the last three years have been stellar for the bank - with growth of 15%. This translates to operating margins of 15% to 18% during the period. These figures are still below the operating margins of 28% to 38% in 2002 to 2005. Moving forward, Citi should be able to gain its foothold in the global finance scene. In my view, the move into China will be one of the key drivers to regain its international leadership.
Goldman Sach's investment banking revenues have also declined. Net revenues from investment banking reached $4.3 billion in 2011, slightly lower than its revenues of $4.9 billion in 2009. For the last three years, its topline growth is at 8.78%. However, its margins are higher at 20% to 30% for the said period. Meanwhile, Morgan Stanley's revenues have increased by 9% for the last three years. Operating margins have improved to 18% in 2011 coming from 3% in 2009. Based on its annual report, investment banking revenues reached $4.2 billion in 2011, but lower than its previous year's revenues of $5 billion.
I believe that this trend will continue in the succeeding quarters, given the lack of confidence in the capital markets. I also believe that this is the best time to make resources work so that these banks will reap the rewards once the environment normalizes. Moving into a big underdeveloped capital market like China is the way to go.
Citigroup remains an undervalued banking giant. It trades at 8 times earnings and 45% of its book value. It also carries a dividend yield of 0.03%. Goldman Sachs trades at 15 times earnings and 73% of its book value and JPMorgan (JPM) is valued at 8 times earnings and 77% of its book value. Separately, Morgan Stanley trades at 11 times earnings and 44% of its book value.
I believe that investors perception of Citi's bad assets is overblown. The market has clearly ignored its growth potential in the overseas markets. Investors would like to see a healthy balance sheet rather than strong profitability. Citi is strengthening its balance sheet and building channels for future growth. The market is missing the whole point.