Angry Banker's  Instablog

Richard Bove, a prominent banking analyst who obviously has a warm place in his heart for Citigroup, has initiated coverage on the company with a Buy recommendation and a price target of $4.00 per share. Never mind that C hit $4.50 just a few weeks ago; it is hovering around $3.00 now, so getting back to $4.00 in the next 12 months would be a substantial return on your investment if you buy the shares now.

While I always read analyst reports with a grain of salt (make that a bucket full of salt), in his latest research, there are some very important points that Mr. Bove makes which do a great job of explaining why the U.S. government has continued to prop up Citigroup, despite the public furor about mismanagement, irresponsible lending practices, and fat-cat executives that continued to draw huge paychecks even as the company’s performance and stock price floundered over the past several years.

Below are some highlights from Mr. Bove’s June 19th report (emphasis added by me):
 

• Some companies have developed such unique positions that their elimination would cause harm to their customers.

• I believe Citigroup is such an organization. Despite 10 years of almost continuous mismanagement, the company retains its position as the only truly international bank in the world. It does business in 140 countries and is on the ground in over 100. It offers a full array of banking services wherever it functions.

• Its payment services activities cannot be matched in this regard. The services it provides to the wealthy and powerful in all countries are also unique. Citigroup can move funds out of a failing country into dollars and the United States almost instantaneously.

• If Citigroup were not there, it would take decades to replace the company. Very few organizations ever reach a status whereby they simply cannot be replicated easily, or perhaps, ever. Citigroup is in that position.

What Mr. Bove is trying to point out here is that there is a lot more to Citigroup than what we typically hear about in the U.S. media. Citigroup is much broader than a mere U.S. lender that plunged too deep into the subprime mortgage market.

The company has numerous business lines that provide extremely valuable services to consumer, corporate and sovereign clients all over the world. To get a feel for Citigroup’s reach and connectivity with markets all over the world, spend a few minutes perusing their “business specific press releases” at www.citigroup.com. Every week, there are literally dozens of concrete examples of how Citigroup’s presence in local markets worldwide is vital to those geographies. 

As an example, take Citigroup’s “Global Transaction Services” division. This business basically facilitates payment processing between governments, corporations and individuals globally. The unit has 65,000 clients, including the United States and other major governments worldwide. The division processes trillions of dollars in transactions every single day, earning incredible and sustainable fee income for the parent company on every transaction.  With Citigroup’s physical presence in over 100 countries, Citigroup is the only provider that can meet the transaction processing needs of many governments, multinational companies, and other institutions (to understand Citigroup’s dominance in this field, you may be interested to know that the next most global bank is J.P. Morgan with a presence in only about 30 countries).

If Citigroup were allowed to fail, resulting in even minor disruptions in the transaction services operations, it could cause major problems for the clients they serve. Since those clients include governments and companies that many of us deal with every day, it would in fact hurt us as consumers if Citigroup could not deliver these services smoothly.

But herein lies the rub. Because Citigroup is so important to the smooth functioning of the global economy, if it were to fail, then the whole world’s financial system would be at risk.

The overly simplistic solution that has been proferred so many times it has become tiresome is that Citigroup should be “broken up”. And often they say “…broken up immediately”.  Well guess what, that is what is actually already happening.

Of course, Citigroup has not come out and publicly announced it is breaking itself up.  That would cause panic in the employee ranks and mass confusion in the investor community.

But in reality, what do you think they have been doing now for the last three years? Just on the surface, they have shed Travelers Insurance, Smith Barney, Nikko Cordial Securities, Germany Retail Operations, data processing subsidiaries in multiple geographies and dozens of other businesses globally. Further, their “Citi Holdings” portfolio includes other significant businesses like CitiMortgage, Primerica and Citifinancial. These are apparently on the chopping block in the near future as well.

When all is said and done, Citi will be a leaner more focused company and the remaining businesses will be powerful generators of clean dependable revenue.

But it's important to recognize that the remaining company will also still be systemically important and thus too important to let fail.  What will be needed then to keep a leash on this future Citigroup is a more well-educated regulator that truly understands the products and services Citigroup offers, and that employs real risk management professionals who can truly understand the risks associated with new initiatives. This regulator should not be charged with “breaking up” Citigroup if it gets "too big," but instead the regulator should ensure Citigroup stays focused on its core operations and that it does not start expanding again into non-core operations and complex financial products that have the potential of destroying the all-important core businesses when the fancy new products breach their risk profiles.

The future Citigroup, operating in the paradigm I have described above, will then provide tremendous value for shareholders.  I currently only own a few thousand shares of C. But at $3.00 each, with a clear line-of-sight to the future business model and the explicit support of the U.S. government, I think the current share price is a bargain and I intend to load up before its too late.

Disclosure: Long C, XLF