Citigroup: The Bad Boy of Finance

Citigroup has looked like an octopus in a minefield lately. The world's largest bank measured by revenues, Citigroup (symbol C) is involved in every aspect of finance you could name -- and appears to have made big mistakes in most of them. The company has booked hits to net income totaling $53.6 billion through the credit crunch so far, which is more than any other bank or broker.

But Citigroup is simply too big and spread too broadly to blow to kingdom come. So with its shares trading as if the end were nigh, is Citigroup stock too cheap to pass up?

Citigroup is a tough knot to unwind. The product of literally dozens of mergers -- most recently the 1998 megamerger of Travelers Group and Citicorp -- Citigroup's structure today is largely the product of acquisition-happy Sanford Weill, the retired chief executive. Recently, many shareholders have expressed an interest in seeing the company split up. Addressing those concerns is just one bullet point on the lengthy agenda of newbie chief executive Vikram Pandit. Pandit replaced Weill's successor, who became overwhelmed by the size of the company's problems.

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The sprawl stretches to more than 100 countries, with some 200 million different customer accounts and 300,000 employees. Operations are divided into four broad branches -- credit cards, retail banking, institutional clients and global wealth management, the latter two of which cover investment-banking functions.

The doomsayers hear ticking bombs on Citi's balance sheet. The company still has an $18-billion exposure to collateralized debt obligations -- those complex debt instruments that no one really knows how to value, but that Merrill Lynch was recently selling for 22 cents on the dollar. Citigroup has already been forced to take major write-offs on CDO holdings as the instruments, which are often but not exclusively backed by subprime mortgages, are downgraded by ratings agencies.

In addition to the alphabet soup, Citigroup has a $4.3-billion exposure to subprime mortgages through mortgage-backed securities, and another $22 billion on its books in direct subprime lending. Meanwhile, the credit-card business, which contributed almost one-third of Citigroup's $18.7 billion in revenues in the second quarter, grows more precarious by the day.

The Pollyannas say Citi is covered against the unexpected, and then some. Its ratio of cash reserves to outstanding loans of 2.93% is well above the average of 1.85%. And its Tier 1 capital ratio, which is the figure regulators examine to gauge a bank's ability to cover losses, is 8.70%. That's more than the average bank's 8.61% ratio, and it looks almost excessively cautious next to the 6% ratio that regulators require.

By conventional measures the stock is undisputedly cheap. At its September 3 closing price of $19.61, Citigroup stock is down 59% from its 52-week high of $48.37, which it struck in September 2007. Short of a miracle, the company will post a per-share loss for 2008, but on average analysts expect it to earn $2.31 in 2009, which would give the stock a price-earnings ratio of just 8. And Citigroup trades below its $20-per-share book value, defined as assets minus liabilities, which is an accounting measure for a company's theoretical liquidation value.

The trouble is, none of those numbers matters a whit if the company continues to fall apart. Citigroup's book value has shrunk since the end of 2006, when it was $24 a share. And the company has posted a net loss in each of the past three quarters, though the amount of the loss has declined from $1.99 per share in the fourth quarter of 2007 to $0.54 per share in the second quarter of 2008. Two of the company's four segments lost money in the second quarter.

Some bulls say that the write-downs are just masking the company's persevering profitability. "There's a basic earnings power under the company right now of almost $3 a share," says Bob Olstein, chief investment officer of the Olstein funds. Olstein is aggressively bullish on the stock. He thinks it deserves a P/E of 11, which suggests a share price of $33 today. "This is a rare opportunity to invest in a big company that's gone astray, but that's on the right side of being fixed."

Others say that, growth aside, the company is trading below its rock-bottom value. "Citigroup is the cheapest stock I've seen in 20 years," says Ladenburg Thalmann analyst Dick Bove, a seasoned financial-sector expert. He prefers to value shaky banks on the basis of deposits, which are hard for companies to manipulate. He figures banks are worth at least 15% of their deposits, by which measure Citigroup is trading right around its bare-bones value.

So to go back to the beginning: Is Citi too cheap to pass up? At some point, yes, but possibly not yet. Citigroup will likely trade in line with the other troubled money-center banks and investment banks. Their fates still hinge largely on home prices and any new turns the credit crunch takes, and the rate of home-price declines has been shrinking all year. However, both Olstein and Bove say that if home prices drop a further 10%, then their estimates will prove to have overvalued the company. Alas, one thing that seems certain is that wherever the financial sector next gets in trouble, the sector's bad boy will already be there.